Water & Drought

Drought trips up real estate development backed by CalPERS

A construction worker rinses down one of the Signature Homes houses under construction on Langford Drive in the community of Mountain House, near Tracy, earlier this month.
A construction worker rinses down one of the Signature Homes houses under construction on Langford Drive in the community of Mountain House, near Tracy, earlier this month. mcrisostomo@sacbee.com

It looked like the perfect real estate investment, a sparkling suburban development that would provide thousands of weary Bay Area refugees with a more affordable place to live.

But the quiet community of Mountain House, perched at the western gateway to the San Joaquin Valley, has provided nothing but torment for its chief investor, the California Public Employees’ Retirement System.

First the housing market crash wiped out much of the pension fund’s $1.1 billion investment, at least temporarily. Now California’s four-year drought has created another crisis for CalPERS and its prized real estate property west of Tracy.

In mid-June, the State Water Resources Control Board issued curtailment notices to dozens of senior water rights holders in the Sacramento and San Joaquin river watersheds, cutting off their ability to pull supplies from rivers and streams. Among those cut off was the Byron-Bethany Irrigation District, which is Mountain House’s sole source of water.

Taps haven’t gone dry in Mountain House. The unincorporated community had stored millions of extra gallons of water in case of emergency, and is working out a deal with a nearby water agency to keep it afloat for six months. But the arrangement only temporarily solves the problem. Until a more permanent solution is found, the state water board said it might restrict Mountain House’s ability to hook up new customers to its water system.

Such a de facto building moratorium could prove disastrous to this community of more than 12,000 residents – and its financial backers. If Mountain House can’t keep building homes and adding residents, it will have difficulty repaying its $350 million in debt to bondholders who’ve financed the suburb’s infrastructure.

Edwin Pattison, general manager of the Mountain House Community Services District, said shutting down growth could also depress home values and make it much harder for CalPERS to recoup its $1.1 billion investment.

“If we’re not growing, we’re dying,” said Pattison, whose district provides water and other services to the unincorporated community. A moratorium on new houses could bring on a “financial death spiral” that would be “more catastrophic than the 2007 crash,” he said.

Housing market analysts agree the water shortage is problematic for CalPERS’s investment. While the community of Mountain House is about one-third built, CalPERS still owns approximately 8,000 residential lots.

“How do you sell any more lots if you’ve got a pending issue with water?” said Stephen Smiley, a senior vice president with market analyst Meyers Research. “It’s got to be an issue for CalPERS.”

The nation’s largest public pension fund is certainly paying attention. Although its Mountain House investment has lost much of its original value, it partially recovered in recent years and was listed at $291 million as of last June, the latest figures available. Ten years after it began putting money into the project, CalPERS still hopes for a payoff some day.

“We are actively monitoring the situation in Mountain House and are working through options with our manager to best protect our investment.” CalPERS said in a statement released by its public affairs office.

Mountain House’s troubles raise fresh questions about California’s long-term development prospects, especially in the fast-growing Central Valley, at a time when climate experts predict recurring droughts. Notably, 285,000 homes are expected to spring up in the six-county Sacramento area over the next 25 years.

“Am I concerned when I look to the future and see there will be more houses to serve? The answer is yes,” said Tom Gohring of the Sacramento Water Forum, a consortium of area municipalities and environmentalists.

Even as demand for water grows, Gohring said he’s encouraged by the steps many municipalities in greater Sacramento have taken to improve their groundwater management and secure backup supplies. A 12-year-old state law requires developers and city planners to take note of their water situation by demonstrating “substantial evidence” of adequate supplies before large-scale housing projects can be approved.

Yet the drought is creating nasty surprises for communities that figured their water was immune. Mountain House, which secured its planning approvals well before the state law took effect, thought it had plenty of water. Its supplier, Byron-Bethany, holds pre-1914 water rights, some of the most ancient claims in the state. Its right to divert from rivers and streams pre-dates the creation of California’s modern water-rights system – a status that had been considered fairly untouchable. Only once before, in 1977, had the state ever curtailed any pre-1914 rights.

“That was considered safe and reliable,” Pattison said.

When the state water board cut off Byron-Bethany’s rights, Pattison dashed off a letter to Mountain House residents acknowledging the folly of relying on a single source: “The lesson is that this crisis has long-term implications: ‘do not put all your eggs in one basket.’” The Community Services District has urged residents to reduce outdoor watering to twice a week, a policy that is expected to become mandatory in mid-July.

Some residents say the water shortage is just another crisis to withstand. They emerged from the recession with their community intact and figure the drought won’t crush them, either.

“I wouldn’t say we’re jinxed at all,” said Airika Payne-Smith, an elementary school teacher’s aide and a Mountain House resident since 2009. “We’re just fighting through something that’s come up ... I’ve never lived in a community that’s so close-knit.”

Payne-Smith moved from San Ramon, one of thousands of Bay Area residents who’ve emigrated to the Central Valley. Mountain House is an almost ideal setting: picturesque, breezy, in view of the famous Altamont Pass windmills, an oasis of relatively affordable housing.

Marketed as “The Town of Tomorrow,” Mountain House was a year old when CalPERS jumped into the project in 2005. The pension fund committed more than $1.1 billion to the community, partnering with Shea Homes to buy up most of the land from original developer Trimark Communities.

The community was an immediate success. Homes sold quickly, and median sale prices peaked at $679,500 in March 2006, according to market researcher CoreLogic.

Because Mountain House was so new, it was basically defenseless against the market crash. At one point in 2010, an astonishing 89 percent of its residents owed more on their mortgages than their homes were worth, making Mountain House the most “underwater” community in America. The median sales price didn’t hit bottom until April 2012, at $283,000.

The downturn was a disaster for CalPERS. Its investment fell by more than 90 percent on paper, to just under $90 million in 2010. The pension fund considered pulling out of Mountain House but decided instead to stay put and wait for the situation to improve.

The housing market in Mountain House has since staged a recovery. Median prices hit $525,750 last month and CalPERS has seen its loss shrink. CalPERS has continued to spend money in Mountain House, including a $52 million contribution to help build the community’s high school.

“Together we had to weather the worst downturn,” said CalPERS Chief Investment Officer Ted Eliopoulos as he spoke to hundreds of residents at the school’s ribbon-cutting ceremony last July.

Now the drought has created a new round of questions about the community’s future. The Byron-Bethany water district last week sued the state, arguing that the water board doesn’t have authority over pre-1914 water rights. At the same time, the Mountain House Community Services District has scrambled to line up a backup supply from the nearby South San Joaquin Irrigation District. The deal was expected to be wrapped up late Monday.

“That will get us through the end of the year,” Pattison said.

Beyond that, Pattison said Mountain House is mulling plans to diversify its water sources and “build a redundant water supply.” Those plans will take several years to bring to fruition, he said.

In the meantime, Mountain House remains in limbo. Tom Howard, executive director of the state water board, said he will have to examine the community’s deal with the South San Joaquin district before deciding whether to allow the community to continue adding customers to its water system.

Such talk is chilling to the people who run Mountain House. Aside from its commitment to CalPERS, the community has to keep building in order to repay the $350 million it owes on its water treatment plant and other infrastructure. The annual report to Mountain House bondholders says the community expects to build 800 new houses by mid-2018.

“Our financial model is a function of orderly development,” Pattison said, adding that state officials are unfairly complicating Mountain House’s attempts to straighten out its affairs: “I don’t see how the state has jurisdiction when we are out there purchasing water to control our own destiny.”

Dale Kasler: 916-321-1066, @dakasler