Open-end Funds: REALPAC queries 15

OPEN-END REAL ESTATE FUNDS OPEN UP

Survey Results Fill Out Picture of Non-Listed Market

OPEN-END REAL estate funds wield considerable clout in the Canadian investment landscape. Recently released results of REALPAC’s inaugural open-end fund survey show that 15 funds, under the auspices of 13 organizations, collectively held more than CAD $143.1 billion in assets under management at the end of 2018. That compares to a market cap of CAD $112.7 billion for TSX-listed real estate companies on the same date and CAD $40 billion in assets under management reported by 22 participants representing 50 funds in REALPAC’s 2018 non-listed closed-end fund survey.

“REALPAC’s continued commitment to transparency and professionalism in the real estate investment market has informed its decision to undertake the 2019 open-end fund survey to build on the market information obtained from its closed-end fund surveys over the last three years,” states accompanying commentary from the organization representing many of Canada’s largest real estate companies, funds and institutional investors.

The defining features of open-end funds — private investment vehicles that typically hold long-maturity incomegenerating assets and allow for contributions and withdrawals on an ongoing basis — are well matched to investors with long-term needs for stable, predictable returns. In contrast, closed-end funds have a specific investment period, set timelines for distributing all cash flows, and typically a higher proportion of valueadded assets — all making for a more volatile mix that can yield impressive or more disappointing payouts depending on market conditions on the termination date.

Seven of the surveyed open-end funds report net asset value (NAV) in excess of $1 billion, with highest NAV surpassing $6 billion. A NAV of $16-million bottoms out the scale, but it falls well below four funds reporting NAV in the $251- to $500-million range at the next rung up.

CORE STRATEGY FAVOURED Data collected between August and late November last year reveals open-end fund contributors heavily weighted to institutional investors, while fund managers generally favour multiple asset classes and are more wedded to core strategy — based on stabilized, fully-leased income-producing assets — than their peers overseeing closedend funds. While one fund reported a predominantly non-core focus in excess of 90% of investment, the greater majority — 13 of 15 — have core investment in the 76 to 100% range.

“It’s not surprising that a core strategy is employed by a majority of the open-end funds because of the stability of the assets, which provide reliable cash flow and better liquidity for investors,” the survey commentary notes.

Other distinguishing differences emerging from REALPAC’s two-track surveys include: open-end funds’ greater propensity to invest outside North America, with 55% of

Membership matters

As the Commercial Real Estate Industry has pivoted to Return to Work Plans, BOMA Toronto is laser focused on providing our members, stakeholders and the Commercial Real Estate Industry with trusted, valuable, relevant resources and guidance.

Leading our industry with collaboration, compassion and partnership is the essence of who we are and what we have done for over 100 years.

Our CRE front line hero’s are the backbone and foundation of our Industry. On behalf of our Board of Directors and the BOMA Toronto team, you all have our deepest gratitude.

Sincerely,

Susan Allen BOMA Toronto President & Chief Executive Officer

investment allocation in Europe compared to a European stake in the 24% range for closedend funds; and a lesser reliance on leverage, with most funds setting a maximum threshold in the 31 to 40% range versus the majority of closed-end funds with maximum thresholds between 51 and 75%.

Open-end fund managers can also typically draw on a long record of dealmaking. Five funds report they have made between 51 and 75 investments; two have made between 76 and 100 investments; and three have made more than 100 investments.

“With the characteristic of open-end funds being long-term vehicles and the fact that some of the participating funds are a few decades old, it is not surprising that the number of investments made fall on the higher end of the scale,” the commentary notes.

INVESTOR MIX Fund managers typically steer the interests of a greater number of investors than in a closed-end fund scenario. Eight of 15 surveyed funds tallied more than 100 investors, with the largest pool topping out at 1,662. Six other funds reported between 11 and 75 investors, while just one fund counted fewer than 10.

Corporate pension funds were the most predominant investor type — represented in eight of the 15 funds, with a contribution stake ranging from 4% to 63% across those funds. In most cases, though, corporate pension contributions equated to less than 50% of investment.

Public pension funds were the sole investor type in three of the funds, while contributing to a total of seven of the funds at levels ranging from 100% to 4%. Endowments and foundations were also active investors, represented in seven funds, but with a contribution stake below 50% in six of those cases.

