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January 29, 2018

Real estate has been an increasingly favorite target for Canada’s pension funds. And 2018 promises more of the same.

Canadian pension funds have been steadily upping their total allocation to real estate, from 9.43 percent in 2011 to 11.76 percent by the end of 2016, observes Gaurav Mathur, from JLL’s Capital Markets Research team in Canada. He points to historically-low real interest rates, changing demographics, higher life expectancy and longer retirements as part of the allure, as well as the fact that some plans are maturing, “to the point where their tolerance for volatility or risk is likely diminishing.”

And it’s easy to see the attraction. Real estate provides the pension plans with diversification and reduces the overall risk in their portfolios. It also acts as an effective hedge against inflation while delivering a steady cash flow to the portfolio in the shape of rental income.

Sunny investment climate
As we head through 2018, Mathur expects direct allocations to commercial real estate to expand even further, citing the favorable macroeconomic situation as one of the main drivers.

The global economy is heading into 2018 with solid momentum having seen strong GDP growth in Canada, the United States, Europe and Japan, with support from China and other Asian emerging economies in 2017.

Following suit, Canadian CRE fundamentals are also broadly positive, with most sectors posting modest property net operating income (NOI) growth. But Mathur says that the best opportunities for pension plans can be found around industrial, edge-of-central business district (CBD) offices, transit-oriented suburban offices, and urban retail.

“While edge-of-CBD office demand in Vancouver, Montreal and Toronto remain strong, suburban demand has increased recently as well,” he said. “Urban retail also remains attractive as the upgrading and redevelopment of older neighborhoods continues, and demand for these assets is steadily increasing.”

Another driver behind the growth in allocations has been the availability of a number of rare marquee assets.

Pension funds and pension fund advisors saw their collective share of purchases increase from 16 percent in 2016 to 26 percent during the first nine months 2017, due to an increase in high quality, institutional caliber offerings in Canada, according to Mathur.

These included Ivanhoe Cambridge’s sale of the flagship Oakridge Centre shopping mall in Vancouver for C$961 million to QuadReal Property. Others were the Dream Office REIT’s sale in 2016 of a 50 percent interest in Scotia Plaza to AIMCo and KingSett Capital for $750 million and Cadillac Fairview’s sale of a 50 percent non-managing interest in its CF Vancouver portfolio to the Ontario Pension Board and Workplace Safety and Insurance Board. The CF portfolio includes top-performing shopping mall CF Pacific Centre and 12 downtown Vancouver office properties.

Foreign lands beckon
The funds’ are not just limiting their sights to Canada though, with more institutions seeking to increase their real estate weightings by pursuing non-domestic opportunities.

Pension plans’ interest in non-domestic assets is twofold, explains Mathur: “First is to diversify their exposure with other jurisdictions, and second, they can find often find opportunities that are comparatively cheaper than those in Canada.”

In Asia Pacific, various sectors are proving attractive, notably retail/office mixed-use products, hotels, urban multifamily, prime shopping centers, office parks, and non-discretionary retail and modern warehouse/fulfillment centers. Meanwhile, in Europe the most appealing opportunities lie in alternative assets, such as student housing, medical office and self-storage, along with prime shopping centers, and industrial and urban logistics products.

Core urban office and mixed-use office, as well as urban multifamily and modern warehouse/fulfillment centers are prime targets in the United States. Niches such as medical office, self-storage and student housing are also drawing attention.

For instance, the joint venture between Canada Pension Plan Investment Board, Singapore’s GIC sovereign wealth fund, and student housing operator The Scion Group recently acquired a student housing portfolio comprising 24 assets across 20 university campus markets in the United States . The JV said it will continue to target student housing opportunities primarily in tier one university markets in the United States.

In for the long term
The outlook for 2018 therefore looks strong. And Mathur expects the uptick in interest in real estate among Canada’s pension plans to be a long-term trend.

“Real estate raises risk-adjusted portfolio returns by maintaining competitive performance over many different cycles,” he said. “Income volatility for stabilized real estate is much lower than stocks, and similar to bonds. And because it doesn’t move in lockstep with other major asset classes, real estate acts as a shock absorber when stocks and bonds are volatile.”

Which may be increasingly important in the months and years ahead.

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Gaurav Mathur

Capital Markets Research, JLL Canada

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