CalPERS Names New Manager for its Real Estate

California Proving To Be a Bear Market for Hines

CalPERS Names New Manager for $1 Billion Real Estate Portfolio; Hines Suffers Setback In Deal To Buy 11 State Office Bldgs
By Mark Heschmeyer
January 5, 2011

The California Public Employees' Retirement System (CalPERS) has replaced Hines as manager of its National Office Partners (NOP) real estate portfolio and tapped CommonWealth Partners LLC (CWP) to take over the huge office portfolio.

The news over Hines losing NOP was tempered by the fact that CalPERS recently agreed to increase its allocation to other Hines-sponsored-fund -- notably $190 million to its Brazil fund. CalPERS also has active co-investment platforms with Hines in Asia, Latin America and Europe as well as investments in the United States through the Hines CalPERS Green Fund focusing on sustainable development.

However, the same week that CalPERS replaced Hines on its NOP portfolio, the California Supreme Court blocked the state's Department of General Services from selling a Hines joint venture 11 state office buildings.

The $998 million NOP portfolio consists of approximately 5.2 million square feet of Class A office properties in office markets across the United States including Boston, Chicago, Seattle, San Francisco, Palo Alto, Minneapolis, Salt Lake City, Austin and Denver. The value figure includes debt in addition to the fair market value of $724 million of the properties.

Hines formed National Office Partners LP in July 1998 with CalPERS to acquire, develop, lease, own and sell Class A, multi-tenant office buildings. From inception through March 2005, the initial phase of the partnership, the total amount committed was $3.4 billion

CalPERS allocates capital to NOP on an annual basis. The current phase of the partnership had total equity invested and allocated for 2010 of $309 million, and focused on pursuing core office opportunities, as well as investments in value added properties and development projects.

As with many commercial real estate investment funds, NOP's performance through the Great Recession took some major hits. In November 2007, NOP invested $95 million in a mezzanine financing position. Due to declining values in the underlying portfolio, NOP lost substantially all of its investment when it sold this position in November 2008.

In December 2006, NOP purchased three office towers in northern California. Due to deteriorating conditions in the capital and leasing markets, those assets defaulted and were subsequently foreclosed upon.

As of June 30, 2010, NOP made up 8.1% of CalPERS core real estate portfolio and was the weakest performing part of that portfolio. It had posted negative returns over the last five years and was showing an overall 2.8% return since 1998, according to CalPERS' annual report.

In September, CalPERS' real estate consultant, Pension Consulting Alliance Inc., reported that the performance in CalPERS real estate portfolio has hurt by four primary factors. After noting the significant impact the collapse of the real estate capital markets had on property valuations and the deleterious effect on rents and net operating income from general macro-economic forces, PCAI pointed to two other factors related to the exposure in the CalPERS real estate portfolio to non-stabilized assets with higher amounts of leverage.

Pension Consulting Alliance also reported that CalPERS' core portfolio was still not in compliance in the pension fund's loan-to-value policy limits. It added that CalPERS was still looking for ways to implement "a deleveraging plan" for its core portfolio.

The transfer of NOP to CWP is part of CalPERS' broad strategic realignment of its real estate program, which includes several other major moves.

Earlier this year, CalPERS shifted the North American assets of its CalEast Global Logistics LLC, valued at $1.9 billion, from LaSalle Investment Management to GI Partners, and its European industrial assets, valued at approximately $60 million, to RREEF.

It also took away management of $1 billion in multifamily investments from BlackRock Realty Advisors and gave the assignment to GID Investment Advisers LLC, an affiliate of The General Investment & Development Cos., which heretofore had managed only $75 million in multifamily assets for CalPERS.

CWP is a privately held, vertically integrated real estate investment, development and management firm based in Los Angeles, with offices across the United States. CWP has executed more than $4 billion of transactions in other CalPERS partnerships, beginning in 1998, and will be an active investor on behalf of the pension fund with a significant capital allocation for investment across the United States.

"CommonWealth Partners has done extremely well for us for over 12 years now, and we anticipate very good performance from them and the domestic office portfolio going forward," said Ted Eliopoulos, the senior investment officer who oversees more than $15 billion invested in CalPERS global real estate. "We're also excited about the opportunities we're pursuing with Hines on a global basis."

Hines received more bad news in California this week when a group of temporary justices assembled by California's Supreme Court denied the state's request to sell and leaseback 11 of the state's office buildings to a consortium led by Hines and international private equity firm Antarctica Capital Real Estate. The Hines consortium offered to pay $2.33 billion for the 7.3 million-square-foot portfolio.

The temporary Supreme Court backed up an appellate court ruling last week blocking the sale in response to a lawsuit claiming the transaction was an illegal gift of state funds to private investors.

Because the building that houses the state's Supreme Court was included in the portfolio deal, the state's seven sitting justices disqualified themselves and were replaced by seven appellate justices.