Blake Hutcheson, the chief executive of Oxford Properties Group, the real estate subsidiary of the Ontario Municipal Employees Retirement System (OMERS), has a global task on his hands. After an 18-month sojourn working with Mark McGoldrick as Mount Kellett Capital Management’s real estate chief, he is now orchestrating the emergence of OMERS and Oxford as a much greater force than it has ever been in international real estate.
In an interview with PERE, Hutcheson and his right-hand man, Michael Kitt, who oversees Oxford’s 45 million square feet of Canadian real estate, talks through the company’s plans, including the recent opening of offices in London and New York, signature projects such as Hudson Yards in Manhattan and its future designs for Asia. He also explains why Oxford will continue to do things directly and has no plans to return to indirect investing for the foreseeable future.
Demand to expand
Few participants in private equity real estate will have failed to notice how OMERS and the other big three Canadian pension funds have been flexing their muscles in recent years. OMERS itself is a huge plan, investing the assets of nearly 420,000 current and former municipal employees in the province of Ontario.
In terms of the amount of equity invested in real estate, OMERS ranked #17 on PERE’s Global Investor 30 list in November. With roughly $11 billion of equity invested in real estate, the municipal pension plan was up there with Caisse de dépôt et placement du Québec, with $18.4 billion; Canada Pension Plan Investment Board (CPPIB), with $16.4 billion; and the Ontario Teachers’ Pension Plan, with $13.475 billion.
Oxford manages all of OMERS’ real estate assets – including 50 million square feet of office, retail and industrial space, 21,000 apartment units and 3,500 hotel suites – and handles all investments in the asset class for the pension plan, which currently allocates between 12 percent and 15 percent of its total assets to the subsidiary. Since 2005, Oxford has aggressively been pursuing global expansion, which included the opening of offices in London in 2008 and New York in 2010. While about 80 percent of its capital currently is invested in Canada and 20 percent in the US and Europe, the company expects its geographic allocation to shift to two-thirds domestic and one-third international by 2015.
In support of this goal, Oxford last year told PERE that it planned to invest C$10.5 billion (€8 billion, $10.6 billion) in real estate in North America and Europe over the next five years – including boosting investment in the US from C$1.5 billion to C$5 billion, from C$2 billion to C$5 billion in Europe and from C$16 billion to C$20 billion in Canada. In the last year alone, Oxford increased its real estate assets under management (AUM) across the three regions from C$16 billion to C$20 billion. Its target for 2015 is a total of C$30 billion in real estate AUM, acquired via equity, debt and third-party capital.
Hutcheson says the need for more geographic diversification is driven by the fact that, “at some point, the Canadian pension funds are going to outgrow a country the size of Canada. You need to start putting roots down and seeding other markets.”
The challenge for Canadian pensions was highlighted recently in a CBRE Group report. “Canadian investors typically are long-term holders and already hold most of the key assets domestically,” said Jonathan Hull, head of capital markets for Europe, the Middle East and Africa, in the report. “This limited domestic universe is leading to the need to diversify and seek opportunities abroad.”
The elimination in 2005 of Canada’s Foreign Property Rule, which limited the amount of foreign assets that the nation’s pension plans could hold relative to their overall assets, also has contributed to an increased focus on global real estate strategies. The rule – which initially had set the limit on foreign holdings at 10 percent in 1971 but later raised it to 20 percent in the 1990s and 30 percent in the early 2000s – had curbed diversification of pension plan portfolios significantly, according to a paper published by the University of Western Ontario in 2005.
Getting more private
At the same time, OMERS has been seeking to invest more heavily in the private markets, which include real estate, private equity and infrastructure. That is because, in recent years, private assets have delivered consistently strong returns to the fund, Hutcheson notes.
According to OMERS’ 2011 financial results, Oxford Properties generated an 8.4 percent rate of return last year, exceeding its performance benchmark of 6.83 percent– up from a 7.51 percent rate of return against a 6.65 percent benchmark the previous year. Overall, OMERS’ private market portfolio generated a return of 8.2 percent, compared to a negative investment return of 0.22 percent for its public markets portfolio.
The C$55.1 billion pension plan’s long-term goal is to realise an asset mix of approximately 53 percent public investments and 47 percent private market investments. At the end of 2011, OMERS’ mix was 58 percent public and 42 percent private, compared with 82 percent public and 18 percent private in 2003, when the fund first adopted its policy to increase its exposure to the private markets. Still, this private market allocation is far greater than those being made by the 20 largest North American and European pension funds and the 20 largest sovereign wealth funds, which currently average 16 percent and 19 percent, respectively, according to Oxford documents.
