Pension fund Calstrs braced for writedowns in $50bn property portfolio

One of the biggest public pension plans in the US is preparing to write down the value of its $52bn real estate portfolio in the latest sign that higher interest rates and the recent turmoil in the banking sector are causing pain in the property sector.

The $306bn California State Teachers’ Retirement System (Calstrs) has ploughed an increasing share of its assets into real estate in recent years in a bid to diversify away from stocks and bonds, and benefit from the superior returns on offer to buyers of private assets.

But the fund’s chief investment officer told the Financial Times that he was now bracing for writedowns in the value of assets in its property portfolio amid growing evidence that the Federal Reserve’s rapid monetary tightening over the past 12 months has knocked valuations in the sector.

“Office real estate is probably down about 20 per cent in value, just based on the rise of interest rates,” Christopher Ailman said. “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.”

Calstrs is not alone in its worries. State Street chief executive Ron O’Hanley told the Financial Times on Monday that the US custody bank’s biggest concern was “what happens with commercial real estate, particularly offices”.

He predicted that commercial real estate woes would contribute to a “gentle slowdown” in the US economy.

For Calstrs, the concerns about property mark a departure for one of the fund’s best-performing asset classes. Real estate had provided double-digit returns over a 10-year period for the 1mn-member plan, according to an update in March. It reported an overall 6.7 per cent loss across its entire portfolio in 2022, in a year that saw both bond and stock markets suffering heavy losses.

Real estate makes up 17 per cent of Calstrs’ overall assets. Its holdings include a $240mn investment in 300 West Sixth, a 23-storey office building in Austin, Texas, and a $1bn holding in a Blackstone European property fund.

Offices have emerged as a key worry for the global real estate market as the combined impact of rising rates, the shift to hybrid working and pressure to upgrade buildings’ energy efficiency hits landlords.

US office values could see peak-to-trough falls of about 30 per cent, according to a forecast by consultancy Capital Economics, while prices in the worst-hit cities like San Francisco could halve.

Real estate is generally slower to reprice than other assets because it is relatively illiquid. The lack of deals in recent months has given valuers less evidence for the true price of buildings.

The industry has also benefited from the broader resilience of private asset markets while publicly traded equities and bonds tumbled last year. That has sparked criticism of the private equity industry for not accurately valuing its holdings, and predictions of heavy declines as prices catch up with reality.

Ailman said parts of the commercial property market could seize up while prices adjust. “The buyers don’t want to step in until it comes down. So it’s an illiquid market and it’s going to be locked for a while.”

Worries around the sector have intensified in the wake of the crisis at Silicon Valley Bank.

Although the amount of lending against properties is broadly lower than before the 2009 financial crisis, smaller US banks have particularly high exposure. “There are still reasons why real estate could be a concern, notably through regional bank exposures,” said Kiran Raichura, deputy chief property economist at Capital Economics in a note.

Ailman said he was “cautious” on the outlook for property, in part because of the risk of a sharp downturn for the US economy. While a recent decline in inflation had bolstered his confidence that the Fed could pull off a “soft landing” — where it manages to tame inflation without inducing an economic slump — there was “an equal chance that we’re still headed to a severe recession”, he said.

Ailman said the fund was 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 said. “Your office portfolio has fluctuated in value before. You’ll continue to get income.”