Canada's commercial real estate market saw a blockbuster year in 20181, expected to tally up record investments. Industrial space has been in tight supply, vacancies declined in almost every city, and rents were up.
Last spring, I wrote about the real estate sector in Canada, how it fits into an investment portfolio, and the opportunities and risks to consider.
As I said then, real estate can benefit a portfolio in many ways by adding diversification, providing generous yields and the potential for capital appreciation.
At the time, I focused on publicly traded real estate and Real Estate Investment Trusts (REITS), that invest in properties from hotels and rental apartments, to shopping malls and industrial spaces.
Now, to complete the landscape, I'd like to talk about another alternative: private real estate, here and around the world.
You don't need stock to own an office block
Few investors have the know-how or resources to directly buy and manage commercial properties on a large or global scale. A more viable alternative is to invest in specialized private real estate pools.
Private real estate does not trade on a public exchange, so you don't see daily volatility of share prices. It also does not have the liquidity of public real estate.
Unlike REITS, private real estate investments offer their managers greater control over the assets, potential tax benefits to investors, and returns with lower correlation to typical financial assets. At the same time, direct investments are generally riskier, more concentrated, and management intensive. They call for a longer duration of time to buy and hold, as long as 10 years or more.
Alternative strategies may enhance a “core" approach
Most publicly traded REITs are classified as “core" or “core plus" strategies. They target stable, fully leased real estate properties in major cities across the globe. These include class A buildings2 in desirable locations with long-term leases to stable tenants. They normally require little in the way of improvements, and therefore do not experience significant capital appreciation. But they can provide stable and predictable cash flows at low risk.
Private real estate investments may pursue alternative strategies that are difficult to achieve within a publicly traded REIT.
One strategy that private real estate managers can engage in is known as “value add."This strategy targets properties that need some improvements and have the potential to increase cash flow over time. Higher rents achieved through renovations or better management can lead to outsized returns, and investors can eventually sell the property to capture increased value. This strategy poses higher risk than core strategies, due to the use of leverage to finance investment in the properties.
In addition to a value add strategy, some private real estate managers may dedicate their investment philosophy to an opportunistic strategy. This strategy identifies properties that require significant investment to realize their potential, such as vacant buildings or undeveloped land. This strategy entails the most risk, as it is most highly leveraged. Properties may produce little or no cash flow for a time. If an investment proves successful, however, the upside to returns can be very lucrative.
Be realistic about real estate as an investment
MD invests across several real estate sectors in Canada and other markets, both equity and debt. Most MD portfolios include REITs as part of a core strategy for their ability to generate dividends and add diversification.
As an asset class, private real estate investment is not suitable for everyone — it takes sufficient assets and patience to stay invested over a longer time period. But for clients interested in value add and opportunistic properties, we've introduced MD Platinum Global Real Estate Pool for a limited time, partnering with Metropolitan Real Estate, part of The Carlyle Group, one of the world's largest alternative asset management firms.
It takes much more than bricks and mortar to construct a successful portfolio, but real estate can be an enduring component. For more information about the asset class, how it can fit into your portfolio or the MD Platinum Global Real Estate Pool, your MD Advisor can help.
2Class A buildings -The newest and highest quality buildings in their markets. Generally speaking, these buildings are considered the best looking and have the best building infrastructure. They’re typically well located, have easy access and are professionally managed. These buildings attract the highest quality tenants and also command the highest rents.
MD Financial Management includes MD Financial Management Inc., MD Management Limited, MD Private Trust Company, MD Life Insurance Company and MD Insurance Agency Limited
MD Advisor refers to an MD Private Investment Counsel Portfolio Manager.