Warming up to a cool country

Canada’s steady growth and lack of volatility make the country an attractive investment for local and foreign buyers – if they can overcome its barriers to entry.

Compared with its southern neighbor, Canada appears in few headlines – and for real estate investors, that’s increasingly a selling point.

The country is not embroiled in a trade war; its financial markets are known for transparency; job growth is steadily rising in its major markets; and, critically for PERE readers, real estate across property types is neither overdeveloped nor overleveraged, according to four executives discussing the market on a sunny April morning in Toronto.

The roundtable participants:

Greg Spafford

Managing director and senior portfolio manager, Manulife Real Estate

Spafford is responsible for the investment strategy, transaction execution and overall portfolio management of Manulife Real Estate’s open-ended Canadian funds, which account for C$3 billion of the firm’s C$22 billion in real estate assets under management.

Prior to joining Manulife in 2017, Spafford worked for LaSalle Investment Management for almost 14 years building the firm’s Canadian fund business.

Mark Renzoni

President and chief executive, CBRE Canada

Renzoni oversees CBRE’s activities including brokerage, outsourcing, appraisal, property management, debt capital markets and consulting. The Toronto-based executive started at CBRE in 1989 in the firm’s office leasing division. CBRE aims to expand its market-leading investment advisory business in Canada in 2018, which saw it advise on 37 percent of all deals by volume in Canada over C$10 million last year.

John McFadden

Executive vice-president and portfolio manager, Bentall Kennedy (Canada)

The Bentall Kennedy veteran oversees client relations and asset management activities in central and eastern Canada for the Canadian core accounts group. The firm’s 35-year-old core fund held C$4.9 billion in assets as of December 31.

Prior to joining the firm in 2002, McFadden spent 14 years at Beutel Goodman Real Estate Group, where he worked in business development, acquisitions and asset management.

Matt Scholl

Executive director, head of investment management Americas, Union Investment

New York-based Scholl joined Union in February 2016 with a focus on expanding the German investor’s Americas footprint. The Hamburg-based investment manager oversees about €35 billion in real estate, with about $6 billion in the Americas, largely in the US.

Scholl previously served as managing director at AFIAA Swiss Foundation for International Real Estate Investment, heading up the group’s North American investment activities.

“A lack of volatility can be good. We find that stability in Canada can be attractive,” says Greg Spafford, managing director and senior portfolio manager at Manulife Real Estate.

Global real estate capital seems to agree: in 2012, foreign capital comprised 2.7 percent of the C$30.6 billion ($24.2 billion; €19.7 billion) of real estate sold, whereas last year, foreigners bought 13.4 percent of the $C43.1 billion transacted, according to CBRE.

“Canada is more open to business than ever before,” says CBRE Canadian president Mark Renzoni, a verdict unanimously agreed on by Spafford, John McFadden, executive vice-president and portfolio manager at Bentall Kennedy, and Matt Scholl, head of investment management Americas at Union Investment.

Barriers to entry

Union, for one, is keen to take part in that openness by re-entering Canadian real estate for the first time since it left the market in 2012 following a single asset sale.

“We’re bullish about Canada and we’d love to plant a flag here again and love for that to be in 2018,” Scholl says. “From a German capital perspective, it’s still viewed as a safe haven market, although we’re finding it difficult to re-enter for a host of reasons.”

One major reason is the dominance of the country’s own institutional investors. Canadian-domiciled public pensions, for instance, rank among some of the most sophisticated global investors, with eight appearing on PERE’s Global Investor 50 ranking of the largest investors last year, second only to US-based investors. On their own turf, these investors have robust platforms with deep reaches into the country’s tenant and business communities. They also have long-term horizons, which lead to far less frequent exits than other players, such as private equity real estate firms with limited-life vehicles.“In large part, the reason why Canada’s marketplace is so stable and enviable is that the institutional market has a big component of the investment stock, providing stability,” McFadden says. “However, they’re the very people who don’t trade a lot.”

Times appear to be changing. Data suggest Canadian investors are indeed beginning to ramp up their sales, particularly of non-core assets. Canadian pensions’ domestic transactions sold about $460 million of real estate 2014, but $2.1 billion in just the first half of 2017, according to Real Capital Analytics.

