Miami Herald: Ill-fated real estate deal costs Florida $266 million

This story was published by the Miami Herald on September 6, 2009

This is the story of how the Florida board that invests public money bet $250 million on a huge Manhattan real estate deal and lost every last penny of it.

On top of the money lost, Florida paid $16 million in fees to real estate developers, bankers and Wall Street money managers who persuaded the state to make the deal.

State elected leaders with potential influence over the pension funds’ investments received campaign contributions from some of those same corporate giants. And state pension managers in the real estate unit got performance bonuses.

The big loser was the State Board of Administration, which invests more than $105 billion for 1 million current and future retirees. On the Manhattan real estate deal, its $266 million is now worth a grand total of $0.00.

How the Florida agency wound up in the ill-fated real estate deal is also a story of lessons learned, as the pension agency’s executive director, Ash Williams, put it when he informed the state’s top officials of the loss.

“We will identify mistakes made, learn our lessons and move on,” Williams said.

Between 2000 and early 2007, four SBA internal reports and a watchdog group identified problems with the real estate investment process — including a lack of risk control.

Nonetheless, the managers shifted assets into higher-risk real estate deals, often by joining private partnerships that used borrowed money.

Investing borrowed money, known as leverage, boosts returns in boom times but amplifies losses in bust times.

In August 2006, at the height of the real estate bubble, a senior acquisitions manager in the SBA’s real estate unit, Steve Spook, received two overtures to join investment firms bidding for adjoining apartment complexes in Manhattan.

The complexes — Peter Cooper Village and Stuyvesant Town — were iconic housing communities, a “city within a city” on 80 prime acres overlooking the East River. Metropolitan Life built the apartments for returning WWII veterans in the 1940s. They became an oasis for teachers, nurses and retirees on small pensions, one of the last refuges for the middle class in Manhattan.

In 2006, an average rent-controlled apartment in Peter Cooper Village went for about $1,340 a month, about 40 percent of the average rent in the surrounding area.

New York’s rent-control rules limited increases to 7.25 percent over two years, with some exceptions. Tenants could be ousted if their primary residences were elsewhere or if they illegally sublet their unit at market rates.

About a quarter of the apartments paid market rates when MetLife put the complex up for sale in August 2006.

The insurer’s whopping asking price — $5 billion — made clear that to make a profit, the buyer would have to convert most remaining rent-stabilized apartments into market-rate units. That October, MetLife announced the winning bid, an eye-popping $5.4 billion by Tishman Speyer Properties and BlackRock Realty.

The buyers put in $225 million of their own money, then passed much of the risk to others.

ENTER FLORIDA

Tishman Speyer had vast real estate holdings in South Florida in the 1980s and early ’90s and was looking to get back into the market. The company contributed $5,000 to the Florida Republican Party in 2002. Two of its executives donated the maximum $500 to the 2006 political campaign of Gov. Charlie Crist.

 BlackRock, 49 percent owned by Bank of America/Merrill Lynch, gave $500 to Chief Financial Officer Alex Sink during her 2006 campaign.

Crist and Sink, who serve as pension fund trustees, declined to be interviewed. Their aides said there was no connection between political contributions and the investment in the Peter Cooper Village venture.

BlackRock already managed more than $300 million in Florida pension money. They wanted more business.

On Jan. 9, 2007, five BlackRock executives visited Tallahassee to make their case. Among those they met with were Steve Spook; Doug Bennett, the senior investment officer in the SBA’s real estate unit; and Kevin SigRist, the deputy executive director.

A few weeks later, BlackRock sent the real estate unit a confidential document outlining the strategy for achieving double-digit returns.

The 92-page memo revealed that Tishman Speyer and BlackRock planned to weed out rent-regulated tenants and turn the units into a “market-based environment” in seven years. They would woo young, affluent renters and “position the asset for a value-maximizing sale.”

Ash Williams, who took over as the SBA’s executive director in October 2008, concedes that in hindsight, the projections may have been “overly aggressive.”

But the documents provided to the SBA show agency managers were made aware of the risks all along.

Line by line across 13 pages, the confidential memo lays out the risks — including the possibility that Tishman and BlackRock could fall short of cash to pay off debt.

“Unless net operating income from the property increases materially,” the memo said, “the partnership will not be able to meet its interest payment obligations in which event it would default.”

Spook evaluated the deal for SBA.

• The report stressed the apartment complex’s “excellent physical condition” and “competitive advantages.” But some prospective renters were turned off by the plain brick buildings that looked like a low-income public housing project.
• The report spoke of the “favorable fundamentals” in the Manhattan apartment market. But some experts were predicting a weakening market.
• The report noted the owners’ “extensive experience” in managing rent-regulated apartments. Tishman Speyer had limited experience managing multi-family rental properties. Its expertise was in office towers.

