Friday Letter Shunning conversion

CalPERS this week succumbed to public pressure by banning investments with managers who target rent-controlled properties for conversion to market rates. Such deals have burned the pension politically and, in the case of Stuy Town, financially. 

When Sam Zell appeared at the Urban Land Institute’s spring conference in Boston last week he warned the biggest risks facing real estate investors in the US were political ones.

The Equity Group Investments chairman may have been referring to growing government intervention in investment markets, but his comments went to the heart of an issue facing real estate fund managers today – that politics is increasingly driving the actions of some of the industry’s largest institutional investors.

That was evidenced this week, when the $201.6 billion California Public Employees’ Retirement System banned investments with GPs who employ strategies similar to those used in New York’s Stuyvesant Town and Peter Cooper Village apartment complex deal.

In that deal – and in many others in New York and across the US – fund managers snapped up rent-stabilised and rent-regulated apartments in an effort to convert them into market rate units.

Many real estate GPs have failed to convert properties at rates previously hoped for. And on top of this, some of the deals have suffered because they were done at the top of the market.

For the investors in such deals, the losses have been particularly painful. CalPERS is believed to have lost up to $600 million on two deals alone, including Tishman Speyer and BlackRock Realty’s deal for Stuy Town and Page Mill Properties’ East Palo Alto portfolio, in California.

CalPERS is not alone though. The Florida State Board of Administration is carrying its $250 million in Stuy Town at zero, the California State Teachers Retirement System has permanently written down its $100 million investment in the same deal, and the Government of Singapore Investment Corporation has written down its investment of $100 million in Stuy Town.

For CalPERS in particular, it has suffered public-relations damage as well as monetary losses. In both the Stuy Town and Page Mills deals, the pension has been vilified by tenants, community organisations, public officials and labour groups for backing investment managers who, they argue, attempt to displace low and moderate income tenants from rent-regulated and rent-controlled properties in favour of more affluent, market-rate tenants. By passively investing in funds and deals that deploy this conversion strategy, CalPERS became complicit in the “predatory” practices of its GPs, as numerous critics have dubbed the strategy.

In response, CalPERS this week agreed to ban investment strategies that “rely on or result in eliminating rent-regulated multi-family housing units, converting such units to market rate units, or raising rents above regulated levels as determined by the appropriate governing authority”.

In truth, the new CalPERS restriction may not be such a bombshell – no doubt the investors in Stuy Town are, by now, highly dubious about strategies that hinge on conversion. Not only does conversion generate bad PR, it’s really, really hard to accomplish.