Real estate stands alone
OMERS’ Oxford subsidiary represents a noteworthy aspect of Canadian pensions – the wholly-owned real estate platform that functions as a standalone company. This set-up is similar to that of the Ontario Teachers’ Pension Plan, which has its Cadillac Fairview unit, and Caisse de dépôt et placement du Québec, which has its Ivanhoé Cambridge affiliate. Indeed, of the big four Canadian pensions, only CPPIB manages its real estate investments in-house.
Oxford is run by a seven-member executive committee, which includes Hutcheson; Kitt, who is executive vice president for Canada; Neil Jacob, executive vice president for the US; and Paul Brundage, executive vice president for Europe. The team is charged with making all operational and management decisions for Oxford, including property redevelopment and upgrades and hiring of personnel.
Major and significant new initiatives, new refinancings and new development projects, however, are taken to the OMERS Administration Corporation Board for approval. That board, via a thorough transaction approval process, “will work to understanding the risk completely and make sure that we understand the investment in the context of the entire fund, not just within Oxford,” says Kitt. As for the speed of approval, “it’s as quick as we need it to be.”
Adds Hutcheson: “The processes are designed around good governance, but they’re also designed around facilitating good business decisions, not setting up an unnecessary bureaucracy.”
A 52-year history
Oxford’s history actually pre-dates that of OMERS. The company was founded in Edmonton in April 1960 as Oxford Leaseholds by securities trader Don Love and brothers John and George Poole, then the owners of Poole Construction (now known as PCL Construction). Prior to forming the company, the trio had partnered on the purchase and renovation of a medical building in Edmonton, and legend has it the three co-founders each put C$100 on the table as a symbol of their partnership. Their first venture as Oxford was the construction of the Essex Building, also in Edmonton, in 1962.
Over the ensuing decades, Oxford continued to grow, amassing sizable real estate holdings in both Canada and the US, and eventually went public under the name Oxford Development Group in 1973. It relocated its head office to Toronto’s Richmond-Adelaide Centre in 1985, coinciding with the company’s 25th anniversary.
In 1998, OMERS acquired a 15 percent stake in Oxford, becoming a major shareholder in the company. The pension plan, which was established in 1962, already had a real estate investment arm, OMERS Realty Corporation (ORC), which had been created in 1989 to increase the pension’s real estate allocation from 5 percent to 15 percent. Between 1991 and 1998, ORC purchased approximately C$4 billion of real estate, including interests in regional shopping centres such as Yorkdale Shopping Mall and Scarborough Town Centre, as well as downtown Toronto office towers such as WaterPark Place and Constitution Square.
The purchase of the stake in Oxford, however, represented a further step in the implementation of a real estate strategy that included the ownership of real estate through public equities, in addition to direct property and debt investments. One year later, ORC teamed with Oxford to purchase the Royal Bank of Canada’s real estate portfolio – including the 1.5 million-square-foot Royal Bank Plaza in Toronto – for C$827 million and simultaneously executed an agreement to sell 22 non-core assets in the portfolio to a joint venture led by GE Capital Canada for C$216 million.
In 2001, OMERS completed a takeover bid for 100 percent of Oxford and took the company private, which gave the pension control of an established property management business and nearly doubled its real estate investments to C$8.2 billion. Over the next several years, OMERS’ real estate operations were consolidated under Oxford. While some of the properties owned by OMERS and Oxford at the time of the acquisition have since been sold, a significant portion of the assets remain part of Oxford’s portfolio today.
The direct approach
Long before the takeover, however, both OMERS and Oxford had focused primarily on direct investments in real estate, following a strategy typical of many Canadian pension funds and investors. These investments are fairly evenly divided between development – to which nearly an entire floor of Oxford’s six-story headquarters is dedicated – and acquisitions.
Oxford has been a direct real estate investor throughout its history, while OMERS has been directly investing in the asset class for the past three decades. Even at their peak, however, fund and other indirect investments accounted for less than 5 percent of Oxford’s portfolio, and today comprise less than two percent.
“We have looked at our historical performance and, almost without exception, we have done better when managing our money than investing in third-party funds,” says Hutcheson. “So we just don’t do it anymore. We have enough in our own pipeline and in our own control that we don’t need to try to put money out with others.”
