_{What TD Asset Management Inc. (TDAM) has learned over 35 years of experience managing real estate investments with one of the longest tenured portfolios in Canada}

TDAM started managing Canadian real estate in 1988 for pension funds through segregated accounts.  In 2004, the firm combined these accounts into a single pooled fund, which led to the inception of the TD Greystone Real Estate Strategy¹.  

At the core of that strategy is the belief that predictable income from quality assets and its growth are the primary drivers of long-term real estate returns. Central to this strategy is the ownership of strategically significant real estate investments across Canada instead of simply focusing on the three major cities within the country.

The TD Greystone Real Estate Strategy is an open-ended Canadian real estate investment vehicle with a gross asset value exceeding $23 billion.² The Strategy began managing Canadian commercial real estate for pension clients in 1988 on a segregated basis before combining the separate real estate portfolios into a single pooled fund in 2004.  Since the pooled fund inception in 2004, the strategy has delivered an annualized performance of 9%,³ a testament to its effective management and strategic foresight.

Some of the members driving this success at TDAM's Global Real Estate Investment team are Luke Schmidt, Head of Transactions, Matt Sych, Head of Portfolio and Asset Management, and Mark Cooksley, Head of Development.

Prairie wisdom and portfolio management

Sych attributes the disciplined and risk-aware approach to the strategy's Prairie roots, emphasizing the importance of stability and long-term value in real estate investments. “We don’t overreact,” Sych states, highlighting a patient, measured approach to market fluctuations and trends.  “With our firm initially established in Saskatchewan, we have a deep understanding of the critical, long-term role real estate plays in a pension portfolio."

Sych says that this understanding has always been fundamental to the firm's approach. "For over 35 years, we have managed every asset class, recognizing the long-term nature of real estate and the steady income and growth it contributes to the pension portfolio. Consequently, we maintain a steady course through various cycles, whether related to specific property types or broader financial crises, valuing the stability real estate brings to the overall pension portfolio's income.”

Sych also explains the decision to integrate multi-unit residential properties into the portfolio in 2008, citing a fundamental supply-demand imbalance and the segment's attractive attributes as an inflation hedge. Unlike commercial properties with longer lease terms, the shorter leases in residential real estate offer flexibility to adjust rents annually, capturing growth and providing a stable income stream.

Challenging misconceptions

Within real estate, the office sector has largely been panned as dead. However, Cooksley confronts common misconceptions about commercial real estate (CRE), from the conflation with single-family housing markets to the premature obituaries of the office space sector. He argues for a nuanced understanding of CRE's value proposition, especially in terms of income growth potential.

“The notion that the office sector is dead is far from accurate. Despite facing challenges, the office market is alive and evolving. There has been a slower return to office spaces in both Canada and the U.S. compared to other parts of the world, yet there's a clear trend towards high-quality, well-located buildings with excellent transit connections and amenities. This shift is evident in our portfolio, reflected in both tenant demand and investment interest.”

Another misconception Cooksley addresses is that the single-family residential market cannot be accurately compared to commercial real estate. This is because income generation is not the primary factor considered when acquiring single-family residential properties.

Lastly, the idea that capitalization rates are directly tied to investment yields is a misconception. While cap rates do move with interest rates, their relationship isn't strictly linear. Unlike fixed rate bonds, cap rates can increase due to income rising faster than valuations, as was the case in 2022 and 2023. Moreover, commercial real estate's value is also influenced by its income potential and growth prospects, which can lead to a decrease in cap rates on a relative basis.

The cap rate environment

The current environment, marked by the COVID-19 pandemic and reflation presents unique challenges and opportunities, with certain sectors like industrial and residential real estate seeing capital appreciation.

As Schmidt highlights, what sets this cycle apart is the varying impact on different property types. Unlike past cycles where all property types would generally rise or fall together, this downturn has seen a clear divergence. Industrial and residential sectors have experienced capital appreciation, a rarity in downturns.

Another distinctive aspect is the battle between rising cap rates and income growth, particularly notable in the industrial sector. Despite the upward pressure on cap rates and yields, the industrial sector saw significant income growth, offsetting these pressures and leading to value stability or even appreciation. The residential sector similarly kept pace due to strong income growth, unlike the office sector, which suffered from weaker fundamentals.

Diversification emerged as a key strategy in managing portfolio performance. Schmidt asserts, “By not being overly concentrated in any particular property type, we could maintain the stability and returns of our portfolio. The industrial sector, having led the market in recent years, was clearly an advantage for industrial-centric portfolios. However, it's now the residential sector that's taking the lead, and a more diversified portfolio can reap the benefits of this rotation.”

Schmidt notes that quality remains a constant factor in recovery from downturns. “Quality tends to perform when we come out of down cycles. High-quality office, retail, and industrial properties can outperform.”

As to where the cap rates are going, Schmidt says, “At the start of this year, we're observing continued increased pressure on cap rates, particularly within the office and industrial sectors, and anticipate this trend might extend into the second quarter as well. However, with indications that interest rates may decrease later in the year, there's a growing sentiment that cap rates could be nearing their peak, potentially by the end of the second quarter or later into this year.”

The current outlook suggests we're nearing a turning point in the market cycle, with optimistic expectations for improvements in cap rates as we move into the latter half of the year. This nearing of the cycle's bottom is a positive development, signaling potential stabilization and recovery in the market's overall dynamics.

Embracing net-zero developments

The portfolio managers of the TD Greystone Real Estate Strategy take a long-term perspective on their portfolio investments, and with that future-forward outlook, part of the strategy has been to look to net-zero developments where it makes sense.  

Cooksley says, “We have made efforts in sustainable development, as evidenced by our creation of Canada's first net-zero industrial building in Halifax, in partnership with Eastport Properties. This innovative project achieved a Zero Carbon Design certification from the Canadian Green Building Council, offering tenants the potential for negligible heating costs throughout the year, contingent on efficient building management. This achievement underscores our commitment to sustainability and the tangible benefits it brings.

“Our investment strategy is characterized by a long-term outlook, spanning 10 to 20 years, helping to ensure our portfolio remains aligned with future trends and values. This perspective extends to our development projects, where we consider sustainability alongside financial viability. By focusing on sectors like industrial and multi-family, we opt for slightly lower immediate yields in exchange for greater long-term income growth, liquidity, and asset value.

“Our commitment to sustainability is not only a fiduciary responsibility to our clients but also a strategic decision to attempt to future-proof our investments. For projects where net-zero construction is not immediately viable, we design with future electrification and conversion in mind. That may minimize future costs and may help to ensure that our buildings can adapt to evolving sustainability standards.”

Ever since TDAM started managing Canadian real estate in 1988, the firm's focus has been on markets with strong income growth metrics rather than capital-chasing assets. This approach has been driven by the belief that strategic diversification and quality investment result in positive client outcomes in the ever-evolving real estate landscape.

_{¹ The TD Greystone Real Estate Strategy is comprised of the TD Greystone Real Estate Fund Inc., TD Greystone Real Estate LP Fund and real estate segregated accounts.}

_{² This figure refers purely to the TD Greystone Real Estate Strategy and does not include any components from any other strategies.}

_{³ As of June 30, 2024, the TD Greystone Real Estate Fund Inc. has delivered one-year return of -0.93%, a three-year return of 5.15%, a five-year return of 4.92% and a 10-year return of 6.42% since its inception on December 31, 2003. As of June 30, 2024, the TD Greystone Real Estate LP Fund has delivered one-year return of 0.43%, a three-year return of 6.49%, and a five-year return of 5.66% since its inception on March 31, 2015.}

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