Despite many institutional investors pressing pause on their real estate activities in the early days of the coronavirus pandemic, those that keep calm and carry on with a focus on diversification and innovation are poised to emerge as winners.
“Real estate values, like other investment vehicles, can vary at different times based on shifting demand factors, so whether inflation is rising or falling or if the cost of funds are widening out or compressing, values will shift accordingly,” says Scott MacPherson, executive managing director and head of capital markets in Canada at Cushman and Wakefield.
Pension funds are continuing to grow their allocations to real estate, he adds, noting the asset class made up 10 per cent of portfolios two decades ago, while it’s now between 12 and 15 per cent. In 2021, commercial real estate trade in Canada ballooned to about $47 billion, according to data from MSCI Inc.’s real assets index. And though it dropped to around $40 billion last year, it still maintained a healthy volume of trade compared to pre-pandemic years like 2018 and 2019, which were $36 billion and $35 billion, respectively.
“It just goes to show the resilience of real estate and why pension plans invest in [the sector],” says MacPherson. “Not every business or industry can say the same in this inflationary environment.”
As the ongoing global health crisis reshapes the workplace and fuels a shift to e-commerce-driven markets, real estate investing is embracing a necessary re-imagination.
In the neighbourhood
As a result of the pandemic shift to remote and hybrid working, the office market is currently weak in terms of occupancy.
However, the suburban office market is performing slightly better compared to downtown core assets, according to William Secnik, senior vice-president and fund manager of Fiera Capital Corp.’s real estate CORE fund.
From an operational standpoint, suburban offices are generally lower cost than those in downtown areas. They’re also less intensive in terms of usage and the pandemic environment has only increased their appeal, he adds. That said, core downtown assets that are rich in amenities and services tend to be relatively stable historically, but he expects they’ll be tested in the hybrid working environment.
Hazelview Investments’ philosophy is that investors’ strategies should always balance defense and offense. From an internal rate of return perspective, the opportunities may be better in suburban, but they need to be because there’s more variability and less liquidity in this market, says Cameron Goodnough, the firm’s managing partner and head of capital and partnerships. “You may not like the price of assets in city centres . . . but you’ll have liquidity when you need it.”
The exodus out of city centres during the pandemic has already started to turn, he says, noting Hazelview’s focus remains on core properties as the firm is comfortable with the long-term viability of cities and urbanization around transit nodes. “Work is not the only thing that draws people to city centres. Hospitals, access to good schools, education — all of these draw people to city centres and that isn’t changing.”
Current projects that are underway in cities around the world are a testament to investors’ confidence in the sector’s future outlook, says Sebastien Betermier, an associate professor of finance at McGill University’s Desautels Faculty of Management. Here at home, as Montreal builds its new light-rail Réseau express métropolitain network, which will connect the airport to the city’s downtown core, residential and commercial development is underway around the planned stations.
Many pension funds are investing heavily in real estate in those areas, he adds, and offsetting risk by taking a concentrated approach to development projects to control the shape of a neighbourhood. For example, Oxford Properties, the Ontario Municipal Employees’ Retirement System’s real estate arm, is building an entire real estate ecosystem around one of the South Shore properties connected to the REM.
In addition, there are retail investments that thrive in times of volatility, such as food, pharmacies and medical services, which are resilient because people still prefer to use these services in person, says Secnik.
Still, the pandemic move to remote working is forcing some organizations to rethink the adequacy of their office space, which has landlords worried there could be fewer growth opportunities down the road.
There’s a sense that, as the workplace evolves, office spaces should also evolve to accommodate the new hybrid environment. Most companies aren’t completely phasing out the traditional office space, says Betermier, though many are downsizing to accommodate a more hybrid working schedule.
“Many employers are asking themselves what they need to do to bring employees back to [the office]. It’s going to take several years until we see what conditions we’re going to come across — that will most likely involve retrofitting and reconversion of office space to a more welcoming, reception-like place where employees go to converge with others.”
Goodnough is already seeing investors retrofit older buildings to make them more relevant to the pandemic reality. “What our clients want and need . . . [is] very different now. . . . The concepts of density are different; they’re less concerned about how tall the building is and how long [people] have to wait for the elevator. They’re more concerned with shared spaces, access to drop-off places for UberEATS — these kinds of evolutions.”
This trend offers a growth opportunity for landlords, says Betermier, noting those that are agile at retrofitting their office spaces in a way that meets the needs of the future workplace will win in the transition. Indeed, institutional investors that are directly invested in real estate are actively watching how building owners are handling the transition in terms of the amenities and conditions that are successfully wooing employees back to the office.