Hutcheson expects that eventually 100 percent of Oxford’s portfolio will be made up of direct investments. “We are working through some legacy investments and some of those have been terrific, so we may keep a few,” he says. “But generally speaking, the direct approach is our modus operandi.”
Kitt adds: “Fund investments were really just used as an opportunistic way to get into certain markets that OMERS or Oxford didn’t have access to. But now, with the opening of the UK and New York offices and more local control, the fund investment concept has been put aside.”
Indeed, OMERS has put a significant amount of manpower behind its real estate mission, with 1,300 Oxford employees across its three regions of focus. The firm is planning to expand its New York team from 10 to 15 people in the next 12 to 18 months, while boosting staff in its London office by a similar number.
“We now have three active local platforms that we use to drive our investment programmes,” says Kitt. Having a local presence “really puts us in a position to see deals that others don’t and develop relationships that are that much stronger.”
Home cookin’
In Canada, growth in Oxford’s real estate holdings over the next three years primarily will come from development. The company – one of the most active developers in Canada over the past five years, building close to three million square of office space during that period – currently has about 20 projects valued at C$2 billion under way in the country.
Half of Oxford’s development projects in the Great White North will involve partners, including other Canadian pension funds. Oxford’s largest project in Canada currently is a 50:50 joint venture with CPPIB for the development of RBC WaterPark Place, a 930,000-square-foot office tower in downtown Toronto announced in October. Oxford also is partnering with CPPIB on the development of the MNP Tower, a 35-story, 270,000-square-foot skyscraper in Vancouver scheduled for completion in summer 2014.
Another major Canadian project on the horizon is the redevelopment of the Metro Toronto Convention Centre complex, which Oxford acquired last year from Canada Lands, an arm’s-length federal agency, for close to C$240 million. Covering an entire city block, the 7.6-acre mixed-use development includes the 260,000-square-foot convention centre, a 265,000-square-foot Class B office tower located at 277 Front Street, a 586-room InterContinental Hotel and a 1,200-space parking facility. Because of the complex’s proximity to two other office assets owned by Oxford—315 Front Street and 325 Front Street – the company effectively will control an 11-acre site, where it plans to build an additional three to four million square feet over the coming decade.
While Oxford remains heavily invested in cities such as Toronto, Montreal and Ottawa, those markets – while continuing to demonstrate strong fundamentals – have a flatter growth trajectory relative to the country’s western region, which currently is benefiting from a commodities boom. “We’re seeing that feed through the industrial development cycle specifically, but also our retail and office programmes,” says Kitt.
Overall, “we see opportunities right across the board,” Kitt adds. “We can buy land and develop it, but we also can buy something that’s broken and fix it, like a rundown shopping center or office building.” In such instances, Oxford “can use the expertise that we have internally to polish the jewel.”
Triple play in the USA
Oxford’s most significant undertaking is Hudson Yards (see Appetite for construction, p. 40). The 12 million-square-foot, mixed-use development on 26 acres in New York City currently is the largest private real estate project in the US.
That said, development is just one strategy in Oxford’s three-pronged approach to the US. The company also is looking at equity and debt investments – often simultaneously for the same asset. “We’ve actively pursued [assets] either as an equity acquisition or as a debt acquisition, and often you’ll see deals that are talked about at the same time,” says Jacob. “People will be looking for either mezzanine debt or they also might consider selling a portion of the asset.”
Oxford expects to increase its real estate debt investments in the US from C$340 million to C$1 billion over the next two or more years, and generally it is looking at deals ranging from C$50 million to C$100 million. Last month, Oxford completed a C$90 million subordinate debt investment for an office building in New York.
Oxford has taken a measured approach to making investments in the US. “Over the last 18 months in the US – and in New York, in particular – there’s been a tremendous amount of global capital looking at opportunities, and we think some of that has caused frothy pricing on assets,” says Jacob, whose team is focused primarily on acquisitions in New York and Washington, DC, as well as Boston and other coastal cities to a lesser extent. “We want to make sure that we stay disciplined and don’t feel the pressure to buy just for the sake of buying.”
That said, Jacob says his team “feels much more ingrained in the markets than we were a year to a year-and-a-half ago. We feel like we’re more settled in, and we feel more comfortable underwriting assets.”
Next up for Oxford’s US office is the hiring an acquisitions professional to be based in DC. “I think we’ll put someone there in 2012 to be our eyes and ears into that marketplace,” says Jacob, anticipating that the company’s first investment in the market – likely the development of an office building in the city’s central business district – will occur this year.
