In the last few years, Ivanhoé Cambridge, the $70 billion real estate subsidiary of $283 billion Caisse de Depot et Placement du Quebec (CDPQ) has turned its portfolio on its head. Five years ago, two thirds of the allocation was invested in return-dragging office and retail assets. Now, in a complete reversal, two thirds is invested in logistics and residential real estate alongside a growing allocation to alternative life sciences facilities and office and retail assets are in the minority.
“Over the last few years, we have pivoted the portfolio to make sure we are aligned with longer term trends,” says Michèle Hubert, chief operating officer at Ivanhoé Cambridge in an interview with Top1000funds.com.
The intensive churn of transactions as assets with less potential or that had reached maturity were sold and money redeployed to growth areas required a keen investment focus and adrenaline-fuelled, long hours to get the volume of deals over the finish line.
In 2022, the team executed more than 70 transactions totalling over $15 billion investing either directly, with strategic partners or via real estate funds.
New priorities
The process highlighted new investment priorities that are now central to strategy.
For example, Ivanhoé Cambridge increasingly seeks property assets that can adapt and evolve, able to change in use alongside changing demand and changes in society. Like the potential conversion of office assets into residential – or malls (which have a 11 per cent weight in the portfolio today compared to 22 per cent in January 2020) doubling up as logistic centres or places to work as well as shop. Similarly, assets should be able to adapt to incorporate new social impacts like the rehabilitation or public spaces, she says.
“Many assets are not designed to allow this conversion, but I’d like to see a new way in how we plan developments to incorporate a mix of uses that could evolve, opening the door to flexibility,” she says.
“The way we use real estate in a post pandemic world is changing. We must make sure we position the portfolio to not just play on current trends but align with future needs of people and communities.”
Risk spotlight
Alongside the physical churn in the portfolio, Hubert highlights another profound change now always influencing decision making.
“Geopolitical and ESG risk have come to the fore, shining the spotlight on the risk team,” she says.
From the fallout of Russia cutting off gas to Europe to de-globalization trends or an asset’s physical vulnerability to climate change and climate regulation, geopolitical and climate risk are now integral to how the investor assesses opportunities.
She says her approach to risk has become increasingly prescriptive, evolving in a forward-looking approach. New tools include Ivanhoé Cambridge’s bespoke risk premium model, that has sharpened how the team rate risk and opportunity, judging and challenging the expected return against external risk models and assumptions.
Rather than have a centralised risk team sitting in the Montreal headquarters, risk teams are present in all key markets, working alongside local investment teams. The risk function is also connected to other teams in the organization – notably the sustainable investment team.
“They have become an integral part of how we manage risk,” she says.
Climate risk
Integrating climate risk (Ivanhoé Cambridge targets a carbon neutral portfolio by 2040) is well underway.
As of December 2021, low carbon buildings account for around $17 billion of the portfolio and 56 per cent of the portfolio has green building certification.
New initiatives to cut carbon emissions are regularly rolled out. A current pilot involves trialling energy efficiency technology in the electric motors that drive water pumps, air conditioning and heating in buildings that uses algorithms and intelligent control systems to reduce utility bills.
Still, measuring carbon remains a key challenge, and is difficult to integrate into the valuation process.
“We are convinced integrating ESG in this way will increase the resilience of the portfolio,” she says. “But the industry is still using traditional measures to assess risk and return and doesn’t integrate carbon.”
Granularity of Data is essential
Data is an increasingly crucial component in risk analysis, offering insights on the market and Ivanhoé Cambridge’s own portfolio.
From a property’s energy and water use to occupancy rates and tenant habits, the construction of smart buildings and the rollout of apps to improve life for tenants is giving a new granularity to the information feeding up to the investment team. Occupants can stay connected to their building via exclusive concierge services allowing them to reserve parking spaces remotely, order a meal or enrol in a group class. It amounts to a vast store of strategic information that will go on to shape the spaces of tomorrow.
The challenge, she says, is making sure data is used correctly and linked to decision-making.
“There is a value lying there that we have to harness,” she says. “It involves taking data from external sources and layering it with data from our own portfolio.”
Risk drives Governance evolution
Integrating geopolitical and ESG risk into investment decision making has required an evolution in Ivanhoé Cambridge’s governance.
