Real estate has become a cornerstone asset class for pension fund investors

Turbulent market conditions are having profound impacts on real estate investment – Steve Marino, GWL Realty Advisors

Real estate has become a cornerstone asset class for pension fund investors
Steve Marino, executive vice-president, portfolio management, Great West Life (GWL) Realty Advisors

Real estate is now a cornerstone asset class that serves a purpose in all long-term diversified portfolios as it can achieve a variety of objectives such as growth, inflation protection, stable income, diversification, and provide exposure to an inversely correlated asset class to traditional asset classes. However, it is not without its challenges.  

Real estate has a role in supporting capital preservation and generating long-term growth and performance with the objective of delivering superior risk-adjusted returns, says Steve Marino, executive vice-president, portfolio management, Great West Life (GWL) Realty Advisors. Speak at an ACPM webinar by Canada Life called, Understanding the Benefits of Direct Real Estate Property Exposure for Pension Plans, he said, “It's important to note there are some meaningful changes happening within the global economy that directly relate to real estate and those changes are having profound impacts on individual asset class and the result is that portfolio construction is more critical today than ever before.”  

Four pillars behind increased investment 

Marino said there are four primary pillars behind the increased investment in real estate by all types of investors.  

“The first and foremost is the predictability of the return profile and that predictability is really driven by the rent or income profile it generates,” he said. “Historically about 70 percent of total performance has been driven by that income component of return. Society needs places to live work and play and, as investors, we certainly take a lot of comfort in knowing where that rental profile is and how it's going to be able to generate cash flow moving forward. 

“The second pillar is the limited correlation, and in many cases inverse correlation, to other asset classes. Private market real estate valuations remove some of the inherent volatility associated with public markets, helping to stabilize overall return profiles and provide complementary return profiles over the long term. 

“Thirdly [real estate investment] provides a very meaningful hedge against inflation as the asset class has historically participated in periods of economic expansion, helping to preserve purchasing power as replacement costs increase during those eras. Short duration lease strategies such as multi-family residential and small bay industrial have historically proven to be very effective as they provide opportunities with increased frequency to reset rent and really participate in that inflationary environment.” 

The fourth pillar is that “the combination of these three factors allows investors to remain invested over cycles and taking the comfort of the stability of cash flow, with limited correlation or inverse correlation, and knowing that there is hedging relative to inflation. These pillars help to keep investors sleeping at night and keeps them invested through the cycle rather than potentially trying to time markets which we have proven time and again to be a bit of a failing strategy,” said Marino.  

Economic changes impacting RE market 

Marino said there are key structural and cyclical changes across the economy that are impacting real estate investment. 

One change is the government of Canada’s significant immigration targets. “More than a million people arrived in Canada last year and 91 percent of those new arrivals locate into large urban areas within Canada, making the ongoing urbanization and densification of our communities a critical challenge as we cope with the limitations of our infrastructure and the associated development timelines to help accommodate growth for those new arrivals. This theme is critical to our asset class. More people are generally good for real estate because it means inherently there is more demand for the real estate.” 

Deglobalization is another factor impacting real estate investment. “Global instability is resulting in an increase in demand by governments and organizations to control their own destiny,” said Marino. “There is an increase in reshoring or onshoring as entities look to migrate to a ‘just-in-case’ inventory systems to find redundancy in their local communities. That has created more demand for industrial real estate and we're seeing some of the implications of that across the industrial asset class.” 

Changes in the office space market are also impacting the real estate market. Marino said the declaration of the death of the office market was premature. “The extended lockdowns together with favourable employee conditions proved consequential in delaying the return to the office. Today, however, utilization rates are materially improving month over month. Current rates of utilization are somewhere between 60 to 80 percent of pre-COVID levels. Employers are moving to hybrid models necessitating three to four days of in-office work weeks. It is contingent on us to ensure we have assets that are positioned to perform and position to meet the needs of tenants moving forward.  

The penetration rate of e-commerce as a percentage of the entire economy increased during the pandemic because consumers didn’t have any other options. Once lockdowns were lifted, that penetration rate slowed, and Marino believes part of the reason is the appeal of brick-and-mortar real estate across the country. “Canadians really appreciate the value of going to those large shopping centres and appreciate the social experience that retail can provide,” he said. He added that e-commerce can co-exist with physical stores and retailers now provide exemplary omni-channel experience.  

Turbulent market conditions are having profound impacts on real estate investment, said Marino. However, these conditions and trends provide opportunities for active management of this asset class. Real estate investing is about “buying the right property on the right street and investing capital prudently to create value. The active management approach allows assets and, ultimately, portfolios to create value over time, stacking together solid outcomes irrespective of the capital market conditions. It allows investors to benefit from resilient and sustainable cash flow and value creation.”