Canada's pension funds, holding a 10% to 15% real estate allocation compared to the global average of 5-8%, were early adopters of international real estate investments. Their success spurred similar strategies among other pension funds worldwide. However, recent reassessments of their holdings, particularly due to underperformance like Quebec's CDQP's 7.2% return in 2023, have sparked concerns about the model's future. A downturn in Canadian foreign real estate investments could have a domino effect, impacting the global real estate market and influencing the strategies of other pension funds which have an estimated $40 trillion in assets.
Canada's Pension Funds Are Overweight Real Estate Compared to Peers
Canada's pension funds hold more real estate than their developed world peers. Industry experts estimate that Canadian pension funds hold around 10% - 15% of their total assets in real estate, including domestic and international properties. A 2021 report by Prequin placed the figure at 12% of funds allocated to real estate. This percentage is significantly higher than their peers, for example in America and Europe, which have between 5% and 8% allocated to global real estate investment strategies.
A study by CEM Benchmarking confirms these findings with a longitudinal study which found that over a five-year period ending in 2021, Canadian pension funds held a median real estate allocation of 11% of total assets. This is significantly higher than the 8% median allocation they found other pension funds had allocated to their real estate investing strategies.
While 2022 data from Canada's $421 billion sovereign pension fund, the Canada Pension Plan Investment Board ("CPPIB" or "CPP"), reveals a direct real estate allocation of 9%, this figure likely underestimates their total exposure. This is because pension funds often hold real estate indirectly through public and private equity investments. Additionally, the data only reflects the allocation of one fund, and as of 2022, Canada boasted over 16,164 registered pension plans, suggesting a more diverse and potentially higher overall real estate allocation across the nation.
Canada's Pensions Hold More Foreign Real Estate Than Peers
Data from Statistics Canada reveals that, as of Q1 2023, Canadian pension funds held 21% of their total assets in foreign investments, including real estate and other holdings. This significantly exceeds the foreign allocations of their counterparts, with U.S. pension funds typically holding between 5% and 15% of their assets abroad and European funds averaging 5-10% foreign investment. This disparity highlights the unique international investment strategies of Canadian pension funds compared to their global peers.
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At first glance, the size of Canada's domestic real estate market, valued at an estimated $10 trillion in December 2023, might suggest that Canadian pension funds could solely focus on domestic investments. Holding roughly $1.8 trillion in assets at the same time, their holdings represent a significant 18% of the Canadian market. This five-to-one ratio appears favorable compared to both the U.S. and Europe.
America's real estate market dwarfs Canada's at an estimated value of $43.4 trillion as of the end of 2023. The United States pension system is estimated to have a value exceeding $40 trillion in assets, or roughly a one-to-one disparity between market value and pension fund holdings. Europe's numbers compare to America's with a real estate market valued at around $48 trillion, and a pension system sitting at around $33 trillion. This suggests that based solely on market size, American and European pension funds might be the ones seeking international opportunities, not the Canadians.
Theories As To Why Canada Favors Foreign Real Estate Investing
While Canada boasts a robust and stable real estate market, the question arises: why do Canadian pension funds venture beyond domestic borders? One key reason lies in the limited availability of "institutional-grade" investment opportunities within Canada. Pension funds, seeking large-scale investments and partnerships with reliable players, often face intense competition for these limited deals, driving up valuations and potentially hindering the desired return on investment.
America is a more dynamic and larger economy and therefore will have more opportunities, at perhaps better valuations, for Canadian pension funds to invest in. America will also have more "institutional-grade" opportunities and since the deals are larger the appetite for co-investment partners should be greater than would be the case in Canada.
Supporting this assertion is data from Real Estate Information Services ("REIS") which revealed that the average commercial real estate transaction in Canada in 2023 was $9.1 million, compared to $22.1 million in America. Most of the transactions in the sample aren't "institutional-grade" but it's not unreasonable to assume the same or greater disparity would apply to those larger transactions pensions funds are always seeking.
Cracks Emerging in Canada's Overseas Real Estate Strategy
According to Bloomberg, Canada's pension funds are rethinking their real estate strategies. This raises concerns for two key reasons: firstly, their early success inspired other pension funds worldwide to follow suit, and secondly, their potential withdrawal could trigger a domino effect in the global real estate market.
Performance concerns are one driver of the reevaluation. For example, Quebec's public pension manager ("CDQP") reported a disappointing 7.2% return in 2023, with real estate allocations significantly impacting performance.
Additionally, Canada's largest pension fund recently sold three discounted office properties: two Vancouver towers, a Southern California business park, and, in a surprising move, a Manhattan redevelopment project for just one dollar. John Kim, an analyst at MBO Capital Markets, had this to say on the disposals:
"[the pension fund unloading properties is] the opposite of a vote of confidence for office... My question is, who could be next?"
Despite this somewhat bad news, it's critical to maintain perspective. Pension funds routinely adjust their portfolios, and selling assets doesn't necessarily signal a complete exit from a particular sector. While this may indicate a shift away from underperforming office space, Canadian pension funds still hold significant office assets and haven't entirely abandoned the sector, as evidenced by CPP's recently completed 37-story Vancouver office tower.
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