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- Pension funds, REITs, and insurers hold more than $1.2 trillion in commercial-real-estate debt.
- CalSTRS, a California pension fund, told the FT it will be writing down its real-estate portfolio.
- "This is just the beginning" for funds, said Trepp's Manus Clancy.
Investor angst over risky commercial real estate has exploded in recent weeks with expectations that banks that hold billions of dollars in the debt are too weak to absorb any losses.
But while banks hold about half of all US commercial-real-estate debt, there are other big holders that are starting to feel the pain, especially over holdings of office properties suffering from the rise of remote or hybrid work schedules. Among them are the large pension funds, REITs, and insurance companies, together accounting for more than $1.2 trillion — or 22% — of the $5.62 trillion in total commercial-real-estate debt outstanding, according to BofA Global Research.
The holdings took on new meaning last week after the California State Teachers Retirement System, or CalSTRs, told the Financial Times it would be writing down the value of its $52 billion in real-estate holdings because higher borrowing costs on the heels of Federal Reserve interest rate hikes have sacked property values. In the office sector alone, values are likely down 20% just based on the rate move, Christopher Ailman, CalSTRS chief investment officer, told the FT.
"This is just an indication of what's to come," said Manus Clancy, a senior managing director at Trepp, a commercial-real-estate-data firm, said about the pension woes on the TreppWire podcast last week.
"This is the beginning of what will be a lot of this from the funds, from the private equity guys, from the insurance companies," Clancy said. "There will be a lot of reductions in equity values over the next couple of years, or sooner. It will be heavily tilted toward office."
As the values drop, the refinancing of some $2.5 trillion in debt over the next five years will be a tall order for landlords as they face a tightening of lending standards on top of the higher interest rates. Already, some big landlords have chosen to default, including Brookfield on $161 million in debt tied to office properties around Washington, DC, Bloomberg reported last week.
"I don't know if you've been in Washington, DC, anytime since COVID, but nobody goes to the office down there," Orest Mandzy, managing editor of Trepp's news outlet, Commercial Real Estate Direct, said on the podcast.
Some pension funds were already planning to reduce their exposures to commercial real estate even before the recent bank failures magnified the risks.
In September, fund managers at Artemis Real Estate Partners and PGIM Real Estate said at a Bisnow conference that their investors indicated they'd be reducing allocations to real estate, just because the assets had been outperforming others. Asset allocations of their investors were "out of whack," Cathy Marcus, PGIM's head of US equity, said at the conference.
CalSTRS reported double-digit returns over a 10-year period, making it a top performing asset class, according to the FT.
International investors are bracing for the worst. Some 39% of the 100 investors from 14 countries surveyed for the Q1 2023 Pulse Report by AFIRE — an association for international investors focused commercial property in the US —said they planned to reduce their US holdings at least somewhat in 2023, compared with 27% that intend to increase their positions.
There is money on the sidelines, however. With the availability and pricing of debt impeding deals, 70% of the AFIRE respondents said they anticipated "meaningful distressed acquisition opportunities as soon as the next six months."
Private lender ACORE Capital, which sources its funds from the insurance industry, is planning on stepping in as a capital provider but at a cost to owners, Warren de Haan, co-CEO and cofounder of the $21 billion lender said on an earlier Trepp podcast.