Critically, these Canadian investors’ continued interest in diversifying globally through exiting local interests and redeploying capital abroad offers opportunity for foreign capital to enter the market.

“We’re bullish about Canada and we’d love to plant a flag here again and love for that to be in 2018”

– Matt Scholl

“This year, you’re seeing a lot of partial interest trades, including trades on some of the best assets,” Spafford says. “It would be prudent for foreign investors to change their scope to look at partial interests. Otherwise, you have to really step up the risk curve to meet their return requirements.”

Partial interest trades have picked up steam since 2013, which saw two such deals totaling C$200 million, according to CBRE research. Last year, by contrast, investors executed eight deals totaling C$4.4 billion.

Scholl concedes that Union will likely be part of this trend as it looks to buy a core office or retail asset this year to make its mark. The firm’s ex-Canada relationships, such as a joint venture it inked with Oxford Properties in the UK, may be the key.

“We’ve always been very open to the idea of leveraging our contact base and our know-how in Europe with Canadian players in exchange for the ability to re-enter and grow in this market,” says Scholl. “Union is thinking about Canada strategically over the long term, so this approach is one that makes a great deal of sense to us.”

These partnerships, for Union and others around the world, will be key to the next generation of foreign capital entering Canada, Renzoni adds.

“As Canadian funds increase their global allocations, it’s a way for institutional money around the world to develop partnerships with Canadian funds in other markets and then, in turn, unlock Canadian assets. In 2018 and 2019, we’re going to see more Canadian institutional capital partner with global capital. The tradeoff is what’s in it for the Canadian funds in Europe or in Asia, and then what can those funds provide in partnership at home in Canada.”

Such local partnerships can help with deal sourcing in the illiquid market. Other options to buy include picking up assets from real estate investment trusts such as RioCan, Canada’s largest REIT, which said it plans to sell C$2 billion of assets by 2019 to focus on core markets.

However, even if foreign capital finds a deal, it can be tough to win. Spafford alludes to foreign buyers taking six to nine months to close CBD core transactions because they have to structure equity and debt for tax and currency efficiencies, among other issues.

“We’ve seen scenarios where even when foreign buyers were at the table with strong pricing, we found that domestic buyers who were close enough, and who had everything in order, were seen as more attractive due to the certainty they provided.”

The investment managers at the table agree that capital deployment is far more difficult than capital raising.

“There’s lots of money out there,” Spafford says. “Money isn’t what drives the industry anymore – it’s opportunity. Investors are asking about market access, and anytime they’re talking about placing more capital into your funds, they want to know if you can execute.”

McFadden, for one, says he sees solid inflows with growing interest in both core funds and other strategies, particularly in higher-risk debt products.

“We’re getting take up on it because it offers higher returns, so our clients are quite keen to think about it. I think the general rule is everyone’s looking for more return.”

Canadian investors themselves are becoming more sophisticated, beyond the global investors already well known outside the country, Spafford says.

“Smaller accounts are also thinking globally and about different asset classes. They aren’t platform-building in Manhattan, but they’re certainly interested in moving their money into global and alternatives funds, even in small amounts of C$5 million-C$20 million.”

Office and industrial in demand

Urban office is a hot sector across Canada’s largest cities, buoyed by employment growth, especially in technology. However, since institutional investors often retain the best assets in their portfolios for years and the country’s development pace is slow, properties that do sell are often of lesser quality than what trades in the US.

“One of our frustrations here in the Canadian market is the age of stock across the office sector which is often considered and priced as core,” Scholl says. “While there has been a great deal of new development in Toronto, we are not looking to invest in assets that require extensive capital expenditures from day one, nor are we looking to reposition assets, particularly at the kind of core pricing we are seeing today.”

Retail, meanwhile, is facing a reduced version of the same headwinds the property type suffers from globally. Canada had about 16 percent less retail shopping center square footage per person than the US at the end of 2017, per CBRE. Retailer bankruptcies, in particular Sears Canada and Toys R Us, are opportunities to bring in more experiential tenants with smaller footprints.