Spook’s report also highlighted “issues” with the investment, including possible cash flow problems, contaminated soil beneath the property and concerns about “liquidity,” meaning Florida could have trouble unloading the investment.

 `RISKY PROPOSITION’

On March 12, 2007, Spook recommended investing $250 million. Two weeks later, Doug Bennett concurred. In a three-paragraph memo, Bennett acknowledged that the deal could be a “risky proposition” but said Florida would benefit from increasing its New York City exposure.

 Kevin SigRist concurred with Bennett, and then-executive director Coleman Stipanovich approved the deal.

The Peter Cooper Village sale fueled a political uproar in New York City over the future of affordable middle class housing.

New York City Council member Dan Garodnick said the high selling price put pressure on the owners.

“They started sending legal notices to many perfectly legitimate longtime tenants claiming they were not using their apartment as their primary residence,” said Garodnick, himself a resident of Peter Cooper Village.

Garodnick helped tenants fight eviction and supported a lawsuit. It contended that the owners had improperly raised rents after getting special tax breaks. The tenants sought $215 million in rent they overpaid.

BlackRock and Tishman Speyer’s confidential memo to Florida’s pension fund had warned that a lawsuit could cripple the deal.

The owners said they thought the tenants’ claims were without merit. But if the residents were to prevail, the memo said, the owners would “suffer an immediate and very substantial loss of revenues and would be unable to carry out a significant part of its plan to convert rent-stabilized units to market rate.”

On June 7, 2007, with the real estate market about to head south, the SBA sank $266,780,948 into the Peter Cooper Village partnership with other investors: $250 million for the investment plus $16,780,948 in fees.

By September 2008, the investment was in deep trouble. BlackRock and Tishman Speyer were having trouble converting the rent-regulated apartments to market-rate units. Expenses were higher than expected, income, lower. The new owners were running low on cash pay their $3 billion mortgage.

On Dec. 4, 2008, at a meeting of the group that advises the Florida pension fund on investments, a member questioned why nobody at the SBA had mentioned the troubled Peter Cooper Village investment.

“I think this should have been on the agenda,” said Jim Dahl, a Jacksonville investor. “Let’s make sure we talk about ’em so we don’t repeat mistakes. This is a serious, serious problem and we almost went through the meeting without discussing it.”

`PIE-IN-THE-SKY’

Dahl said many investors thought the deal was based on “pie-in-the-sky” assumptions and was “going to have a bad ending.”

 The SBA said otherwise.

“This is a long-term investment,” SigRist said in an interview a few weeks later. “The view here is, as a long-term investor, we’re uniquely qualified to hold these investments.” He blamed problems not on inadequate vetting but on the changing financial world.

After a New York court ruled for the tenants, SBA managers exchanged e-mails and acknowledged their investment had been “wiped out.”

On July 28, Doug Bennett authorized the SBA’s director of accounting to write off the entire $266,780,948.

In a memo last month to the three trustees who oversee the SBA, Crist, Sink and Attorney General Bill McCollum, Williams blamed the loss on the recession, slow income growth and leverage.

In an interview, he deflected questions about whether the SBA needed to change policies or add checks and balances to property investment decisions.

“I don’t want to be overly sunny,” Williams said of Peter Cooper Village. But when the economy comes back, the rents could go up and the property could regain its value. “That’s what America is all about.”

Last Tuesday, Sink brought up the real estate deal at a public meeting in Tallahassee. It was the first of the quarterly meetings they ordered after a Times investigation found deceptive and misleading practices by some SBA officials.

Williams told the trustees that investors besides Florida got hurt. He said the SBA staff followed all procedures. “To the extent we had a bad experience,” he said, “that’s unfortunate; we regret it, and we’ve endeavored with all our hearts to make sure we don’t do that again and we understand how it happened.”

VALUES TUMBLED

But overall, Williams said, the agency’s real estate holdings are doing well. Worth $9.7 billion last year, their values tumbled to $7.8 billion for the fiscal year that ended June 30, 2009.

 With stocks starting to rebound, Williams emphasized the uptick in the value of the entire pension fund. It hit $138 billion in September 2007, dropped to $83 billion in March 2009 and now is up to $106 billion.

Meantime, the SBA managers are bracing for additional real estate hits, especially in their higher-risk, commercial property holdings, like hotels and office buildings. Tanking values are making it tough for their owners to refinance.

For Doug Bennett’s performance during the peak of the market in 2006-07, on top of his $135,000 annual salary, the SBA last year awarded him an $11,000 bonus.

Spook, who analyzed the Manhattan investment and last year made about $87,000, received a $7,000 bonus.

Two other real-estate employees who had a role in the investment also got bonuses last year for their work in 2006-07.

The SBA said the bonuses were reward for good performance of the entire pension fund.