CPPIB Goes Christmas Shopping?

Steve Ladurantaye of the Globe and mail reports that CPP goes shopping:

The Canada Pension Plan Investment Board snapped up a Scottish shopping mall Monday, partnering with an English fund Hammerson on the $479-million deal.

The Silverburn mall, which opened in 2007, is a single-level covered centre anchored by Debenhams, M&S, New Look, Next and Tesco Extra. It provides 94 retail units let to high quality retailers, has an occupancy level of 98 per cent, and an average unexpired lease term of over 12 years. The centre attracts approximately 14 million customers per year.

“This transaction represents a unique opportunity to acquire a high quality asset alongside one of the top retail developers and operators in Europe," said Graeme Eadie, senior vice-president of real estate investments for CPPIB. "We are delighted to be partnering with Hammerson as co-investor and manager, given their proven track record in managing similar assets.”

Karen Mazurkewich of the National Post provides more details, reporting that CPP lands U.K. mall in distress sale:

Thanks to a distress sale, Canada Pension Plan Investment Board is a part owner of Scotland's second-largest shopping centre. CPPIB paid about $250-million for a 50% stake in the Glasgow Silverburn mall -- a deluxe retail property that featured 95 stores and 14 restaurants when it opened in 2007.

This latest sale boosts CPPIB's real estate assets in the U.K. to more than $1-billion from $800-million, according to Graeme Eadie, its senior vice-president for real-estate investments.

The U.K. media reported that Silverburn cost a whopping £350-million ($597-million) to build, significantly more than the £297-million CPPIB and its partner, Hammerson PLC, paid to the receiver appointed by the bank to recover its losses from the mall's original owners.

Silverburn's Retail Property Holdings Inc., a unit of Elementary Property Co., went into receivership in July.

"My understanding is our price does not pay the bank back," said Mr. Eadie.

The purchase of the Scottish mall comes almost six months after retail property values ended a 46% slump that had lasted two years. Nevertheless, Mr. Eadie is upbeat about the purchase. "This was built by a private company at the top of the market and over-levered ... but we considered it a good asset. It's fully leased, and our view and Hammerson's view is that the rents are under market, and when the renews come up we will be able to push the rents up."

Another plus is that it was one of the few retail properties on the market that was available in total and, with a footprint of a million square feet, it had major heft.

It comes as little surprise that the first real-estate plays following the economic crisis are in the U.K. "The U.K. market moved down more quickly than the other markets; we've found the bottom now, so there have been more transactions there," said Mr. Eadie.

While the pension fund is still eyeing the U.S. market, and pricing is moving down, he said there is very little being sold there yet.

Unlike Brookfield Asset Management, which bought portions of General Growth Properties' debt and bonds in order to position itself for a piece of the equity, Mr. Eadie said CPPIB is not playing in the debt markets.

CPPIB has direct holdings in three other U.K. properties: an 80% ownership in two office buildings in London and a 50% stake in Whitefriars Quarter shopping centre. Through the Westfield U.K. core shopping centre fund, the pension plan holds interests in four shopping centres in Birmingham, Derby, Northern Ireland and Tonbridge Wells.

Earlier this year, CPPIB's private-equity arm kept busy with its own shopping spree. In addition to purchasing IMS Health, one of the world's leading providers of market intelligence to the pharmaceutical and health-care sectors, with U.S.-based private-equity firm TPG Capital in a deal valued at US$5.2-billion, the pension fund joined forces with U.S. Sterling Partners to buy the Canadian customs brokerage firm Livingston International Income Fund in a deal priced at $273-million. The pension fund also announced in September that it's part of the investor group acquiring a 65% interest in Skype Technologies from eBay in a US$2-billion cash and debt, and snapped up Macquarie Communications Infrastructure Group for $1.52-billion in June.

I have nothing to add on the latest real estate purchase as it sounds like a good deal, especially if retail properties recover in the UK (not sure when this will happen as they are mired in a deep recession).

My only comment is that all these investments in private markets must be carefully evaluated relative to a benchmark that reflects the risks they're taking. And while CPPIB publicly discloses the transactions, they don't bother clearly disclosing their private market benchmarks. Without beating the point to death, this is totally unacceptable and not in accordance with best standards on pension governance.

***UPDATE***

Laura Chesters of Property Week provides crucial details on the deal, reporting that Hammerson and Canada Pension Plan buy £297m Silverburn. I quote the following:

As revealed by Property Week on 18.11.09 the pair have entered a 50:50 joint venture which has bought Retail Property Holdings, the company that owns the 1m sq ft Silverburn shopping centre, from The Elementary Property Company.

The £297m price equates to £148.5m each. The current gross rental income is £18.4m, representing an initial yield of around 6%, and an equivalent yield of 6.8%. After operating costs, net income will be approximately £17m in 2010. Hammerson
will be the asset manager for the joint venture.

Silverburn opened in 2007 and is anchored by Debenhams, M&S, New Look, Next and Tesco Extra. Its 94 retail units have an occupancy level of 98%, and an average
unexpired lease term of over 12 years.

Hammerson and CPP believe the centre has rental growth, asset management and development opportunities. Average prime zone A rents are £140/ sq ft, with overall rents passing estimated to be up to 20% below current market rental levels. First rent reviews at the centre start from 2012.

There is also potential to extend the centre by around 100,000 sq ft and the purchase of the centre includes also includes 743,000 sq ft of development land opposite.

Hammerson will fund the acquisition from existing bank facilities which have a margin of 37.5 basis points over LIBOR.

I received this comment from Erik Andersen,a BC economist:

News Item today (Globe and Mail); CPP IB is investing CDN $252 million to own a 50% interest in a shopping mall in Scotland. Gross rentals are reported to be $31.3 million, or 6.2% on the total price of $505 million.

When one removes operating expenses (particularly the management expense to be charged by co-investor Hammerson) what will be left is certainly going to be close to a zero return.

So once again the CPPIB is the "investor of last resort" where the return on investment must be almost zero; then there is the risk of owning real estate in a relatively poor part of the UK and to add further insult to injury we Canadians are exposed to currency risk.

The sellers must just love Canadians these days as we continue to re-affirm that the "greater fool" theory is alive and well.

I'm not sure how he calculates a return close to zero since even after expenses, yield looks over 5%. As for currency risk, it comes with all foreign investments. But Erik did mention that this is "gross rental income" and there must also be property taxes to pay, utility bills and maintenance and repair of the asset.

Another buddy of mine who used to work in real estate sent me this comment:

I believe it is too early to invest in equity in retail RE. This said it is possible to find very good deals. At 6% of return, this is not enough. It is not because you have leases that you will have revenues... companies can go bankrupt and vacate. The current normal RE wisdom is to invest in debt and let others waste their equity until they can not support the asset anymore... then you foreclose the asset by kicking out the owner you become the only one in the equity position. To invest in equity in RE you must be at the bottom of the RE cycle... I am sure that CPPIP is too early for that case.

I think the big gains will come if CPPIB can turn around and sell this property to a greater fool in the next five to ten years.