Tuesday, February 3, 2015

Canadian Pensions Snapping Up Real Estate?

Gary Marr of the National Post reports, Canadian pension funds scoop up US$2.75B in U.S. commercial property in first half of January:
A falling loonie has done little to reduce the appetite of Canadian commercial investors for U.S. property. Early returns show US$2.75-billion was already scooped up south of the border in the first two weeks of January, according to a survey provided to the Financial Post.

The quick start to 2015 comes on the shiny heels of 2014, in which Canadians dominated the U.S. investment scene, easily doubling the country’s closest foreign rival, Norway, according to real estate research company CBRE. Canadian companies or pension funds bought US$9.7 billion in real estate south of the border, 26% of all real estate purchased by foreigners in the U.S. in 2014.

While Canadian investment in the U.S. is impressive, it’s still a fraction of the entire investment market in America, which was worth US$434 billion in 2014.

Whether a falling dollar will impact future purchases, Jeanette Rice, Americas Head of Investment Research at CBRE, said, “It could mitigate investment, but there are a lot of other positives to balance each other out.

“We know that since September, 2012, the dollar has [gained] 20%, so it has been significant,” she added.

Proximity and similar customs factor into Canada’s U.S. interest, but the limited ability to grow domestically has also created a need for pension funds to invest abroad, Ms. Rice, the author of the study, pointed out.

“If you want to invest in China, it takes a lot of homework. It’s a lot easier to come visit a property, talk to professionals and so on [in the United States],” she said.

The Canadian invasion has been led by pension players who are heavily weighted in real estate compared to their American peers. Canada’s five largest pensions funds by asset size hold on average 12.7% of their investments in real estate compared to an average of 8.7% for 11 similar U.S. pension funds, according to CBRE.

“Many of the institutional players, to put it simply, like real estate, and they’ve done well in real estate and the last couple of decades they’ve gotten high returns,” said Ms. Rice.

The U.S. investment only represents part of the overall real estate holdings of pension funds, which totalled US$119.2 billion for the big six Canadian pension funds at the end of 2014.

“They’ve all gone beyond North America. They’re not moving capital out of the U.S. but they are becoming even more global,” she said.

The timing of the CBRE report came as Oxford Properties Group, a subsidiary of the Ontario Municipal Employees Retirement System, announced Monday a further push into Europe with its second purchase in France in the last six months. Oxford’s European real estate portfolio has grown to $5 billion.

Paul Finkbeiner, chief executive of GWL Realty Advisors, said the pension funds have benefitted from the rising U.S. dollar in terms of the value of their holdings but he doesn’t expect it to affect anyone’s future strategies.

“I think you stick with the strategy of diversifying your portfolio because you are too heavily weighted to Canada,” said Mr. Finkbeiner. “The pension funds and the people doing it long term, they’ll stay in the U.S. They’ve bought some pretty good assets. What the dollar has done is great, but if it reverses you’ll lose some value but people will hold.”

He said it is interesting how the Canadian pension funds continue to compete internationally. “It’s a phenomenon because we have all these provincial and federal pension funds and they have all this money,” he said.
The article discusses how busy Canadian pension funds have been snapping up mostly U.S. real estate but some (like OMERS) are also buying European properties.

Why are they doing this? There are a few reasons. First, real estate has long been heralded as the best asset class among Canada's large public pension funds which are increasingly shifting assets away from volatile public markets into private markets, especially real estate and infrastructure which offer more predictable yields over the long-run.

Second, Canada's large pension funds aren't dumb. They read this blog and many other market sources and I'm sure the most savvy of them agree with me, Canada's crisis is just beginning. This is why they're scrambling to snap up as much U.S. and European real estate even though the loonie keeps declining. They know it will fall further but they also know there are better opportunities outside of Canada at this time given their long investment horizon.

Third, some of Canada's large public pension funds, like bcIMC, are much more exposed to Canada's commercial real estate market than others. bcIMC recently announced it agreed to sell Delta Hotels and Resorts to Marriott International for $168 million, but it has a lot more work to properly diversify its real estate holdings outside of Canada.

Fourth, in my opinion the Caisse's real estate division, Ivanhoé Cambridge, is by far the best real estate investment management outfit in Canada. There are excellent teams elsewhere too, like PSP Investments, but Ivanhoe has done a tremendous job investing directly in real estate and they have been very selective, even in the United States where they really scrutinize their deals carefully and aren't shy of walking away if the deal is too pricey.

Fifth, I don't see interest rates rising anytime soon. In fact, I see central banks pumping a lot more liquidity into the global financial system. And as I recently explained, I'm not in the camp that the Fed will raise rates in 2015 and risk making a monumental mistake.

Having said all this, the rush into real estate and other illiquid alternatives worries me. Why? Because I'm increasingly worried about global deflation and the long-term effects it will have on all investments, especially illiquid private markets. 

Don't get me wrong, done properly, real estate, infrastructure and private equity are great asset classes. But as global pension funds and sovereign wealth funds topple over each other to find deals, they are significantly bidding up prices, lowering prospective returns on all private market investments, and this will really hurt them if a prolonged period of deflation sets in.

A long time ago I wrote a comment asking whether pensions are taking too much illiquidity risk. I think you should all read that comment again and keep it mind as you plow into U.S. and global real estate. Sure, pensions should take the long, long view, but they also need to be acutely aware of price entry and how a prolonged period of debt deflation impacts all their investments, especially private market investments.

Below,  CNBC's Diana Olick discusses why real estate investment trusts (REITs) are a favorite among global investors. In a low rate environment, public and private real estate investments are very popular but do the fundamentals still warrant taking on the risk of snapping them up at these prices? That remains to be seen.

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