Commercial-property meltdown clobbers pension funds

Canada’s national pension plan said in May that it is selling stakes in Manhattan and San Francisco office towers for $225 million less than it paid for them. In April, California’s government worker pension fund said that it had unloaded a Sacramento property it had been trying to develop for almost two decades. In March, consultants warned California’s teacher pension that office holdings would continue to drag down returns, even after a 9% real estate loss in 2023.

The moves offer a new glimpse into the widespread and slow-moving commercial real estate slump. Because those investments generally don’t trade on public markets like stocks, there isn’t an agreed upon price. When the market shifts, it can take months or years for managers to adjust the value of their holdings.

Now, two years after rates started rising and four years after Covid-19 hit, the impact of those events is spreading from U.S. banks with trillions of dollars of property loans and investments on their books to the retirement savings of teachers and firefighters.

Canada’s pension plan, which ended its fiscal year in March, said that real estate returns over the past five years have amounted to less than 1% annually. Large U.S. public pension funds, meanwhile, reported their first annual real estate loss since the Covid-19 pandemic, returning negative 6% for the 12 months ended Dec. 31, according to Wilshire Trust Universe Comparison Service.

Many pension-fund managers fear the storm isn’t over, said Wilshire managing director Shawn Quinn.

“Folks are allocating less dollars, trying to understand what they have in their portfolio," Quinn said. “Institutional investors are not quite sure if we’ve hit the bottom yet."

Offices will continue to drag down returns in the $333 billion California State Teachers’ Retirement System’s real-estate portfolio, Taylor Mammen of RCLCO Fund Advisors told board members at a March meeting. Traditional office space makes up about 18% of Calstrs’s roughly $48 billion in property holdings.

RCLCO attributed Calstrs’s 9% real estate loss for the 12 months ending in December in large part to higher interest rates driving down property values. Mammen said that reset could eventually leave pension managers with some attractive real-estate investment options, outside of offices.

“Most of the industry and really Calstrs included have spent much more time over the past 12 months playing defense," he said.

Pensions, like sovereign-wealth funds, university endowments and family offices, generally either buy properties outright or invest through private fund managers. Some analysts and pension advisers suspect those managers are themselves slow to report losses. Share prices of publicly traded real-estate investment trusts have generally fallen much further than private marks.

But pension funds to date have reported even less strain than private managers. Privately managed funds tracked by the National Council of Real Estate Investment Fiduciaries reported a negative 12% return in 2023, double the loss pension funds booked. The tracked funds hold a mix of apartment, industrial, retail and office properties. Pension officials often factor in private fund marks on a one-quarter lag because they take longer to arrive than stock and bond valuations.

The board overseeing Canada’s $461 billion national pension plan is shifting the focus of new real-estate investment away from bricks-and-mortar buildings and toward infrastructure such as highways and energy, according to its annual report published in May.

The Canada Pension Plan Investment Board said in the report that it had sold its stake in a downtown San Francisco office tower that once housed Uber’s offices for $44 million. CPPIB bought the stake in 2014 for $219 million. And the fund said that it signed an agreement in March to sell its stake in a building at 10 East 53rd Street in Manhattan for $7 million, after buying it in 2012 for $57 million.

The $493 billion California Public Employees’ Retirement System, meanwhile, is hanging on to a nearby Manhattan office tower, the AXA Equitable Center at 787 Seventh Avenue. A February analysis by KBRA estimated the building’s value at $917 million, down 12% from the firm’s estimate when Calpers purchased it in 2016.

Many properties have been sitting in pension-fund portfolios for a decade or more. In the years leading up to the Covid-19 pandemic, U.S. retirement funds leaned into riskier real estate deals as they strained to make up for funding shortfalls in an era of low rates.

Other property purchases were made before the 2008-09 financial crisis when many pensions were flush and pension boards were often eager to cheer on local economic development projects. As of June 2023, Calpers had 41% of its $69 billion real assets portfolio invested in California, a bigger share than any other type of investment.

One property in particular has inspired years of hand-wringing. In the early 2000s, Calpers embarked on a plan to build twin 53-story condominium towers on a block-long parcel in its hometown of Sacramento. Financing fell through in 2007.

A decade later, Calpers’ board approved new plans for the site: an office-condominium-retail complex that would be Sacramento’s tallest tower. But not enough office tenants were ever found and a new investment chief scrapped the plan shortly before the pandemic struck.

In total, Calpers invested $87 million in the parcel, a spokesman said. Then, in April, the pension fund said that it had sold the land for $17 million to the Shingle Springs Band of Miwok Indians of Placerville, Calif., a federally recognized tribe. The parcel is part of the group’s ancestral homeland, Shingle Springs Band Chairwoman Regina Cuellar said in a press release.

Calpers said it had shifted its real estate strategy away from more speculative not-yet-developed properties and toward more established projects that provide a stable cash yield.

Write to Heather Gillers at heather.gillers@wsj.com