Insurance companies, funds of funds, direct contribution pensions, investment banks and fund managers themselves add to the institutional investor mix, along with the assorted “other” category, defined as “high-networth investors, corporations, foreign charity, trusts, group retirement solution platforms and general institutional investors”.

Meanwhile, retail investors figured in six of the funds, at levels ranging from 95% to 0.3%. Although only three of the 15 funds report any foreign capital investment, one of those is 100% subscribed by foreign investors.

ASSET MIX Nine of the surveyed funds are targeting new development, which is generally in sync with sector-wide trends. MSCI’s historical overview shows development as a growing component of capital value across the Canada Property Fund Index over the past decade, hitting a high of 9.5% in 2019, up from a low of 3.9% in 2012.

Five funds appear to be sticking in that range with targets of five to 10%, while the remainder are poised more aggressively, including three with targets in the 16 to 20% range. That aligns with challenges fund managers report facing, including “the competitive landscape for product, which results in a challenge to find institutional grade real estate in Canada.”

Currently within Canada, Ontario, British Columbia, Alberta and Quebec capture the vast share of open-end fund investing, which is largely directed to the industrial, office, retail and multi-residential asset classes. All 15 funds report holdings in Alberta, but more investment occurs in Ontario and British Columbia despite the slightly lower participation of 14 funds. Notably, 11 funds hold upwards of 40% of their portfolio in Ontario, while no fund has a similarly sized share in Alberta.

Outside the big four, Atlantic and prairie provinces host a modest level of fund activity. Nova Scotia tallies the highest number — five — while New Brunswick receives the highest level of investment from any one fund, at 12%. Open-end funds are entirely absent from Prince Edward Island, Yukon, Northwest Territories and Nunavut.

Funds show varying commitments to the four predominant asset classes, but office and industrial capture both the highest number of funds and the largest share of their investment. Fourteen of 15 funds channel 86% to 3.8% of total investment into industrial properties. Thirteen of 15 funds invest in office, with allocations ranging from 71% to 15.3% of their total investment.

Land, hotels and seniors residential projects make up a tiny fraction of a minority of open-end funds’ holdings. There is no investment in student housing. zz

REDEMPTION GATES BOLSTER STABILITY

REALPAC’s recent survey of 15 Canadian open-end real estate funds offers insight into when and why fund administrators would suspend the ability for investors to redeem their holdings. It’s a step that some property funds based in the United Kingdom have taken as the COVID-19 outbreak triggers economic uncertainty and market volatility. Twelve of the 15 Canadian funds have the same ability to deploy redemption gates.

“The ability to gate or suspend redemption is an important mechanism that general partners have to address a possible max exodus at a time that may have long-term repercussions for the fund,” accompanying commentary from REALPAC states. “Redemptions can be suspended, and have been numerous times globally, for a variety of reasons including market closures, cyclones, cyber-security incidents or difficulties in valuation of certain assets at a time of significant redemptions.”

Most recently, U.K. based property funds also suspended redemptions in the days following the June 2016 Brexit referendum results. The 2008 financial collapse and the September 2001 terrorist attacks in the United States have similarly spawned suspensions.

“The use of this mechanism is often to curb a possible contagion in the affected sector and diminish the impact it may have on financial stability,” the REALPAC commentary clarifies.

The investor profile revealed in REALPAC’s survey results is one heavily weighted to institutional investors. That’s unsurprising since openend funds — private investment vehicles that typically hold long-maturity income-generating assets and allow for contributions and withdrawals on an ongoing basis — are considered well matched to investors with long-term needs for stable, predictable returns.

The 15 open-end funds responding to REALPAC’s survey report a varying schedule for, and limits on redemptions. However, conventionally, it’s not a routine practice for investors. Just six funds reported redemptions in the three years of 2016 to 2018.

Five funds provide a quarterly window for redemptions, while four funds allow monthly redemptions and three permit daily redemptions. Alternatively, two funds restrict it to a onetime annual opportunity, while the remaining fund applied the specifics outlined in the limited partnership agreement.

More than half of the Canadian funds set no threshold for the value of withdrawals. The other seven reported seven different formulas for allowable redemptions, including stipulated percentages of net asset value (NAV), assets under management (AUM) or the requesting limited partner’s own holdings.