Cleaning Up on Urban Cleanup?

The lure of big returns is buoying ambitious fixer-upper funds

He was called "Magic" for his deft ball-handling skills and ability to turn plodding teams into champions. In a 13-season Hall of Fame basketball career, Earvin Johnson Jr. helped lead the Los Angeles Lakers to five championships. But even those exploits pale alongside the 43-year-old superstar's latest ambition: turning Los Angeles' down-and-out downtown into a vibrant, 24-hour community.

Johnson took his big shot on May 21, when an investment fund he co-founded closed on a $100 million purchase of the Transamerica Center. The 38-year-old office complex -- surrounded by parking lots and warehouses -- is only 54% leased, but Johnson and his partners think they can change that by spending $50 million more to convert some of the space into 2,000 residential units. The project may be the toughest in Johnson's 10-year history of opening movie theaters, coffee shops, and restaurants in urban markets. Rooting from the stands will be Johnson's financial backers: retirees at Coca-Cola (KO ), Verizon (VZ ) Communications, and the City of Detroit police and fire departments, whose pension funds are among the 21 big investors in his $272 million Canyon-Johnson Urban Fund LP. "Three or four years from now, downtown is going be the place to be," Johnson says.

Pension funds used to steer clear of blighted urban areas because of the risks. But the rising prices of high-end office buildings, coupled with an influx of people into downtowns, have tempted them to put a small fraction of their portfolios into fixer-upper funds. One of the pioneers, the California Public Employees' Retirement System, has $1.6 billion in such investments, or 1.2% of its assets. Says Stephen Ross, founder of Related Companies LP, a New York City real estate manager and financier: "You'll find more and more money going toward urban environments."

They may well produce more and more profits, too. Richmond S. McCoy, chief executive of New York's UrbanAmerica LP, rehabs old shopping centers in low-income neighborhoods. He figures he has made 40% over three years on one such investment in Eastover Shopping Center in Oxon Hill, Md., a Washington suburb, for a $120 million fund that counts Prudential Insurance (PRU ) and General Mills (GIS ) Inc. as investors. He was able to jack up both rents and occupancy by making improvements such as stepping up security; he gave land to the county for a police station.

Some developers take on even riskier projects in the hope of bigger rewards. In February, Cherokee Investment Partners LLC in Raleigh, N.C., closed a $620 million fund focused on environmental-remediation projects. The fund, which got 90% of its money from college endowments and state pension funds, is removing asbestos from the old Gates Rubber (TKS ) Co. plant near downtown Denver and turning a landfill in Bayonne, N.J., into a golf course. Says Cherokee CEO Thomas F. Darden: "No one would invest in us for safety and diversification. They're only interested in returns."

Of course, urban investing can turn sour as well. Trizec Properties (TRZ ) Inc., a real estate investment trust that usually buys top-grade office buildings in big cities, has written off more than half of its investment in Hollywood & Highland, a $640 million hotel, shopping, and entertainment complex it built as part of an urban-revitalization scheme in Los Angeles. Aimed largely at foreign tourists, the project opened three months after September 11 and hasn't generated the hoped-for traffic.

It's too soon to tell whether the urban-investing game will pan out. "Will the funds be able to sell the properties?" asks Robert Kochis, a pension-fund consultant for real estate at Townsend Group in Cleveland. "It takes three years to get the money invested, three years to develop the portfolio, and another year to sell before we really know how they did." But with players such as Johnson signing up, this trend could be a winner.

By Christopher Palmeri in Los Angeles

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