There is a widely held belief that it isn’t possible for smaller funds to construct real estate portfolios similar to those of the largest funds. The fact is, not only is it possible but it’s also quite straightforward. The starting point is to understand what the big funds are doing. Across the largest funds in Canada, the average real estate allocation is 13%. Without exception, policy statements of the biggest funds in Canada cite stable, predictable income as the main reason for having such significant exposure to real estate.
The place to start creating a real estate portfolio is at home. Canada has been the best-performing global real estate market for the last five to 10 years. In a broad sample of global real estate investors, 71% said Canada will be the best place to make real estate investments over the next year. Of those investors, 87% said they plan to maintain or increase their real estate exposure over the next year, and an overwhelming 92% said they would maintain or increase their real estate over the long term.
The objective in building the portfolio should be to diversify by strategy, vintage year, property type, size, liquidity, region, country, sector, risk and return. It is critical, as well, to ensure that the portfolio is appropriately matched to the unique liability characteristics of each particular fund. There are well-diversified domestic funds available that provide an excellent foundation for the portfolio. Notably, while the big funds in Canada generally make direct investments and participate in club deals on large acquisitions, they also use funds, typically for speciality strategies and for single-country or regional international exposure.
A five-year plan
A smaller plan sponsor can build out its portfolio over a five-year period. The first year would see the addition of one or two diversified, core, open-end domestic funds, with an investment in a global real estate index exchange-traded fund (ETF) to begin establishing the international component. In the second year, a smaller pension fund would move up the risk/reward curve with the addition of one or two closed-end value-add funds. Year three brings in an opportunistic fund and a diversified global fund, replacing the global ETF. The portfolio construction could end here and be quite satisfactory. Or, a plan sponsor could progress further over the next two years by adding an emerging-markets fund and a development or speciality fund.
What does the target end portfolio look like? It’s 50% domestic open-end core, 10% closed-end value add, 10% closed-end opportunistic, 20% global core/core plus, 5% emerging markets and 5% development/speciality.
David Mather is executive vice-president and director, Integrated Asset Management Corp.