Commercial Real Estate Finance

We all learn this lesson at one point or another in our lives: Stick to what you know.  Its an age-old adage that proves true in the world of commercial real estate.  Asking a developer with a track record in retail development to build a hotel is a recipe for disaster.  Asking an office broker to underwrite an apartment complex could be similar.  But more glaring than the obvious scenarios mentioned above is the case of real estate investors, like the California Public Employees’ Retirement System. A recent Wall Street Journal article details their harrowing journey.

Calpers, like most other pension funds and many life companies who invest in commercial real estate, rank very low on the risk/reward spectrum when it comes to investing.  They are risk-averse and look for stable returns.  Why?  Mostly because the goal of their investment committees and advisers is to protect their nest egg first and foremost, and grow it modestly if they can.  In the case of insurance companies, the goal is to match future income to future liabilities.  Through a rigorous actuarial process, they can determine their expected future liabilities, and thus know what type of returns they need to achieve to meet those potential liabilities and remain solvent, if not profitable.

With pension funds, you literally have hundreds of thousands of people’s futures riding on the investment decisions that are made.  What’s worse is that the pensioners have zero control over the types of investments made, let alone the actual decisions on which properties to invest in.  Therefore, there is a lot riding on the line.  You would think then, that their risk-averse investment strategy is not only a prudent one, but an absolutely necessary one as well.

So what did they do?

During the boom years, Calpers, like many other big investors, sought profits on risky land deals and boosted its real-estate returns with increasing amounts of debt, generating annual returns as high as 30%.

That strategy had disastrous consequences when the recession hit. Calpers’s real-estate portfolio lost nearly half of its value, or more than $10 billion, from July 2008 to June 2009. Calpers’s sourced investments included those made in such high-profile deals as the Stuyvesant Town and Peter Cooper Village apartment complex in Manhattan, and a venture called LandSource, which held thousands of acres of California land.

Greed is an amazing phenomenon.  Its one thing not to sell high on a stock because you want to wait for the absolute peak, only to see it plunge before you can pull the trigger.  That is an individual decision based on your risk tolerance.  But when the guys in charge are risking huge sums of other people’s money, when their mandate is to be conservative, that is just downright irresponsible.

Sure, Joseph Dear, CIO for Calpers can blame the investment managers like BlackRock (NYSE: BLK), Jones Lang LaSalle (NYSE: JLL) and others who were managing large sums of Calpers money.  But in my opinion, the blame should lay squarely at the feet of senior executives like Joseph Dear. He should know who he;’s serving, what his mandate ought to be, and the profile of the stewards whose hands he chooses to leave billions of dollars in.

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