Development was the longest four-letter word among real estate professionals earlier this decade when it was blamed for the oversupply of commercial space and the credit crunch afflicting lenders.
But the word has returned to the realm of respectable language, and pension funds want to become fluent in its use.
The $24 billion Colorado Public Employees' Retirement Association, the $69 billion New York State Teachers' Retirement System and the $29 billion Virginia Retirement System all have either invested in development projects or have committed to funds that will.
Real estate advisers ERE Yarmouth, and SSR Realty Advisors also have undertaken property development either for separate account clients or as part of a commingled fund.
Low vacancy rates, rising rents, tight supply and eager lenders have made commercial property development attractive for certain property types and in certain markets.
"In the context of where we are in the cycle, we believe very strongly that this is an opportune time to put money into development-type projects," said Graham Bond, senior executive vice president of New York-based ERE Yarmouth. "One has to be focused in certain areas by asset type and region," Mr. Bond cautioned.
"It occurs in pockets and one has to be selective, whether in relation to office development, retail or hotel," he said.
"You are getting to the point that development makes sense from a pure economic standpoint," said R. David Webb. "You are starting to see more and more markets with rents that justify new construction."
"In 1995, with apartments, you had significant number of markets that were hitting rent levels justified new construction," said Mr. Webb. "Industrials hit a year later, and office has been hitting over the last couple of years."
SSR Realty Advisors Managing Director Joseph Gaudio concurs. His firm, through its Tower Fund commingled fund, started five years ago with apartments and progressed to industrial and suburban office properties about three years ago.
The party is going strong, but it could be ruined by too much money, said Mr. Webb.
"One scary thing that is going on is you have a lot of investors -- pension funds, REITs, the opportunity funds -- that are reaching for yield," said Mr. Webb. "That pushes you into thinking about more aggressive ways to invest and that leads to (speculative) development.
"If we get too much money it could ruin the party for everyone," he said. "Things look good at this point."
SSR has already cut back on its development plans. Plans for the Office Value Fund, which would have had a development component, were dropped last year because SSR officials felt development opportunities might have passed by the time the money was raised, said Mr. Gaudio,
"It's getting a little late in the cycle," he said. "Many more buildings are coming on line.
"When we did an office development in Lisle, Ill. a few years ago, we were one of two buildings under construction," he said. "Within a five-mile radius today, 10 buildings are coming out of the ground.
"We wouldn't take some bets we took two years ago because of the increased level of competition," said Mr. Gaudio,
The majority of pension funds didn't invest in development projects in the 1980s, preferring finished properties. Development of that era was characterized by building because money was plentiful, not because there was a need.
But pension fund property portfolios were hurt nonetheless because the oversupply of space created by the development sent rents, and returns, tumbling.
Development 1990s' style is characterized by trying to take advantage of opportunities in the market, which is the manner in which Colorado PERA is doing it.
"It is a way to acquire properties in which we are under allocated to, and a way to be opportunistic," said Kim Roberts-Mosko, director of real estate for Colorado Public Employees'.
"We wouldn't do a product type just to get it," said Ms. Roberts-Mosko. "The market should be right for development."
Colorado has committed a total of $125 million to three development relationships with The RREEF Funds, Sage Hospitality Resources LLC and Miller Global Properties. The RREEF relationship was approved in 1996, though projects are just now getting underway; Sage and Miller received the go-ahead last year.
RREEF will develop industrial properties in the western United States; Sage will focus on limited service hotels; Miller Global has no particular property focus or geographic constraints, but it will probably do suburban office investments, said Ms. Roberts-Mosko.
Virginia and New York State Teachers' have thrown their hats in with experienced developer Hines Interests. New York Teachers committed $100 million and Virginia committed $50 million to the Office Development Fund, which will develop suburban offices.
New York State Teachers also has developed an Atlanta office building; it has another under construction in Overland Park, Kansas; and the system is developing two apartment projects under construction in Houston and Dallas.
ERE Yarmouth will pursue development opportunities in offices, retail and resort and central business district hotels, said Mr. Bond.
The firm has done development through its Yarmouth Capital Partners opportunistic fund. It plans to begin raising a $300 million development fund this quarter and begin committing to projects by the third quarter, he said.
"If one is to take advantage of the window of opportunity, one needs to be able to get that money appropriately invested," said Mr. Bond. "That is where I see our advantage.
"We have our own pipeline, but we can also work with other developers who are ready to roll."
Chances are, successful development this time won't be a roll of the dice.
Funds get $5.7 million in court settlement
The pension funds that owned 10 Los Angeles and San Fernando Valley office buildings damaged in the 1994 Northridge earthquake were finally made whole on their investment when a group of insurance companies settled a bad faith and breach of contract lawsuit.
The pension funds received $5.7 million in an out-of-court settlement from the insurance companies, said Steven A. Fox, a partner with Davis & Fox, the Los Angeles law firm which represented the owners.
Trust Company of the West and Westmark Realty Advisors were the trustee and manager, respectively, to the pension funds which invested via separate accounts and commingled funds.
Among the investors were the pension funds for Ford Motor Co., Pacific Telesis Group, U S West, Pacific Gas & Electric Co., McDonnell Douglas Corp., United Mine Workers of America Health & Retirement Funds, the Board of Pensions of The Presbyterian Church, Minnesota State Board of Investment, Los Angeles County Employees Retirement Association and the Illinois Municipal Retirement Fund.
The sticking point and the primary reason for the litigation was a dispute over the deductible on a series of excess insurance policies that Westmark bought from five insurance companies for the buildings, said Mr. Fox.
The excess insurance was bought because the policy from the primary insurer limited liability for earthquakes to $10 million, said Mr. Fox.
After the earthquake, the insurers claimed that the policy language stated that each damaged building must pay its own deductible before insurance payments would be made.
"We disagreed," said Mr. Fox. "The policy language clearly stated that one deductible, the highest individual deductible among the buildings, apply to all the damaged buildings."
An internal memo from an insurance company employee, concerned about the policy's wording, was uncovered during discovery and led to the settlement, he said.
A portion of the $5.7 million settlement will compensate the investors also for loss of rental income, which the insurers claimed they were not obligated to pay, said Mr. Fox.
"The insurance companies claimed that they were not obligated to pay rent loss for any tenants who left the buildings in breach of their lease because the resulting damage was caused by tenant conduct, not by the earthquake damage," said Mr. Fox. "Not only was this factually absurd, but the wording in the insurance policy stated otherwise."
The insurance providers who settled are Firemen's Fund Insurance Co., Navigators Insurance Co., Westchester Surplus Lines Insurance Co., Homestead Insurance Co. and RLI Insurance Co.
Suburban properties targeted by partnership
A Singapore government investment subsidiary formed a $300 million partnership with Principal Financial Group to invest in suburban office properties, a spokesman for the insurer said.
GSIC Realty and the Principal formed Principal Office Investors, which was seeded with six properties from the insurer's general account, said Frank Schmitz, relationship manager for Principal Office Investors.
Principal Office Investors will acquire about $180 million of properties valued between $5 million to $30 million in major U.S. metropolitan areas.