“E-commerce is an evolution of our shopping habits, and Canadians are well positioned for it,” Spafford says, noting Canadians have long shopped through catalogs, a predecessor to e-commerce. “One sentiment I’ve heard is that Canada is not over-retailed, but the US is under-demolished. I believe we’re right-sized.” While retail can be more difficult than other property types to sell because of the seeming headline risk, Spafford says net operating income is stable.

Industrial, on the other hand, is the easiest to sell – but little is trading in what McFadden deems the “healthiest market in Canada,” with particular demand for large logistics centers in Toronto, Calgary, Vancouver and Montreal.

“There’s no simple way to get into that market,” Spafford says. “You have to go in and create value. You have to step up the risk curve. Build-to-core, which back when I started in the industry used to be called speculative development and was considered quite risky, is now core investing. You have to get into that, or you have to take more of an active management role by picking up older industrial and recycling it.”

Development can be difficult no matter the property type, McFadden says. Bentall Kennedy is cautious on development because of the difficulty in obtaining approvals and entitlements, as well as increasing land and construction costs.

“The stability of the Canadian marketplace ripples through the whole asset class and is also evident in the development world. History has proven that we are very cautious about new development relative to our neighbors to the south, which keeps most of our markets at a pretty good spot from a vacancy standpoint.”

However, he says that for careful investors, there is opportunity to add alpha. In one major deal, for example, Ivanhoé Cambridge and Houston-based real estate investment manager Hines teamed up to buy and develop land for a 2.9 million-square-foot office campus in Toronto that will be completed in 2020. CIBC Square will encompass two office towers, with amenities including fitness and bicycle parking facilities, restaurants and interior parking. The project broke ground in June.

Market momentum

What is next for Canada? More macro stability begetting more growth. The roundtable participants agree there are few economic or political concerns to give real estate investors pause. All are watching the US’s trade negotiations, including NAFTA, but say it is a variable, not a tipping point, for commercial real estate. Indeed, just days after the roundtable, US President Donald Trump surprised the political and financial worlds by saying he was interested in rejoining the Trans-Pacific Partnership, in which Canada is a longtime member, a year after he pulled out.

However its southern neighbor decides to proceed politically, Canada’s stable political landscape, solid employment prospects, wage growth and business spending, continues to drive real estate demand. Last year saw the country set its second consecutive investment volume record, and CBRE predicts it could surpass that C$43.1 billion mark this year.

“It’s going to be a strong year for continued growth and solid market fundamentals,” Renzoni says. “This is a very positive economic moment for Canada and the commercial real estate market. There is real strength and momentum, especially in our core markets.”


Capital destinations in Canada

Foreign and domestic capital has plenty to like in Canada, but geographic diversity is challenging, with institutional capital largely focused on Toronto, Vancouver and Montreal

Toronto: Because the country’s financial market is concentrated in Toronto, it can be difficult to diversify outside. Toronto itself is seeing record low office vacancy with a surge in interest from tech employees. “2017 was the year that Toronto truly moved ahead as one of the top global cities for economic growth, investment and job creation,” says Renzoni.

Montreal: The country’s second most populous city is piquing investors’ interests. In the multifamily sector in particular, CBRE expects large portfolio transactions and record pricing.

“We’re bullish on Montreal,” McFadden says. “There is some good growth we believe that’s going to occur in Montreal. It’s come already in employment, when you think about artificial intelligence particularly, but more generally, there’s a healthy economic environment in Montreal and the province of Quebec. We’re very keen about Montreal as the third major market that we are participating in in a big way” in 2018.

Vancouver: Investment volumes in Vancouver climbed to a record C$11.7 billion in 2017, up 45 percent year-on-year, according to CBRE.

“Vancouver is increasingly more expensive and attracts significant foreign capital,” Renzoni says. “Asian buyers are still very active in Vancouver, even if it seems that local media reports indicate otherwise.”

Alberta: The roundtable’s consensus is that oil-dependent Alberta, which has found its low point after oil prices plummeted in 2014, is once again a destination for capital. McFadden says Bentall Kennedy would again look to invest in the province, and he is not the only one with a bullish opinion.

“We started to see stability in the Alberta market last year and it is continuing to show signs of stability this year,” Spafford says. “Calgary and Edmonton have now stabilized because people have a general sense of where the global oil and gas market is.”