She is responsible for an investment process whereby investment leaders and the risk and sustainability teams present all material issues to committees overseeing strategy and investment decision making. Governance, she says, must be robust and solid, but also able to evolve to align with changing priorities. Governance and investment decision making is always viewed through a ‘one portfolio’ lens rather than regional portfolios and pipelines to better optimize risk-return, she says.
“A one portfolio view is critical to us taking better decisions,” she says.
She is also responsible for ensuring staff spend time on asset management and extract the maximum return from existing assets in the portfolio – particularly in the wake of a pivot that demanded such an intense investment focus
“When you keep an asset, you make a decision not to sell,” she says. “It should be seen as a decision to constantly re-buy and we are trying to make sure our committees and governance also looks at assets we own, dedicating time and space to go through important decisions.”
There are many elements to being a successful real estate investor, she concludes. It involves selecting the right opportunities and being intentional. It requires playing to different horizons and adjusting the execution and tilting strategies to play on different time frames. It also requires a global view, identifying areas that can perform better in particular regions and sourcing investments aligned to cyclical (the inflation proof revenue growth in the logistics portfolio, for example) and structural trends that could play out over the next decade. In short it requires building a portfolio that comes together to generate a superior performance.
“We strive to have a selection of good deals that together lead to something even more,” she says.
I've never met or spoken to Michèle Hubert, COO at Ivanhoé Cambridge, but she sounds like a very sharp lady who knows her stuff.
I've been in and out of hospitals lately dealing with intense nerve pain and addressing ongoing issues with my herniated disc at L3/L4 level impinging on my nerve root so I have fallen behind covering pensions.
But tonight I wanted to get this comment out because commercial real estate is on the cusp of a major transformations.
And I mean big.
It's not just Retail, Offices are getting killed and you can see this by looking at a long-term chart of SL Green Realty (SLG), Manhattan's largest office landlord.
The share price is headed back to GFC levels.
What is going on? Are offices becoming extinct?
Before writing this comment, I saw Jon Love, CEO of KingSett Capital, posted this Reuters article on LinkedIn on how JPMorgan has asked senior bankers to return to office for five days a week.
I'm not particularly impressed with JPMorgan's memo forcing its managing directors back to the office five days a week and let my thoughts be known in a reply to Jon's post:
JPMorgan Case & Co is worried about a CRE crash so it will try doing whatever it can to force its bankers back five days a week. The problem? The pandemic has changed everything, its bankers do not need to go into some office five days a week and the very best can leave for a competitor that doesn't treat its employees like children. This is a dumb, really dumb policy and I predict an 180 degree turn before the end of the the year. This big bank has tried similar things in the past and they always failed.
Don't get me wrong, I love Jamie Dimon and think JPMorgan Chase is a top bank but this is a really dumb policy which will backfire on them spectacularly.
I tell all bankers and real estate people to stop acting and thinking like we are back in the 80s and 90s, wake up, smell the coffee or you will die.
You can hope and pray we return back to the pre-pandemic days in commercial real estate but you're wasting your time and jeopardizing your organization in the process with silly policies.
Start treating your employees like adults.
Never mind this nonsense that "you can't build culture over the internet" or through Zoom, Teams and WebEx.
Total nonsense.
I spend my day on LinkedIn sharing knowledge with people, some share wise insights back, I do not need or want to be stuck in some office, I do not care about going out to lunch downtown or having drinks after work.
True, I'm not in my early thirties and did all that stuff years ago.
Right now, I value independence, flexibility and peace of mind.
Truth is I have the luxury of setting my own schedule but most employees want the exact same thing.
My former boss at PSP, Pierre Malo, liked coming in at 7:30 a.m. and leaving by 4:30 p.m.
He was a currency trader so those guys like waking up early.
I hated waking up early back then, strolled in the office after 9 a.m. and often stayed till 7 p.m. and if anyone gave me lip, I told them "what have you produced lately?" and shut them up.
People are different. You like going in early, I like staying late, my productivity increases as the day wears on. Why should I be penalized because of your prejudices that everyone should come in the office at 7 or 8 a.m.?
I value my health, sleep is the most important thing to me (ironically with nerve pain, haven't slept well the last two months and I wake up at 5 a.m. to get out of bed because the pain is worse in the morning if I stay in bed).
Will Offices return? Yes, the very best offices which have the highest sustainability scores will be in demand by top tech firms and other companies, but let's not kid each other, we aren't returning to pre-pandemic levels any time soon.
