Canadian pension funds prefer direct route for investment

Several Canadian public pension funds in recent months have made large investments in commercial real estate outside of the country, either directly or through co-investments.

The deals, involving plans including the C$192.8 billion (US$181.8 billion) Canada Pension Plan Investment Board, Toronto, and the C$189.5 billion Caisse de Depot et Placement du Quebec, Montreal, highlight the different philosophy Canadian plans use in real estate investing, choosing more direct methods over hiring external managers.

Among deals made by the Canadian plans in the second half of 2013:

• CPPIB and DEXUS Property Group's joint A$3 billion (US$2.7 billion) deal to acquire Commonwealth Property Office Fund, a portfolio of Australian office properties, which was accepted by the Australian REIT's board on Dec. 18;


• The acquisition of two office buildings in Chicago's West Loop neighborhood for US$360 million by Ivanhoe Cambridge Inc., the real estate investment arm of the Caisse, announced in November;


• A 50%-50% co-investment between CPPIB and Hermes Real Estate Investment Management Ltd., valued at £100 million (US$163 million), in London office building Aldgate, announced in October; and


• CPPIB's US$480 million equity deal to acquire a 27% stake in Aliansce Shopping Centers SA in Brazil from General Growth Properties Inc., announced in late July.

“We work differently” than U.S. public pension funds, said Bill Tresham, president of global investments at Ivanhoe Cambridge in Montreal, which manages C$40 billion in real estate assets on behalf of the Caisse. At Ivanhoe Cambridge, Mr. Tresham said, 50% of its investments are direct, with another 40% done through co-investments with other investors, including real estate managers or other pension funds. Only 10% of assets are invested in discretionary funds.

While Canadian plans chart a more direct course on real estate investments, U.S. pension plan executives likely will continue to use external managers, although some direct investments could be considered, said Mark Marasciullo, New York-based managing director, national investor services, at Jones Lang LaSalle Inc.

“Canadian plans — more so than most — do direct investing,” Mr. Marasciullo said. “In the U.S., I think they'll continue to employ managers and look at direct investments as well. The question is, (U.S. pension funds) might not be staffed to do so.”

Mr. Tresham said Ivanhoe Cambridge has a total of 1,000 employees managing property investing and the assets themselves. In comparison, there are 65 positions in the $277.3 billion California Public Employees' Retirement System's real assets unit, which oversees investment of the Sacramento-based system's $20.2 billion real estate portfolio, and 18 staff members in the real estate investment office at the $175.9 billion California State Teachers' Retirement System, West Sacramento, which oversees $21.9 billion. There are no property management employees at either California pension fund, spokesmen there said.

The issue isn't that returns are greater in direct and co-investments compared with external management, Mr. Tresham said: “In my view, over time, you're generating higher returns through third-party managers than through direct investing.” What matters to the Canadian plans like the Caisse is the control they have over the portfolio. “Our strategy is totally more nimble” than U.S. pension funds, Mr. Tresham said.

Blackstone Real Estate Advisors, Lone Star Funds, CIM Group and RockPoint Group LLC manage the combined 10% of Ivanhoe Cambridge's assets in discretionary funds. “They're a special group,” he said of the managers. “But the real issue (favoring direct investing) is if the pension fund wants to push the panic button in real estate and get out; in discretionary funds, there's nothing they can do about it. The question is, how much of your portfolio do you want direct control over?”

At CPPIB, “we only do direct investments, and as a rule outside of Canada we will invest alongside a local partner,” said Linda Sims, spokeswoman. “We have a small amount of money in a few real estate funds, but those are legacy holdings from the early days of CPPIB. As those funds reach maturity, we have been deploying the monies elsewhere, so that soon 100% of our real estate holdings will be through direct investments.”

But while Canadian plans are reaching out for international investments, a large amount of their direct investments are still made in Canada. In one Canadian property deal, Ivanhoe Cambridge in August took full ownership of Place Ville Marie, a Montreal office complex it had owned jointly with the C$70 billion Alberta Investment Management Co., Edmonton, for C$400 million.

Mr. Tresham said 46% of Ivanhoe Cambridge's assets are invested in Canadian properties. Cadillac Fairview Corp. Ltd., the real estate arm of the C$129.5 billion Ontario Teachers' Pension Plan, Toronto, had 82% of assets invested domestically as of Dec. 31, 2012, according to OTPP's latest annual report. CPPIB had 23.3% of real estate assets in Canadian property as of March 31, according to its website, and Oxford Properties Group, the real estate unit of the $C60.9 billion Ontario Municipal Employees Retirement System, Toronto, had 77% of its C$22 billion in assets under management in Canadian properties as of Dec. 31, according to OMERS' annual report.

Deborah Allan, OTPP spokeswoman, said the success of its real estate investments “is largely thanks to our 'homegrown' direct investment capability. … We now only use third-party managers to access markets or expertise that we believe would be uneconomic for us to develop internally.”

One of OTPP's first moves into direct investing of any sort was in real estate, in 1991, partnering with then-independent real estate investment manager Cadillac Fairview to purchase three major Canadian malls. OTPP took full ownership of Cadillac Fairview in 2000. “Instead of purchasing properties one at a time or handing decisions over to a fund manager, this purchase of an operating real estate company that owned prime properties instantly brought the real estate portfolio up to the target asset mix we had been trying to achieve,” Ms. Allan said.

Jones Lang LaSalle's Mr. Marasciullo said Canadian plans can take a more direct approach in general because they're heavily invested in Canadian property. “U.S. (real estate) markets move more quickly than Canadian markets,” he said. “It's easier to manage there, whereas in the U.S., values can rise (by) three, four times in the same decade. The U.S. market is just so incredibly liquid. It's why pension funds leave this to managers; conducting a $500 million trade in two weeks takes someone who can do this in their sleep.”

The demand for real estate by pension funds and other institutional investors globally is outstripping the supply for hard assets, which also makes it more advantageous to use third-party managers, said Mr. Marasciullo. Also, the experience of third-party managers that survived the real estate bubble of 2007 is an added benefit when the next “hiccup” in real estate returns comes, he said.

“Big institutional investors are asking, 'How can I make sure I get as many deals as I can and generate returns?' ... Institutions have great pools of capital, and right now real estate has most-favored-nation status for investors,” Mr. Marasciullo said. “There's room for everyone.”

Ivanhoe Cambridge's Mr. Tresham said that while co-investments are more likely for U.S. pension funds that want to move away from using third-party managers, “I don't think they'll ever evolve to the active Canadian model. I hope they do, because the way it works for us, it's kind of our secret sauce.”