Canadian capital is the single largest source of inbound capital into the U.S. commercial real estate market.
OVER THE 36 MONTHS ending in May 2015, Canadian institutional capital represented $33.2 billion in investments in U.S. commercial real estate, over 50 percent more than the two largest Asian sources of capital combined. The Canadian investor types represented include pension funds’ direct investments, pension fund-controlled asset managers, public and private vehicles, life insurance companies and independent asset managers. Institutions are focusing on gateway cities like New York, San Francisco, Boston and Los Angeles, while public REITs and private investors are active in the secondary markets.
While Canadian institutional capital is very active, not all Canadian institutions are investing directly in the U.S. Smaller Canadian funds and those not yet established enough to invest directly are committing to larger funds that invest in the U.S. on their behalf. These investments represent an additional $3 billion to $5 billion annually.
Why is Canadian institutional capital flooding the U.S.? Although the reasons are specific to each investor, the simple answer is that the risk-adjusted returns are far greater than those available domestically. The two markets can be differentiated as follows:
- The Canadian institutional real estate investment market is dominated by very few, very large players. Institutional-quality “core” assets of any class rarely trade on the open market. When they do, competition for those assets has compressed yields to historical lows.
- The U.S. investment landscape is much larger (15 times larger than the Canadian real estate market), the transaction velocity is far greater and the market has a very robust general partner/limited partner system of closed-ended funds that must be constantly harvested, creating buying opportunities for institutional and sovereign buyers.
As the U.S. suffered more value erosion than Canada during the 2008-2010 global financial crisis, Canadian buyers took advantage of these pricing discrepancies in advance of a U.S. economic recovery. Despite the price recovery that occurred between 2010 and 2015, the U.S. remains very attractive to Canadian capital because of the previously mentioned adjusted returns, even with the current 20 percent currency deficit.
One of the more nuanced reasons Canadian institutional investors are busy in the U.S. — and elsewhere around the world — is the sheer size of the opportunities outside Canada. Canadian pension funds, in particular, have grown so large that they must invest in very large opportunities to meet their objectives. They simply cannot meet their investment and return requirements in a country as small and with opportunities as constrained as Canada.
Canadian institutional investment in the U.S. is not limited to direct purchase of assets. Much of it has taken place as platform purchases of existing operating entities. For example, Brookfield Asset Management has acquired stakes in General Growth Properties (retail), Associated Estates Realty Corp. (multifamily) and Thayer Lodging (hospitality). It is also reflected in continuing investment in the development and intensification of U.S. markets, such as the Hudson Yards project in New York, led by Oxford Properties and The Related Companies, Brookfield’s Manhattan West redevelopment and the repositioning of Brookfield Place in Lower Manhattan. And the Canadian Pension Plan Investment Board (CPPIB) increased its commitment to real estate investment manager Goodman Group, an investor in U.S. warehouses, to $900 million, up from $400 million in 2014. All of these represent significant investment in other commercial real estate opportunities, which is not always factored into the annual investment figure stated earlier.
This level of Canadian institutional investment will likely continue in the short run. Canadian institutional investors still control the throttle, and it is wide open. However, three external factors may temper their appetite and could slow investment velocity:
- Various funds have committed — but not yet invested — over $120 billion in equity capital for U.S. real estate as of year-end 2014. This is up from $79 billion in 2010. When you consider the impact of leverage, the capital available can stretch to over $200 billion. And with the amount of capital committed to real estate funds growing and the supply of opportunities dwindling, this unplaced capital in the U.S. will add to the oversupply of funds looking for opportunities.
- The Asian institutional investor market is growing fast. With the liberation of constraints on the movement of capital from Asian markets, a wave of capital will have to be invested globally to achieve the desired strategies and returns required by these massive investment vehicles. The U.S. will remain a primary destination for this capital. The Asian institutional capital chasing quality assets in the U.S. has the potential to crowd out many other international investors, Canadians included. However, for that to occur, these Asian investors will need to develop more sophisticated due diligence processes and operating platforms and scale to compete with established U.S. and foreign players.
- The strengthening U.S. recovery will compress yields in primary gateway markets to the point where, eventually, the risk/reward ratio will look less attractive to Canadian investors, and those sophisticated, well-established institutional investors will start to move new capital into other markets.
For the time being, however, for an asset of core quality in a gateway U.S. city, Canadian investors will be there with very sharp pencils.