By Erik Sherman

Which was more shocking? When Peter Ballon, global head of real estate at the Canada Pension Plan Investment Board, announced in March that he would step down from his position? Or when the CPPIB sold off interests in “a pair of Vancouver towers, a business park in Southern California and a redevelopment project in Manhattan, with the New York stake offloaded for the eyebrow-raising price of just $1,” according to Bloomberg.

It’s not just Canadian pensions. The Wall Street Journal wrote in May that the $333 billion real estate portfolio of the California State Teachers’ Retirement System (CalSTRS) had seen a 9% loss for 2023.

The real estate market has been rough, with falling valuations and transactions, rising waves of mortgage maturities, tough financial markets for refinancing, and banks facing increasing percentages of their loan portfolios being problematic, if not in trouble. However, the actions that pensions have taken aren’t a desperate panic. Experts say that the organizations are doing no more or less what any institutional investor does — balancing interests and imposing an overall corporate-like strategy and discipline to further their interests and those of stakeholders.

Too Big to Run Away

Before any other consideration, Canadian pensions have far too much invested in real estate, both equity and debt, to give up and go elsewhere. Here are some reality checks:

  • The British Columbia Investment Management Corporation (BCI) wrote in the 2023-2024 annual report that it has $35.1 billion in real estate equity and another $8.9 billion in real estate debt. The wholly owned QuadReal Property Group disposed of $1.2 billion of investments with 60% being in Canada but also deployed $3.3 billion in new investments. As for debt, “Despite muted lending activity, 2023 investment commitments were $3.2 billion. Sixteen new debt borrowers were added to the portfolio, 12 in the U.S. and four in Canada.”
  • CPP Investments, which manages the Canadian Pension Plan’s funds, real estate was about 8% of total assets. That’s down a percentage point from 2023, 2022, and 2021, but still a significant portion.
  • The Healthcare of Ontario Pension Plan (HOOPP) saw a drop in the value of its real estate from $21 billion at the end of 2022 to $19.5 billion at the close of 2023. “In 2023, the portfolio produced a net return of -6.5% on a currency-hedged basis, and -$963 million in value add – this negative value add was primarily due to our large international portfolio, which experienced sharper downward mark-to-market adjustments relative to our all-Canadian benchmark.”
  • The Ontario Municipal Employees Retirement System (OMERS) blamed weakness from private equity and real estate for a 2023 annual return of 4.6%, not the benchmark 7.0%. Still, real estate was 15% of the asset mix.

The pension funds have had worries, like every other large, sophisticated institutional investor. Some properties lost significant value. However, strategies for commercial real estate depend on several factors. “In many instances, and pension funds are no exception to this, there are overarching corporate decisions being made,” says Steven Jason, managing principal of EOS Real Estate and Financial Advisory.

The point isn’t to make real estate the center of a pension but to blend the collection of asset portfolios in a strategy that meets pension goals of growing financial strength and having capital available when needed to meet obligations to members.

Part of that strategy is to ask several questions about assets, with variations for real estate:

  1. What is the relationship to the asset? Whether sole ownership, owning some share, investing in a fund, or investing in debt, the structure of the relationship will influence what options the pension can exercise.
  2. Has there been a loss in value? If so, the pension has to decide whether value will return in a reasonable amount of time. As Jason says, “Office is still probably going to get worse and selling now, sometimes they say your first loss is your best loss.” If the value has risen, will it remain high or does it make more sense to sell and take the profit while available?
  3. Is there a better use of the capital tied in the asset’s value? The pension might find it wise to sell one asset and put the resulting cash into some other investment.
  4. Is it time to rebalance the portfolio? When values change, it might be that the investor needs to sell assets in one category and move the capital into another to maintain the planned balance.

And there is the reality of where markets and investors are moving now. “None of my pension clients are selling real estate at all,” says John Nicolini, managing director and senior consultant at consultancy Verus. “All the sectors other than office may be past bottom. We expect more pain in 2024 but believe we are much closer to a bottom than where we sat one year ago.”

If that’s accurate, selling now might not make sense after all. But that’s a complex decision that each pension has to make for itself.