Why? Companies have seen they can function without an office or trim their office space down to a bare minimum and use them on a rotating basis.
They save money and their employees are happier because they don't waste time commuting back and forth to the bloody office every day.
"Come on Leo, you're so cynical, is it your back pain?"
No, it's not my back pain, I'm not cynical, I'm a realist, most people can easily live without going back to the office, especially older employees who hate it and value their time and independence.
So, when Michèle Hubert says Ivanhoé Cambridge is looking to revamp some of its offices into mixed-use properties and transform them into mutlifamily/ retail/office properties, I believe it.
The problem? It's costly and not easy to do, you need to get through city permits and really plan this out carefully with top developers to make sure you will recoup those costs.
And as I keep warning people (who do not listen), we are heading into a major global recession/ depression unlike anything we have seen since the 1970s.
The depth and duration of this global recession will hit all assets, including private equity, real estate and infrastructure (ie private markets).
REITs got hit very hard last year, down almost 40%, and they're not recovering:
Last week, I had a chat with OTPP's CEO Jo Taylor who told me: "We are very comfortable with our real estate valuations. Unlike our large peers, our real estate asset values reflect the challenges in that market."
That was a direct swipe at OMERS's real estate arm, Oxford Properties, and CDPQ's real estate arm, Ivanhoé Cambridge, which posted 10% returns last year while OTPP's real estate subsidiary, Cadillac Fairview, was down 4% in 2022, underperforming its benchmark of 6.7%.
But it's a little more complicated than this because as I explained when I went over Teacher's 2022 results, its real estate portfolio isn't as diversified geographically and by sector as its large peers:
As far Real Estate, Cadillac Fairview is still struggling to diversify outside of Canada and Retail but it;'s happening ever so slowly, and this will benefit OTPP's members over the long run.
But it's slow, that portfolio should have followed Oxford Properties back when Blake Hutcheson was running it, diversifying out of Canada and into Industrials and Multi-Family.
In fact, while both Oxford and Ivanhoe Cambridge delivered strong double digit gains last year, Cadillac Fairview was down 3.5% significantly underpeforming its benchmark of 6.7%.
For this to change, it needs to go full speed ahead with its geographic and sector diversification strategy but Jo Taylor told me they aren't going to sell assets at fire-sale prices.
Ziad Hindo sits on Cadillac's Board and makes sure they're executing ion their strategy, which they are but it will take time.
Having said this, I do think Cadillac Fairview takes a more conservative approach in valuing its real estate assets relative to its peers and this is the right thing to do.
If REITs go down another 20% this year and I see clear signs of a global recession and Canada's large pensions start posting solid real estate returns, my BS antennas will go up.
It's not going to happen.At one point, the economic forces of gravity take over.
What else? When I went over CDPQ's 2022 results, I stated this on real estate:
And in Real Estate, you can read this in the press release:
For one year, the Real Estate portfolio recorded a return of 12.4%, significantly above its benchmark index’s 9.2%, driven by the CDPQ real estate subsidiary’s repositioning in 2020 toward more promising sectors, including logistics. The residential sector also contributed positively to performance, while the office sector continues to undergo a significant transformation. Over five years, the annualized return was 2.3%, below the index’s 5.3%, due to the historic prevalence of shopping centres in the portfolio, which now represent its smallest sector.Clearly, Nathalie Palladitcheff and her team have done a wonderful job repositioning that portfolio into logistics in Europe, Asia and elsewhere but what is the RE benchmark and does it accurately reflect the risks being taken?
And added this:
Also, I heard Ivanhoe Cambridge gave packages to several senior managers and is cleaning up house.
While I like Nathalie Palladitcheff and think she's doing a good job, I don't like how she is placing her own minions in positions there (mostly French from France) and is getting rid of experienced people Dan Fournier hired, people you need during a deep and prolonged global recession!!
That is a rookie mistake by an inexperienced CEO and she has to be careful, times are changing fast in real estate and the good years are definitely over!
I don't mince my words, when you're heading into a global recession, you better take a hard look at your team and if there are only young pretty faces, you're in big trouble!
You need older, more experienced grey -haired people who have actually lived through many cycles.
This goes for private and public markets, when the going gets rough, you need experienced people who know what they're talking about and lived through hell and survived.
