Prominent asset managers for Canadian pension funds appear poised to take an even bigger position in the commercial real estate market. A meteoric entry into next year’s Who’s Who in Canadian Real Estate survey is foreordained with British Columbia Investment Management Corporation’s (bcIMC) recent move to launch an independent real estate arm, QuadReal Property Group, while newly adopted legislation in Ontario opens the way for another national player on the scale of bcIMC or Caisse de dépot et placement du Québec (Caisse).
Both new entities are slated for action in 2017 as approximately $18 billion in assets will be transferred to QuadReal from bcIMC’s current third-party property managers, and the newly established Investment Management Corporation of Ontario (IMCO) begins operations. The latter brings the Ontario Pension Board’s (OPB) $23-billion investment portfolio and the Workplace Safety and Insurance Board’s (WSIB) $26.3-billion kitty into a shared asset management framework along with an invitation for other Ontario-based broader public sector (bps) organizations to join the pool.
“This will increase efficiency when providing pension support and income for injured workers,” submits Ontario Minister of Finance Charles Sousa. “OPB and WSIB, and public sector pension plans that may join in the future, will benefit from IMCO’s ability to deliver enhanced services.”
Similar to other major pension funds — OMERS, Caisse, Ontario Teachers’ — that already have their own real estate subsidiaries, QuadReal‘s mandate has been clearly stated. An executive structure with two presidents to oversee domestic and international operations has been tasked with managing bcIMC’s already sizeable portfolio and augmenting it with new acquisitions inside and outside Canada.
“We are creating a company that has a global perspective and is entrepreneurial and ambitious,” affirms Remco Daal, QuadReal’s president of Canadian operations.
At a more nascent stage with the naming of its board of directors just occurring in early July, IMCO’s real estate related goals are less enunciated. However, representatives of its founding partners have dropped some fairly strong hints.
“In a global investment environment, scale can be an important contributor to consistently strong investment returns. We believe asset pooling will enhance our ability to invest directly in a broader array of high-quality opportunities,” says Mark Fuller, OPB’s president and chief executive officer.
Benefits of scale
Real estate’s record of producing stable, long-term returns makes it a favoured asset for portfolio diversification and hedging risk, especially for fund managers that must generate steady income to pay out to pension plan members. The emergence of new investment vehicles and capital market dynamics have also motivated investors big and small to expand their direct and indirect real estate exposure.
“Over the last 10 to 20 years there has been a massive allocation to real estate. The REIT market is only 21 years old in Canada. Real estate is a direct standalone investment class now; it wasn’t 20 years ago,” observes Scott Chandler, senior vice president, advisory and investment sales, with Colliers Canada. “When you look at the equity market recently, there’s a lot of volatility year-to-year. At the same time, bond yields are at historic lows. Real estate generates the risk-adjusted returns that pension funds in particular need.”
Globally, JLL projects annual direct investment in commercial real estate will surpass US $1 trillion within the next 10 years. In Canada, 46 institutional portfolios represented in the REALpac/IPD Canada Property Index have a collective value of more than CAD $138 billion, while seven open-ended property funds participating in the REALpac/IPD Canada Property Fund Index hold assets valued at nearly CAD $25 billion.
Even so, direct real estate investment can be intimidating for investors with shallower resources since it typically ties up large amounts of capital in illiquid holdings that can’t be quickly converted back to cash. Informed industry expertise at the acquisition stage and ongoing professional management are also critical to maximize returns — requirements deemed challenging for many smaller pension plans with assets in the $100 million to $150 million range.
“In the broader public sector there are a lot of pots of money that are very small,” explains an advisor on pension administration. “There are a lot of public sector plans where essentially it’s the organization’s CFO who is investing the money in the plan. They have to pay high fees to fund managers to get access to expert management, or they might not even be big enough to qualify.”
These are the entities now tagged as potential joiners of IMCO’s asset pool, thus gaining access to dedicated professional investment management services and contributing to its overall scale. Meanwhile, bcIMC’s QuadReal is an outcome of scale, which underpins a business case for in-house asset and property management.
“Historically, most institutions and pension plans have increased their real estate allocations over time, but the internalization of the real estate function is also about having more direct control and lowering costs,” says Chris Langstaff, senior vice president, research and strategy, with LaSalle Canada.
Spec builders squeezed out
A 2015 study from The Boston Consulting Group identifies internal management and proportionally higher allocations to alternative asset classes — real estate, infrastructure and private equity — among the defining characteristics of Canada’s 10 largest public pension funds. On average, the 10 funds — ranging from Canada Pension Plan Investment Board (CPPIB) with $265 billion worth of assets under management to OPTrust at $18 billion — report a 32 per cent allocation to alternative asset classes with 14 per cent specifically to real estate. In contrast, pension funds with portfolio values ranging from $25 million to $10 billion allocate 4 to 11 per cent to alternative asset classes, while sample ETF retail funds topped out at 5 per cent.
Looking at IMCO, formational partner OPB was already pegged Canada’s ninth largest public pension plan — a ranking that IMCO will initially retain despite more than doubling the value of assets under management. OPB reported a 15.4 per cent allocation to real estate and 3.4 per cent allocation to infrastructure as of December 31, 2014, while WSIB’s most recent breakdown in its Q1 2016 report to stakeholders shows 8.5 per cent of its net asset value is in real estate with 5.3 per cent in infrastructure.
Ultimately, though, direct real estate investment is predicated on availability of institutional-grade buildings. In Canadian cities, institutional investors already own much of what they’d be willing to buy.
“It’s the best-in-class assets: Class A and AAA office, regional malls and new functional industrial. So, if you can’t buy it, you build it,” Chandler says. “Almost all the new downtown office buildings and mall expansions have been by pension funds.”
In doing so, they’ve effectively squeezed out the entrepreneurial developers who have long propelled building booms. Today’s spec builders, were such creatures to exist, would be competing against pension funds that can finance new development with their own on-hand reserves and have extensive networks to recruit anchor tenants.
This new generation of owner/developer has even upended traditional expectations about occasional market crashes, as currently witnessed in Calgary. With vacancies climbing, asking rents dropping and 2.4 million square feet of new downtown office space still under construction, there’s little sign owners are restless.
“The very nature of these pension funds is they have lots of patience. They have deep pockets and they can take a long-term view,” Chandler advises. “There is no fire sale.”
Barbara Carss is editor-in-chief of Canadian Property Management.