California Pension Fund Writing Down $52B CRE Portfolio

The $306-billion California State Teachers’ Retirement System pension fund, known as Calstrs, is too big to call a canary in a coal mine—and that sound you’re hearing is not singing.

It’s the roar of plunging property values going over a Niagara Falls of maturing debt as interest rates turn spreads upside down. It’s so loud we can’t hear the guy in the barrel next to us, but he’s mouthing the words “soft landing.” Hi, Jay.

The Calstrs fund’s chief investment officer told the Financial Times this week he is now “bracing” for write-downs in the value of assets in the fund’s $52B property portfolio amid growing evidence that the Fed’s monetary tightening has unleashed a spiral of plunging valuations.

A retired English teacher from Rancho Cucamonga just tweeted: “he means bracing for impact.”

“Our office real estate is probably down about 20% in value, just based on the rise of interest rates,” CIO Christopher Ailman told FT. “Our real estate consultants spoke to the board last month and said that they felt that real estate was going to have a negative year or two.”

If that sounds like someone who is going to ride out the storm, it’s because CRE—which makes up an estimated 17% of Calstrs’ overall holdings—has been one of the fund’s best-performing assets, routinely generating double-digit returns over a 10-year period for the pension plan, which has more than 1 million members.

On cue, Ailman said the fund is a long-term investor and would avoid selling property assets into a falling market.

“If you have long-term leases and solid debt financing, you’ll just hold,” he told FT. “Your office portfolio has fluctuated in value before. You’ll continue to get income.”

What, you’re going to argue with someone sitting behind a $300B pile of chips? Here’s Ailman’s bet on a soft landing: “There’s an equal chance that we’re headed to a severe recession,” he said.

While there appears to be a consensus that regional banks won’t be falling like dominos, distressed office buildings have become the focal point of concern in the CRE sector. Several forecasts are projecting peak-to-trough plunges in office valuations of up to 40%—cliff dives that could drop to as much as 70% in cities like San Francisco and New York.

Because real estate assets are highly leveraged—and therefore illiquid—they generally are slow to reprice. The fire sale of assets from failed regional banks SVB and Signature is expected to speed up revaluations, GlobeSt. reported.

Ailman warns that parts of the commercial property market could “seize up” while prices adjust. “The buyers don’t want to step in until [prices] come down,” he told FT. “So, it’s an illiquid market and it’s going to be locked for a while.”

It’s not only office building owners who are finding themselves backed into a corner by loans coming due, plunging valuations, the rising cost of debt and a lending window for refinancing that’s been slammed shut.

Multifamily owners also are feeling the squeeze. As a pending wave of $1.5T in CRE loan maturities crests in the next three years—Trepp says a record $152B in CMBS backed by rental apartment buildings will expire in 2023, $940B over the next five years—many may have no option but to hand over the keys to the property.

Green Street is estimating that apartment building values are down more than 20% from their peak. At the same time, rent growth is slowing, which means some properties with large, floating-rate mortgages no longer generate enough profits to make debt payments.