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Jun 30, 2016

Investing In Real Estate: Tap Into The Institutional Advantage

by Derek Henderson

Derek Henderson

 

 When evaluating the effectiveness of your investment portfolio, whether you are working with an advisor or managing your own investments, the following objectives are important considerations:

 

 

  • Capital preservation
  • Return enhancement
  • Risk mitigation
  • Inflation protection
  • Income generation
  • Low volatility

Given the current market environment of increased volatility, low rates and overall market uncertainty, you may be wondering if there are also unique investment options to consider. An alternative asset class like real estate can play a vital role in any multi-asset portfolio—to provide capital protection, consistent income and the opportunity for significant value creation and capital growth.

Real estate investment has not always been viewed advantageously; it wasn’t until a 1970 speech to the Treasurer’s Club in New York when George Russell suggested that pension funds should start to consider investing in foreign stocks and real estate to help diversify their portfolios1. Fast forward 40 years and real estate has become an integral part of the institutional investment portfolio as a diversifier, income generator and a way to enhance overall returns1.

In Canada, we only need to look to our 10 largest pension funds to see that they are heavily invested in alternative asset classes, such as real estate, infrastructure and private equity—a strategy which has boded very well.

According to Morningstar3 there are three distinct categories of alternative investments:

  1. Non-traditional asset classes, such as currencies and commodities
  2. Non-traditional strategies, such as shorting and hedging
  3. Illiquid assets, such as private equity or private debt and real estate

These pension funds have managed significant growth in the last 10 years. They have seen assets under management triple since 2003, generating $600 billion in net investment returns from 2003 to 2014. 80 percent of the increase in value was driven by investment returns in today’s low rate environment.

These 10 large pension funds have allocated an average of 32% of their investments in alternative asset classes, which includes a real estate allocation (we do not have the specific real estate percentage). In contrast, most other Canadian pension funds carry an 11% allocation in alternative asset classes while the average retail investors hold approximately 5% alternative investments in their portfolio2.

Using this top 10 is not a fair representation since the average retail investor has historically not had the size, the clout or the overall ability to invest in such direct assets. Even small pension funds do not have the ability to own 50 million square feet of Canada’s best office, retail, multi-res, industrial and hotel real estate. However, through investment product innovation, today we have a multitude of investment options including investing in publicly traded Real Estate Investment Trusts (REIT), Real Estate Mutual Funds and Exchange Traded Funds, as well as opportunities to invest in private REITs and private funds focused on direct real estate ownership.

As we start to realize a greater ability to access ways to invest in real estate, it’s important to understand the advantages and disadvantages of the tools we utilize to access the asset class.

With this in mind, we wanted to share some interesting and exclusive insight into some of the options we have for investing in real estate and why it is important.

One of the advantages of spending a number of years on the institutional side of investment management is developing wonderful relationships with some of the country’s brightest minds in the Canadian financial community. I recently had an opportunity to sit down and chat with a number of them to share their perspective on real estate, the advantages of investing, and why they personally are firm believers in this alternative asset class.

In this article we will share some insight from the manager of a private real estate fund, Peter Cuthbert, Senior Vice President and Partner at Fiera Properties.

Peter Cuthbert has 30 years of experience within the commercial real estate investment industry in Canada. His multi-disciplinary background includes hands-on experience with capital fundraising, real estate portfolio and asset management, real estate finance, appraisal, leasing, acquisitions and dispositions.

Below are some highlights from our conversation.

Derek Henderson: Peter, why do you feel investors look to real estate as an important asset class within their investment portfolios?

Peter Cuthbert: Most investors come to invest in commercial real estate because it has investment characteristics that are unique. It has a low correlation with equity and bonds, lower volatility than equity and has proved to be a good hedge against inflation. In essence, real estate has both bond-like and equity-like qualities and serves to further diversify an investment portfolio, reducing overall risk and volatility.

DH: Can you expand on the thought of investors looking to real estate as a bond-type investment?

PC: Of course, the asset class does have inherent bond-like characteristics in that you are not just investing in a building but you are investing in tenant leases that represent commitments to pay rent/income to you every month over lease terms that can range from 1 year to more than 20 years. If your building is leased to high-quality tenants for long lease terms, it is a bit like a bond in that there is an obligation to make regular payments to the investor/landlord on fixed terms over an extended time period.

