California Steaming


1177 ave amer property shark California SteamingIn 2006, just as the real estate market was nearing its sharp crest, California came marching into New York City.

In deal after deal, the Golden State’s two main pension funds—the California Public Employees’ Retirement System and the California State Teachers’ Retirement System, which collectively manage a mammoth $330 billion on behalf of teachers and civil servants—ramped up their previously small New York portfolio. Aggressively bidding on properties, they scooped up two midtown skyscrapers, some residential buildings and two development sites, and they were lead investors in the largest-ever sale of a single property: Stuyvesant Town-Peter Cooper Village, which was bought in a $6.3 billion deal.

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Perhaps offering a window into the funds’ larger troubles today—they are, by some estimates, being swallowed by a $425 billion shortfall for California pensions—the investments are a spectacular lesson in poor timing, and have left a legacy of distressed assets on the New York skyline.

A Calstrs New York real estate fund is among the sorriest in its core domestic portfolio; the $600 million the funds put up to buy Stuy Town has vaporized, with no return expected. Two development sites in Lower Manhattan and in Harlem, where a hotel and an office tower were once envisioned, now sit stalled. A midtown skyscraper is headed toward default, and another has seen vacancies jump as rents fall.

Of course, most every investor who played the New York game at the end of the last cycle lost money. But the California funds were an extraordinary case, as they used their own cash to take major stakes in skyscrapers, often with few other partners.

By contrast, the bulk of the Manhattan landlords who overpaid in 2006 and 2007 kept their own money in their pockets, leveraging huge amounts of debt with small bits of personal equity. And many of those landlords had bought successful properties during safer times to fall back on.

Calpers and Calstrs had limited New York experience, having invested in only two successful projects of note: the Time Warner Center and 120 Broadway.


A KEY FIGURE in California’s New York tale is Larry Silverstein, the 78-year-old developer of the World Trade Center. Calstrs decided it wanted more New York real estate in its portfolio, and, as pension funds often do, it forged a tie with a local landlord, starting a fund called Metro Fund LLC. Funded chiefly by Calstrs, it was to have $2 billion in buying power. Mr. Silverstein would take that money and invest it, hoping for returns of his own.

And so he did. In the summer of 2006, Metro Fund spent $416 million on a 35-story, glass-and-aluminum-clad skyscraper at 575 Lexington Avenue, between 51st and 52nd streets, at the center of Manhattan’s—America’s—prime business district.

That December, the fund purchased Moody’s old headquarters, a 13-story, 441,000-square-foot building at 99 Church Street, for $170 million, then tore it down with the hope of building a Robert A.M. Stern-designed, 80-story, 912-foot tower with condos and a Four Seasons hotel. It was to open in 2011.

And in late 2007, as the credit crisis was first making its presence felt, the fund bought the soaring, 50-story skyscraper at 1177 Sixth Avenue, between 45th and 46th streets in Times Square, for $1 billion, or $1,000 per square foot.

In the deals, Mr. Silverstein took the lead, and those on the other side of the transaction didn’t deal with Calstrs at all.

Multiple executives involved on the sellers’ side said they were intrigued as to why Mr. Silverstein, with so much else going on, was interested in buying so many office buildings. “It didn’t even make sense to me why a guy who had so much else on his plate would bother with this,” said one executive.

Of course, he did not have much of his own money in the deal. In at least two of these deals, as is common in similar pension-fund arrangements, Mr. Silverstein put in 3 percent of his own money, with much or all of the rest coming from Calstrs, according to mortgage documents and executives involved with a sale.

And now, the deals are going sour.

The latest Calstrs real estate performance report, with values and returns through September, lists Metro Fund as among the worst-performing funds in its domestic core portfolio, with a rate of return of negative 82 percent since its inception. (This stat is likely skewed by the inclusion of the development site at 99 Church, which is sitting vacant with no revenue coming in.)

The high sales prices paid by the fund assumed rents would continue to soar, and the buildings now cannot cover their mortgage payments.

In March, the loan on the 2006 purchase of the skyscraper at 575 Lexington was sent into special servicing for a potential restructuring. Mortgage documents filed with the S.E.C. indicate that the assumptions underlying the Bank of America loan for $325 million were highly ambitious. Though the income for the tower was only $9.8 million in 2005, the year before it traded hands, Mr. Silverstein and Calstrs expected it to grow to $21.6 million by the loan’s maturity, in October 2013, if not before. According to research firm Real Capital Analytics, “The building is in danger of imminent default.”

The development site at 99 Church, once an office building with rent coming in, is now rent-less, as Mr. Silverstein searches for financing in a very rough market for hotels.

At the 1177 Avenue of the Americas tower, the loan is current. But vacancy is up to more than 25 percent from less than 5 percent, according to the database CoStar.

In a statement, Silverstein spokesman Dara McQuillan defended the venture with Calstrs, noting that the fund has signed a number of new leases and suggesting that it is looking to stay for the long term.

“Our investment strategy, as reflected by our Metro Fund activities, is to acquire strong assets, make substantial improvements, and manage them for long-term success,” he said. “Since acquiring these properties with Calstrs in 2006 and 2007—and despite the economic downturn—we have successfully leased more than 360,000 square feet and raised occupancy levels in each building. New York remains a great place to own and manage commercial real estate, and we remain bullish on the fund’s long-term prospects.”

Calpers had a similar experience, although its was far more concentrated, in the one disastrous purchase of Stuyvesant Town, led by Jerry and Rob Speyer’s Tishman Speyer. The fund was the single largest investor there, putting in $500 million (Calstrs separately put in $100 million); it once expected rents would rise year after year, as rent-stabilized apartments were rapidly converted to market-rate apartments. Some estimates put the property’s value at less than $2 billion based on current income, and the equity partners are expecting a full loss.

Through a fund run by MacFarlane Partners-which has now resigned as fund manager, amid criticism-Calpers bought a stake in a prominent development site on 125th Street, next to the Metro North stop, for more than $55 million in 2006. A plan for a Major League Baseball-anchored tower, developed by Steve Roth’s Vornado Realty Trust, fell apart in 2008, and the fund’s stake-60 percent, according to a tax break application filed with the city-is now worth a fraction of what it once was, with no development publicly planned.


NEW YORK WAS was by no means the only place the California funds ran into trouble, due to the unfortunate strategy of pouring money into real estate nationally-and outperforming similar funds at the time-in the last years of the boom. In 2005 and 2006, Calpers put more than $26 billion into real estate, with most of the investment considered risky; in the prior two years, it invested about $8 billion in real estate. Calstrs pursued a similar approach.

As of its latest performance reports, Calpers posted one-year returns of negative 48 percent on its real estate portfolio, worse than other similar funds (pension funds often endeavor for an 8 percent return). Calstrs showed returns of negative 43 percent.

Both funds are now reviewing and restructuring their real estate investment policies, along with changing some investment advisers. As for their future in New York, time will tell whether the funds will be willing to put in more money in order to save their properties from foreclosure, should they indeed continue down that route.

A spokesman for Calpers, Clark McKinley, said in a statement that the fund is evaluating its relationships with managers, and may end some partnerships. “Calpers is in a major restructuring mode, reducing risk and leverage,” he said. “We have adopted new policies and have new leadership since the Peter Cooper investment.”

A spokesman for Calstrs declined to comment. California’s governor, though, summed it up rather ominously-and accurately. “In California, we had the Internet bubble, then the housing bubble,” Arnold Schwarzenegger said on April 14, in one of his weekly messages to the state. “Next is the pension bubble. And it’s starting to burst.”, 

Editor’s note: This story reflects corrections made on May 14.