Michèle Hubert, chief operating officer at Ivanhoè Cambridge, the real estate arm of the Caisse de dépôt et placement du Québec, believes the commercial office sector is seeing a transformation through an underlying flight from quantity to quality.
As a long-term investor, Ivanhoè Cambridge is navigating the current environment bearing in mind what communities need today and in the future. People spend 90 per cent of their time indoors, so it’s critical that real estate spaces fulfill these needs, says Hubert, noting it’s also important to look at data and have the right networks on the ground to pinpoint these needs, rather than trying to replicate a one-size-fits-all approach.
Growth of green
As more institutional investors pledge to meet net-zero targets by 2050, the demand for green real estate is growing, says Betermier, noting more energy-efficient spaces are doing better, which is driving Canadian pension funds to seek out core properties that can be redeveloped to make them greener.
“Multi-use buildings are easier to retrofit from commercial to residential if there is a drop in the commercial value. For example, when I’m looking at a lot of the Canadian pension funds that invested heavily in direct real estate, . . . the towers they’ve built tend to be [for] multi-use. These towers are easier to convert from commercial — where there’s currently less demand — to residential, where there’s a ton of demand right now. Home prices in Toronto are high and benefiting from the high demand for greener, more energy-efficient office space. There, again, is an opportunity from the investor’s perspective.”
Globally, the real estate sector accounts for about 40 per cent of carbon emissions, so it must be part of pension funds’ strategies for hitting their net-zero goals, says Hubert. Ivanhoè Cambridge has pledged to reach net-zero carbon targets on operational emissions in its real estate portfolio by 2040. The fund is actively aiming to reach its goal by decarbonizing its existing stock through new products and by bringing new buildings to market that are already adjusted or adapted from an environmental, social and governance perspective.
If institutional investors intend to reach net zero by 2050, they have to start cutting their carbon budgets by eight per cent annually for the next 30 years, says Betermier. “Even COVID did not reach that eight per cent drop. When we were confined, . . . we cut a lot of . . . energy consumption. But even then, we didn’t meet that eight per cent drop.”
That implies a fundamental restructuring of the way businesses operate, he says, with real estate a key factor in that transition.
Drive to e-commerce
Historically, the office sector dominated a large portion of pension funds’ portfolios, with lower allocations to industrial and multi-family assets — which have grown a lot over the last decade, says MacPherson, noting investors are now right-sizing their portfolios.
Prior to the pandemic, industrial was a key focus for Ivanhoè Cambridge, which has increased its holdings in the asset class over the last two years as the health crisis sped up the shift to an e-commerce economy. Online shopping, fulfillment and securing the supply chain are the biggest drivers for growth in this sector, says Hubert, noting the organization has purchased several logistics platforms in different global regions.
The move towards deglobalization and on-shoring reflects both corporations’ and governments’ desire to increase supply chain certainty, says Goodnough. While the industrial asset class may be seen as expensive, it has a lot of long-term value, which is why there’s growing interest in this area, he adds.
Another rising trend is investments in data centres in response to the move away from the traditional business model to e-commerce, notes Betermier, adding he only expects to see greater demand in this sector.
Demand for residential
A few years ago, Ivanhoè Cambridge’s two main asset classes were office and retail, but today, logistics and residential make up most of its portfolio.
The evolution to residential stems directly from the discrepancy between the demand for housing and the current availability, says Hubert.
In September 2021, the organization invested in multi-family, student housing and manufactured housing properties throughout the U.S. In October, it invested $645 million in an Australian student housing operator. “We see the possibility in bringing in interesting products that serve specific needs . . . that we can deliver in an interesting way.”
Hazelview also sees momentum in housing, says Goodnough. The federal government has steadily increased its immigration targets, aiming to bring 10 million people to Canada in the next 20 years. By 2030, he estimates there will be 1.85 million units under supply, with the vast majority in the Greater Toronto Area. “From our perspective, where we see a 10-year investment opportunity [for our firm and clients], multi-res has to be on top of that list.”
Hazelview is also focused on the growing needs in the rental market, says Goodnough, noting new immigrants tend to gravitate towards urban settings and rent for the first few years. The coming shortage of affordable rental housing shouldn’t be left entirely to governments to fix. “Government cannot solve all of these problems. There needs to be private participation as well.”
Secnik agrees. “The development of new single-family or multi-residential housing products that are innovative and include ESG initiatives is a positive for the general public and certainly our investors who are associated with real estate.”
Lauren Bailey is an associate editor at Benefits Canada.