DH: Can you expand on the equity notion?

PC: Real estate has some equity-like characteristics in that the investment can also provide capital appreciation. If the site upon which your building is situated is in a strong location that appeals to a broad array of enterprises/tenants, then it is likely to grow in value over time. Picture an office building sitting next to a light rail transit stop and then think about competing for tenants with other buildings that are two blocks from the transit stop. Which building will a tenant prefer, all other things being equal? Which building is likely able to charge more rent? How likely is it that another transit stop will be built two blocks away near the other buildings? In essence, the building has a locked-in locational advantage due to its proximity to mass transit and that generally equates to long-term value appreciation over time.

Not surprisingly well-located, well-tenanted commercial real estate tends to deliver investment returns that are better than bond returns but less than equity returns over time.

DH: Thanks Peter. Are you able to provide some insight into your philosophical view on real estate and how real estate should be viewed as a diversifier?

PC: Real estate simply houses the economy—an investment in real estate is an investment in the broad economy. If you have a good quality, functional building in a strong location you can attract a broad array of tenants. Should, in a worst-case scenario, your tenant fail, it’s okay because there are many other tenants who are happy to lease the well-located, functional building. In other words, unlike a bond or an equity investment, you are not dependent on the success or failure of a single enterprise and, over time and no matter what happens, the land under your building will very likely grow in value over time.

That by far is an over simplification but I believe it captures the essence of real estate investment.

Real estate can act as a diversifier and can play such a role in any investor’s portfolio. We encourage you to review your allocation and ensure you are utilizing the real estate asset class appropriately for your circumstances. Whether you are focused on capital preservation, looking for stability and income or seeking opportunities to enhance growth, real estate may be a positive addition to your portfolio.

 G. Derek Henderson, Portfolio Manager, The Bush-Henderson Investment Team, CIBC Wood Gundy. Email: Derek.Henderson@CIBC.com www.Bush-Henderson.com

 

1. Structuring a private real estate portfolio, Leola Ross, Ph.D., CFA, Senior Investment Strategist and John Mancuso, CFA, Senior Research Analyst

2. Top Canadian pension funds major RE players: Study by Paul Brent | Commercial | Property Biz Canada | 2015-12-17

3. http://www.morningstar.com/advisor/alternative-investments.htm

 

CIBC Wood Gundy is a division of CIBC World Markets Inc., a subsidiary of CIBC and a Member of the Canadian Investor Protection Fund and Investment Industry Regulatory Organization of Canada. If you are currently a CIBC Wood Gundy client, please contact your Investment Advisor. G. Derek Henderson is an Investment Advisor with CIBC Wood Gundy in Waterloo. The views of G. Derek Henderson do not necessarily reflect those of CIBC World Markets Inc This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed and is subject to change. CIBC and CIBC World Markets Inc., their affiliates, directors, officers and employees may buy, sell, or hold a position in securities of a company mentioned herein, its affiliates or subsidiaries, and may also perform financial advisory services, investment banking or other services for, or have lending or other credit relationships with the same. CIBC World Markets Inc. and its representatives will receive sales commissions and/or a spread between bid and ask prices if you purchase, sell or hold the securities referred to above. © CIBC World Markets Inc. 2016. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed. Their values change frequently and past performance may not be repeated. The securities mentioned in this article may not be suitable for all types of investors. This article does not take into account the investment objectives, financial situation or specific needs of any particular client of CIBC Wood Gundy. This article is not an investment recommendation. Recipients should consider this article as only a single factor in making an investment decision and should not rely solely on the information contained herein as a substitution for the exercise of independent judgment of the merits and risks of investments. Past performance is not a guarantee of future results, and no representation or warranty, express or implied, is made regarding future performance of any security mentioned in this article. Information, opinions and statistical data contained in this article were obtained or derived from sources believed to be reliable, but CIBC Wood Gundy does not represent that any such information, opinion or statistical data is accurate or complete, and they should not be relied upon as such. All estimates, opinions and recommendations expressed herein constitute judgments as of the date of this article and are subject to change without notice.