This article is sponsored by Macquarie Capital Real Estate Advisors.
The Canada Pension Plan Investment Board increased its real estate holdings by C$16 billion ($12.38 billion; €10.69 billion) globally in the past three years, with investments in the US contributing heavily to that growth. In a conversation observed by PERE, Erin Ledger-Beaupré, managing director at Macquarie Capital Real Estate Investments, discusses CPPIB’s recent investments and its take on the current market with three CPPIB real estate professionals: Hilary Spann, managing director and head of real estate investments for the Americas; and Lora Gotcheva and Pamela Thomas, both directors in CPPIB’s real estate group.
Growth of CPPIB’s portfolio
Hilary Spann: The US contributions to our growth over the last three years have been facilitated by strategic investments. One I would highlight is the acquisition of Parkway Inc, where we took a US office REIT private last year. We also achieve scale through significant joint-venture relationships, including in the student housing sector and the industrial sector, where we’ve been able to align with our partners and build high-quality portfolios very quickly.
Lora Gotcheva: Our acquisition of Parkway was the first public-to-private transaction that CPPIB has led globally. The company was a publicly traded REIT and it owns a fairly concentrated portfolio of about nine million square feet of Class A office assets in Houston. It was a very complex execution. Certainly, it was a lot harder than buying assets, but asset-level liquidity was limited and buying the company allowed us to get a scalable investment in a market that was, and still is, experiencing severe dislocation.
The importance of partnerships
Pamela Thomas: The vast majority of our investing is done through strategic joint ventures. We were able to form a very strategic joint venture in the student housing space and scale very quickly. We found a like-minded capital partner with GIC and a very resourceful private operator in the Scion Group. Mostly through portfolio acquisitions, we’ve grown our portfolio to a gross asset value of over C$5 billion in just a couple of years.
Erin Ledger-Beaupre: Can you talk about the challenges you face in a less traditional asset class like student housing, and coming in and creating scale quickly?
PT: There wasn’t a lot of institutional capital in the space at the time we entered, so we were able to scale pretty quickly. And we were attracted to the space by the outsized returns. That dynamic – limited capital, good risk-adjusted returns – began to attract a lot of new capital to the space. I think the challenge in specialty sectors is to get in and get to scale before other capital enters, compresses the returns and prices you out. Returns have compressed 50-100 basis points since we started investing in the sector, and this compression in yields has slowed our pace of deployment.
ELB: When was Scion?
HS: We closed on the joint venture with Scion in early 2016.
ELB: I’m interested in the time progression. It all happened relatively quickly when you look at it over a three-year period of time or less.
HS: Getting scale over a quick time period is critical in a sector like student housing where there are synergies that stem from having a larger platform. We identified at the time of our entry that the ownership of student housing was extremely disaggregated and ripe for consolidation. There was a big shadow market. There was a big local ownership market. By virtue of committing significant capital to that institutionalization of the sector, we attracted the notice of other investors and they joined the process. The window to achieve scale was very short.
LG: Having great partners helps us achieve scale quickly when it’s desirable. It’s part of our business model to partner with the best-in-class across every sector. Those are the most knowledgeable operators in the market. They’re able to unearth attractive opportunities in a variety of different market conditions. That really helps us.
PT: Retail is not dead but it is changing really rapidly. There are niches of retail that are actually doing pretty well, growing and performing well at this point. It’s the players like Sears, which have failed to keep up with the pace of change, that have suffered the most. They haven’t had the capital to invest in their business models, and they have just failed to keep up with the rapid change.
HS: While painful for the retail industry, I think it is healthy for retailing. The companies that are innovators in the space are thriving. The companies that have failed to innovate continue to struggle in this shake out.
ELB: If you look at your own retail portfolio now, versus where you thought it was going to be maybe two or three years ago, has it been better or worse? Has it been the apocalypse?
PT: We have a large mall portfolio. It’s become more capital intensive in recent years but our malls still generate very strong, very stable cashflows. If you strip out the noise around the sector, as a stream of cashflow, our investments are very high quality.
HS: The increasingly capital-intensive nature of retail assets is a market-wide phenomenon. Historically, one of the things that favored retail as an asset class was that it was less capital intensive than some others. That gap in capital expenditures as a percentage of NOI between retail and other sectors, like office, is closing.
Tight cap rates
ELB: Looking at the overall market, what are some of the hot topics?
HS: One topic that has received a lot of attention this year is public-to-private transactions. These transactions can be really compelling opportunities; but buyers shouldn’t go into it thinking that every company can be acquired at a significant discount to NAV, because that outcome would be contrary to the objectives of the board that is acting on behalf of its shareholders. If you think it’s a good value and business plan at NAV, the transaction could be a good one. If you need a significant discount to NAV to execute your business plan, you should proceed with caution.
ELB: Conversely what are some themes that haven’t received enough attention?
LG: I definitely think that capital expenditure is not being talked about enough. We’re seeing consistently across sectors that older assets really struggle to compete with new developments and recently renovated projects. Bringing them up to standard can be really expensive, if it’s even possible, because in some cases the physical characteristics of the older assets will never allow them to be Class A products. An example is the amenity packages at multi-family buildings and office buildings, where the market standard has significantly shifted over the last five-to-seven years. The increases in capital spent on these items is having a material impact on returns.
ELB: What’s been the most surprising thing in the market in the last 12 months?
PT: That cap rates haven’t moved more in the face of interest rates changing.
HS: But we think they will. Spreads have been compressing for the last 12 months or so, but can’t compress forever. Cap rates will eventually have to move in response. Since we can be unleveraged buyers, we see potential opportunity in the rise in rates – the market should have less competition from leveraged buyers. So we see opportunity where others may see risk.