Canadian pension funds are the world's most active buyers of real estate, kicking off a revolution that has inspired retirement funds around the world to follow suit.Now the country's largest pension funds are taking steps to limit their exposure to the most distressed property type: office buildings.
Canada Pension Plan Investment Board has sold three discounted stakes in two Vancouver towers, a Southern California business park and a Manhattan redevelopment project. The New York shares sold for the eye-watering price of just $1. The concerns are that the deals could set an example for other big investors looking to exit turmoil.
“This is the opposite of a vote of confidence in office,” said John Kim, an analyst who tracks real estate companies at BMO Capital Markets. “My question is, who's next?”
Worries about office buildings are sweeping the financial world as continued work-from-home policies and rising borrowing costs undermine the economic fundamentals that made them a good investment in the first place. A number of banks from New York to Tokyo recently acknowledged that loans on office buildings may not be repaid in full, sending stock prices plummeting and raising concerns about a broader credit crunch.
But the real test will be how much office buildings actually trade for, and there have been very few of those since interest rates began rising. That's why industry watchers see discounted deals like CPPIB's as an ominous sign for the market.
Reallocation of cash
The pension fund isn't actively moving away from offices, but it isn't looking to increase its office holdings either, said a person familiar with the fund's strategy. And for properties that need additional investment, CPPIB may simply consider selling them and investing the cash in places with higher returns, said the person, who asked not to be identified discussing private matters.
Peter Baron, CPPIB's global head of real estate, declined to comment on the recent transactions but said the fund continues to invest in office buildings, including a recently completed 37-storey tower in Vancouver.
“Divestments are an integral part of our investment process,” Baron said in an emailed statement. “We close divestitures when the value of the assets has been maximized and we are able to reallocate the proceeds to other assets, sectors and markets, including office buildings.”
CPPIB's C$590.8 billion (US$436.9 billion) fund is one of the world's largest pools of capital, and its C$41.4 billion real estate portfolio stretches from Stockholm to Bangalore and includes nearly every type of property, from warehouses to life-science complexes to apartments. That size should mitigate potential losses from any individual deal, but it also means that even small changes in CPPIB's demand for office space have the power to send ripple effects through the market.
Manhattan Tower
Late last year, the fund sold a 29% stake in 360 Park Avenue South in Manhattan to one of its partners, Boston Properties Co., which also agreed to assume CPPIB's share of the project's debt. The investors, along with Singapore sovereign wealth fund GIC Pte, plan to buy the 20-story building in 2021 and redevelop it into modern workspace.
Boston Properties said last month that its sales partner, which it did not name, had already spent $71 million on the project, but by severing ties it was freeing itself from an obligation to put in another $46 million.
Around the same time, CPPIB sold its 45% stake in Santa Monica Business Park, which it held with Boston Properties, for $38 million, nearly 75% less than what CPPIB paid for its stake in the property in 2018. Boston Properties CEO Owen Thomas said on a conference call that the deal came shortly after the landlords signed a lease with social media company Snap Inc. that required them to spend additional money on improvements to the campus.
The two Vancouver buildings, co-owned with another Canadian pension fund, differ in that they don't require significant new investment and already have Amazon.com Inc. as an anchor tenant. But their sale price last month was about C$300 million, more than 20% below the property's 2023 estimated value, according to data from Altus Group.
The sale coincided with the completion last year of a new Vancouver office building that CPPIB developed with the same pension fund, and the partners wanted to limit their growing overall exposure to the Vancouver office market, the people said.
Hybrid work schedules will dampen demand for office space in the long term, and rising interest rates will increase the costs of the ongoing upgrades needed to attract and retain tenants, meaning even the best office buildings may find themselves unable to compete with other investment opportunities.
“To get a higher return on your office investments, you need to modernize your offices and put more capital into them,” said Matt Hersey, a partner at real estate capital advisory firm Hawes Weill & Associates. “Sometimes it's better to take a loss and reinvest in something that's likely to perform better.”
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