The Bay Area Real Estate Journal
RREEF’s Troubles Deep Across the Bay Area
San Francisco investment manager’s troubles deepen.
Submitted September 8, 2009
RREEF, the real estate investment arm of Germany’s Deutsche Bank, is facing serious questions not only about its investment in the Sunnyvale Town Center but also its 2006 purchase of Silicon Valley’s Peery-Arrillaga portfolio for $1 billion and the potential bankruptcy filing of the fund that owns both as well as San Francisco’s Market Center at 555-575 Market Street.
Now San Francisco’s United Commercial Bank has filed a notice of default to begin foreclosure proceedings on 11 Sunnyvale parcels also controlled by RREEF, the San Francisco-based investment fund behind the faltering redevelopment of the Sunnyvale Town Center.
The lender is owed nearly $150,000 in back payments on a $21 million loan secured by the parcels, according to the filing. The properties are in downtown Sunnyvale adjacent to the Town Center and generally bounded by Taaffe Street and Capella Way. They are not the same parcels encumbered by subcontractors in multiple mechanics liens filed in recent weeks. The subcontractors also cite RREEF for failure to pay.
The default is but the latest sour development for RREEF and its America REIT III fund, which raised about $2 billion in equity from institutional and private investors starting in February 2003. The fund bought the 5.3 million square-foot Silicon Valley portfolio in April 2006 from local notables Richard “Dick” Peery and John Arrillaga for more than $1 billion. At the time, the transaction was touted as the largest commercial property sale ever in Silicon Valley. Now, a Pennsylvania company that tracks the commercial mortgage-backed securities market says it is watching the Peery-Arrillaga portfolio for signs of trouble. The portfolio backs $700 million in debt, all but $55.5 million of which is held by three separate CMBS pools.
One of the America III fund’s independent board members, a former investment chief for CalPERS, says the fund could be forced into bankruptcy.
In the case of United Commercial Bank, RREEF negotiated an extension of the original October 2006 loan earlier this year but was forced to put up five additional parcels as collateral on top of six originally pledged. All 11 parcels are in a tight block immediately north of the Sunnyvale Town Center. Now the loan is in default.
Meanwhile, according to RealPoint of Horsham, Penn., occupancy in the 5.33 million square-foot Peery Arrillaga portfolio is 76 percent, less than 10 percentage points above where it was when the portfolio was originally offered in April 2005. Since the acquisition, RREEF has invested $400 million in “cash equity” to improve the buildings, which range in quality from average to high.
“Lease rollover is a considerable concern for this portfolio,” RealPoint says in its report. “… [L]eases for 53 percent of the [gross leasable area] roll prior to maturity. In addition, the average in-place rents are above market averages.”
“Our concern with this loan is primarily due to the concentration of the collateral properties in California, a state that is being impacted more so than most by the current difficult economic conditions,” the RealPoint report continues. “Reported cash flow, however, has remained stable.”
GE Capital is a 49 percent equity partner with the RREEF fund in the Peery Arrillaga holdings. At GE’s urging, RREEF sought several years ago to sell a portion of the Peery Arrillaga portfolio but never did.
RealPoint Managing Director Frank Innaurato said none of the debt has been reported to a special servicer due to borrower troubles since their report was issued. The loan matures later this year but has two, one-year extension options.
JP Morgan Chase Bank and CIBC Inc. were the original sellers of the debt.
The America REIT III fund also owns San Francisco’s Market Center at 555-575 Market Street. RREEF acquired the 770,000 square feet building from San Francisco’s Divco West Properties several years ago. It also sought to sell it late last year but pulled it from the market.
DeWitt Bowman, a former chief investment officer for the California Public Employees’ Retirement System and an independent director on the America REIT III board, said in a brief interview from his Mill Valley home that all options are on the table, including a potential bankruptcy filing by the fund.
The value of assets owned by the fund has fallen in line with current market conditions, he said. He could not be specific about the magnitude of the fall with respect to particular assets, such as the Sunnyvale center.
Bowman is an investor in the fund, he said, as are the other independent directors on the board. They include Duncan L. Matteson, chairman of The Matteson Cos., a Redwood City-based commercial property owner with holdings across the Bay Area in multiple property types; Claude Gruen, principal economist with Gruen Gruen + Associates, which specializes in the economics of land use and has offices in San Francisco and a Chicago suburb, Deerfield; and Willis K. Polite, a principal and co-founder of Seagate Properties Inc., a San Rafael-based commercial property owner with holdings throughout the Bay Area.
Matteson referred a reporter’s call to Bowman as the lead independent director. Gruen and Polite did not respond to calls for comment.
Asked how he felt about the fall in his investment’s value, Bowman declined comment. He was not critical of RREEF’s management of the fund, citing market conditions as the main culprit.
RREEF most recently sought to add additional investors to the fund in March, according to documents on file with the Securities and Exchange Commission. The fund had 271 investors at that time. Other investors in California include the Marin County Employees’ Retirement Association, the San Joaquin County Employees’ Retirement Association and the Ventura County Employees’ Retirement Association.
Frank Garcia, a managing director for RREEF, told the Ventura County Retirement Board in December that 82 percent of the fund’s holdings had been written down and that the write downs in the portfolio were “large” with more anticipated, according to published minutes of a board meeting.
Twenty percent of the fund’s holdings at that time were development properties, he said. The remaining 80 percent consisted of “value-add” or “core-plus” assets. Development properties are by definition more risky that existing properties with established tenancy. Value-add or core-plus properties are existing buildings that the investor intends to improve, possibly through renovation, then re-tenant, presumably at higher lease rates.
Annette St. Urbain, the chief executive officer for the San Joaquin County employee retirement fund, said she had invested $25 million in the America REIT III fund. She is looking forward to an investor conference scheduled for early October in Chicago, she said, and would prefer the fund not declare bankruptcy if possible.
Of RREEF’s performance, she said, “You can always Monday-morning quarterback, and there are some decisions and tactics employed that, understanding where we are now, we might have wanted them to handle differently. But I don’t think we are extremely critical and we have confidence in the management team for the fund.”
RREEF’s troubles in the America REIT III fund have surfaced over the last several months. After slowing construction on the $750 million Town Center project last fall, RREEF stopped all work earlier this year. The subcontractor and contractor on the job began filing liens in early August against the property, citing millions of dollars in unpaid bills. Now RREEF’s general contractor on the job, Devcon Construction Inc., has sued the RREEF fund, several of its special-purpose entities, lender Wachovia N.A. and others seeking payment of more than $18 million for damages that Devcon says it and its subcontractors have suffered after completing work for which it has not been paid. RREEF had not responded to the complaint as of Sept. 4.
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