Alright, let me just end with some more quick comments on commercial real estate.
It's obvious to me there's a paradigm shift going on, retail and offices have been hit hard, logistics and multifamily (residential) properties are still in high demand.
But in a really bad recession, rents will come down everywhere including logistics as companies require less warehouse space. It's only logical.
There will also be plenty of opportunities for these large Canadian pension funds to buy commercial real estate from distressed sellers who need to sell and some of these assets will turn out to be great long-term acquisitions.
So, it's not all black and dark, more like grey.
But make no mistake, real estate will not be producing the same solid returns it has produced in the past, that I'm very sure of.
Below, Berkshire Hathaway’s Warren Buffett joins 'Squawk Box' from Tokyo to share his thoughts on the health of the commercial real estate market, and why there is no reason for investors to panic.
Second, Bill Rudin, Rudin Management Co. co-chairman and CEO, joins 'Squawk Box' to discuss Rudin's concerns with the regional bank sector, the state of commercial real estate and how to balance the need for revenue and desire to attract wealthy people.
Third, Scott Rechler, CEO of RXR Realty, joins 'Squawk Box' to discuss the pressures in the commercial real estate market, why the real estate market was surprised by the higher rate environment, and more.
Lastly, billionaire Barry Sternlicht says inflation will drop as the rental and housing market crash is here.
Update: Shelly Hagan of Bloomberg reports offices across America must be torn down according to an investor who won big in 2008:
Kyle Bass has some advice for real estate investors: Tear it down.
The founder of Dallas-based Hayman Capital Management says office buildings in cities need to be demolished because demand isn’t returning and it’s impractical to turn most towers into apartments.
“It’s one asset class that just has to get redone, and redone meaning demolished,” said Bass.
The Dallas-based investor shot to fame more than a decade ago betting against subprime mortgages before the US housing collapse. He’s since pushed a series of contrarian investments that have occasionally burned investors such as predicting the collapse of Japanese government debt and Hong Kong’s dollar.
His expectation of more pain in the office market reflects a more widespread view that the pandemic has driven a semi-permanent shift toward remote and hybrid work that imperils lower quality buildings that are older and lack amenities.
The office vacancy rate in the US climbed to 20.2% in the first quarter, up from 19.6% in the last three months of 2022, according to Jones Lang LaSalle Inc., and recent weakness in tech has forced companies including Meta Platforms Inc. and Amazon.com Inc., to scale back their footprint.
“We are now approaching the eye of the economic storm, and I expect it will get even worse,” Steven Roth, the chairman of Vornado Realty Trust, said in a recent shareholder letter.
Bass, who’s most recently been investing in Texas land, said there’s an imbalance in real estate with a severe lack of multifamily units, especially in fast-growing cities such as Dallas, but it’s impractical to convert the vast majority of offices into housing.
“You have to jackhammer, rebar and concrete. You have to re-plumb everything,” Bass, 53, said in an interview. “And when you finish it, it just doesn’t feel right. You wouldn’t want to live there,” he said, citing for instance the lack of light.
Despite high demand for housing, developers of multifamily properties simply can’t get the financing right now to proceed with projects, Bass said. Banks are constrained by the rise in borrowing costs brought on by the Federal Reserve’s rate hikes, and the rapid movement of money out of deposits amid turmoil in the sector. That means high rental rates are likely here to stay with demand outpacing supply, he said.
Bass isn’t shorting office markets, partly because publicly-traded real estate companies have already priced in significant pain. The Bloomberg REIT Office Property Index is down more than 50% since the end of 2021.
Bass is long a more traditional investment — buying Texas land. He’s spent about $100 million acquiring six properties since starting Conservation Equity Management.
Bass said he can restore some of the properties into wetlands. In exchange, Conservation receives credits it can sell to companies needing to offset the environmental impact of their developments.
He’s also maintaining his short on the Hong Kong Dollar, which he established in late 2017. The investment is influenced by his critique over China’s banking system and escalating geopoliticial tensions between the US and China, especially over Taiwan. Bass said he has more confidence than ever the bet will play out, citing data showing the scale of deposits that recently left Hong Kong’s banking system.
“We only have one position in Asia and it’s short the Hong Kong dollar,” Bass said. “As many as we can be short.”
Whether or not you agree with Kyle Bass, I think he makes great points here, many offices should be torn down and converted to multifamily residences.
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