Branching out in Europe
In Europe, Oxford’s strategy so far has been focused on the development and acquisition of properties in the UK, particularly office assets in London. “We started slowly, shadow bidding on some things and looking in that market,” says Hutcheson. In the past year, “we’ve found it’s been a little less competitive than in prior years, as some domestic players retreat from the playing field for a period of time.”
Last year, the company acquired Green Park, a 1.3 million-square-foot, 17-building business park in Reading – one of the largest office campuses in Europe – for C$650 million. “It’s allowed us to scale our business even further in the UK and bring more people onto the team to manage and execute against that real estate,” says Hutcheson.
In addition, Oxford currently is in development on 122 Leadenhall, a 610,000-square-foot office building in central London. Also known as the Cheese Grater, the 47-story project is being built through a joint venture with British Land, a local REIT.
Oxford now is eyeing a few markets outside of the UK, including Germany, where it already owns a number of residential units, and France. “We’re going to move slowly in those markets and learn as we go,” Hutcheson says. “Until things start to stabilise, we won’t look elsewhere in Europe, the Middle East or Africa.”
The reason to begin monitoring other European markets is twofold, says Hutcheson. “One, if things get healthy, we ought to get in the game, and two, if they get worse, we’re armed with a strong balance sheet and can play very opportunistically, either with credits or our assets.”
Looking ahead
As it continues to build its real estate operations in the US and Europe, Oxford also is considering extending its global reach further to Asia, where it plans to open a new office, most likely in the next three years. And while some OMERS entities are active in Latin America, “we’re finding we have enough real estate opportunities in the markets in which we’ve chosen to invest that we can do beautifully without being in Latin America,” says Hutcheson. “Maybe one day, but not now.”
In the meantime, the gap between Oxford’s Canadian and international investments is on track to narrow further and could be a 50-50 split in 10 to 15 years, according to Hutcheson. “Canada will remain the engine and our home, but we think there will be a greater shift globally over time,” he says.
Ontario Municipal Employees Retirement System
Headquarters: Toronto
Established: 1962
Chief investment officer: Michael Latimer
Total Assets: C$55.1 billion
Direct assets: 84% of total assets
Indirect assets: 16% of total assets
Real estate subsidiary: Oxford Properties
Real estate assets under management: about C$20 billion
Equity invested in real estate: roughly C$11 billion
Appetite for construction
Hudson Yards, Oxford’s flagship development in New York City, is being billed as the largest private development project in the US
Hudson Yards, a massive mixed-use project in New York City, represents the feather in Oxford Properties’ development cap. However, the site of the project also has a colourful past.
In July 2007, New York City’s Metropolitan Transportation Authority (MTA) issued a request for proposals for the development rights over the West Side railyards – a portion of which originally was intended to house a stadium that would have hosted the city’s failed bid for the 2012 Summer Olympics. The MTA received five proposals in October 2007 and selected New York-based developer Tishman Speyer as the winning bidder in March 2008. After negotiations with Tishman stalled, the agency reached a conditional agreement with another bidder, a joint venture between local developer Related Companies and investment bank Goldman Sachs, in May 2008.
By January 2010, however, Goldman Sachs had exited the joint venture, which led to Oxford acquiring a 50 percent interest in Hudson Yards. Oxford and Related each have committed $475 million to the project, which is expected to be built over a 10- to 15-year period and cost a total of $10 billion upon completion. The team will finance each component of the development with a combination of equity, debt and third-party capital.
The master plan for Hudson Yards – the single-largest piece of undeveloped property in Manhattan – will encompass about 5,000 residential units in nine buildings, 6 million square feet of office space, 1 million square feet of retail space, a 150-room hotel, a cultural centre and a new public school. The first building of Hudson Yards – a 51-story, 1.7 million-square-foot office tower that will be home to Coach’s new global headquarters – is set to begin construction in mid-2012 and be open for occupancy in 2015.
“I think what’s a bit unusual is that Canadians are generally comfortable with development,” says Neil Jacob, who was a principal at Atlanta-based Chatham Capital Partners before joining Oxford in 2008. “Some pension plans tend to really avoid development because they either don’t understand or don’t have the people who fully understand the development process. Therefore, they rely completely on a third party to handle it.”
In Oxford’s view, however, “if you want to have top-of-the-line, top-quality assets, building it yourself gives you the opportunity to have that kind of investment,” Jacob says. “You have the leasing risk, but there’s the trade-off about the quality of the asset that you have at the end of the day.”
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