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Canadian pension funds gain more control

By Susan Thorne

They're big, influential — and getting bigger. Public pension funds such as OMERS (the Ontario Municipal Employees Retirement Fund) and Caisse de dépôt et placement du Québec have executed the biggest deals most recently in Canada's shopping center sector — transactions such as the OMERS acquisition of Hammerson plc's Canadian portfolio in November 1998 and the Caisse's purchase of a majority interest in Cambridge Shopping Centres in February 1999.

But the role of these funds, with total assets of around C$250 billion, is broadening as they extend their activities beyond direct real estate investment to operating company investment. In the past year, pension funds have gained controlling interests in the two Toronto-based regional mall leaders, Cambridge and the Cadillac Fairview Corp. In the case of Cadillac Fairview, taken over by a C$2.3 billion bid from the Ontario Teachers' Pension Plan Board in March, that involvement has progressed from investment to outright ownership.

So what are the implications of the funds' growing participation? There are definite advantages. The cash-rich pension funds have provided capital for the shopping center industry during a period of depressed real estate stock values since the mid-1990s, when other potential investors have often found it difficult to finance any ventures. With their deep pockets, funds can take a longer-term view than other investors and spend more generously on expansion or refurbishing of their shopping centers. John Marino, president of Snowcap Investments Ltd., Toronto-based retail leasing consultants, points to the recent expansions of Square One, Yorkdale Shopping Center and Scarborough Town Centre in the Toronto area, all owned by OMERS, as examples of that. Such expansions have created more opportunities for retailers, he said.

With the exception of the Caisse, public pension funds are relatively new kids on the block, having been permitted to invest in real estate only since 1991, but they seem to be learning fast. Ron Meiers, the retiring senior vice president of Cambridge, gives the fund managers full marks for doing their homework as new players in the shopping center sector.

"They have devoted a great deal of time to becoming knowledgeable about the industry," he said. "They're quite savvy; that's helpful when you talk to them, they know what's going on, and they've introduced a discipline to financial reporting." Yet there is a potential downside to the funds' expanded role — although people in the industry don't always like to talk about it. The sheer size and financial reach of public pension funds and their large cash reserves mean that they can often out-bid and out-maneuver smaller companies when purchase opportunities arise. These funds are income-tax-exempt and their reserves of capital allow them to avoid the expense of financing debt instruments; that gives them a lower threshold of return on investment than investors who must finance loans and pay full tax.

They have also tended to cherry pick — to invest in trophy assets like Class A regional malls. Their methods are felt by some observers to be heavy-handed; the Caisse in particular, elicited comment when it insisted on guarantees of continued business with Québec suppliers at the time of the November 1998 purchase by Loblaw Cos. Ltd. of Provigo, the Montréal-based grocery company in which the Caisse had a 30% interest.

The pension fund presence is cutting down on U.S. investment in Canada, said David Fick, principal and senior analyst for Legg Mason Wood Walker, the Baltimore investment bank. "Canadian public pension funds can pay more for assets than U.S. investment companies are willing to," he said. "They have an increasing appetite for Class A Canadian assets — the same ones U.S. investors are interested in."

Toronto-based Gentra Canada Investments was outbid by OMERS for the Hammerson portfolio when the British developer pulled out of Canada in November 1998, and was reportedly interested in parts of Cadillac-Fairview's holdings last winter. Brian Collyer, Gentra's senior vice president, pointed out that the funds are extending their activities beyond the role of passive investors.

"Public pension funds have traditionally invested in trophy assets; that is not a new phenomenon," he said. "What is new is a move by the larger funds to directly own and control real estate operating companies."

That change could result in fewer public real estate companies with high-quality portfolios, he argued, and consolidation of the surviving companies. Yet while pension funds may have competitive advantages, Collyer said that "in terms of concentration of ownership, there's still good competition among the funds, as there has historically been with public real estate companies."

With pension funds at the helm of developers like Cambridge or Cadillac Fairview, this could potentially have an impact on the management of those companies, although the parties in those two deals insist that nothing substantive will change.

"Obviously a pension fund acts differently than an entrepreneur, " said Fernand Perrault, senior vice president in the real estate division of the Caisse. "But regional and super-regional shopping centers have for some time been out of the hands of entrepreneurs. The style of management is no different whether it's a pension fund, a large publicly owned company or a REIT."

The Caisse's involvement in Cambridge is strictly through its three members on an 11-person board of directors, Perrault emphasized. Both Teachers and Cadillac have also stressed that it will be business as usual there, with Cadillac retaining its independence.

An important indicator of that is the fact that Peter Sharpe, Cadillac's former executive vice president, was appointed CEO shortly after the Teachers' takover became official in March.

Lee Fullerton, spokeswoman for the Ontario Teachers Pension Plan Board, said her organization plans a hands-off relationship with Cadillac Fairview.

"They will be part of us — the real estate arm of Teachers — but run as a separate company," she said. The new chairman of the Cadillac board will be Ted Medland, a former CEO of Wood Gundy and 10-year veteran of the Teachers board.

Steven Messinger, partner with Goodmann and Carr solicitors, Toronto, and past winner of the ICSC Trustees' Distinguished Service Award, said that going private with the backing of a financially strong pension fund "means you can concentrate more on your core business, and make decisions without looking at short-term gain all the time," he said.

But could Cadillac become a bit lazy with the security blanket of Teachers' deep pockets? Sharpe is aware of the danger.

"From our standpoint, we don't want to lose the intensity of the discipline that the public market brings," he said. "It will be up to management to maintain that."

Whatever the misgivings, pension fund investment in shopping center properties and companies looks set to grow. Teachers, which 18 months ago talked of limiting its real estate investments to 5% of its total portfolio, has now upped that target figure to 7%, and the Cadillac acquisition nearly doubles the dollar value of Teachers' real estate holdings from C$2.4 billion to C$4.7 billion.