Can investing in Canadian commercial real estate help smooth volatility in your portfolio?
In this article, we look at the potential benefits the asset class can offer investors in today’s inflationary environment.
Understanding real estate investment
When people think of real estate, they most often picture houses and apartments. Although both form a large part of the market, the asset class covers a wide range of opportunities, including land, structures on the land, air rights above the land and ground rights below the land. Real estate investment strategies seek out rising income and capital appreciation opportunities by investing in commercial properties that reflect the evolving needs of businesses, consumers, and occupiers.
When managed correctly, real estate can provide several potential benefits to an investor’s portfolio, including income, portfolio diversification and protection against inflation.
Ways of investing in real estate
There are several ways investors can benefit from real estate, but unless you have the ability and resources to buy and manage a portfolio of properties yourself, an alternative could be through investing in a pooled fund. This approach allows investors to leave property selection and management to expert property investors, while benefiting from the income growth and capital appreciation of the portfolio of properties.
Real estate strategies can vary widely, with some focusing on riskier investments with higher growth potential, and others targeting specific markets, property sectors or tenants. Some of the most common types of real estate funds include:
Core: This describes a portfolio of assets that are institutional grade, with a high focus on income. These tend to be high-quality, stabilized assets with low capital exposure and long-term leases in place. About 80% of the return on a Core portfolio is typically derived from the income component, with the remainder made up of capital growth, which generally comes from inflation of rents over time.
Core Plus: These funds will include similar elements to a core fund, but with a little more risk and the potential for greater return. They might include buildings that are just 80% occupied or require some capital investment to increase the value of the asset. There might be the potential to build further on the site and create more space for leasing.
Value-add: Further up the risk ladder are value-add funds, which typically target vacant buildings and look to reposition it to increase the occupancy again. Generally, these assets don’t offer significant cash flow, but through significant capital reinvestment the aim is to improve the asset value and achieve a strong capital return.
Opportunistic: These are essentially development funds. Instead of investing in buildings they buy land, and subject to the municipal approval process, invest it in construction costs to build a new asset and lease it. Understandably, the risks are higher than those found in other types of funds.
The potential benefits of investing in commercial real estate
Commercial real estate historically offers a low correlation with equity and bond markets, providing investors with powerful diversification and the potential to reduce the risk within their portfolios over time. The asset class can also offer strong risk-adjusted returns due to the majority of that return coming from income. A core fund for example will hold secure assets with long-term leases in place, and typically have secure covenant tenants in place to back those leases. With long-term contractual rents forming such a strong income component, returns on core real estate have significantly lower volatility than other asset classes.
Perhaps the biggest – and most relevant – benefit of real estate in today’s market is its ability to provide a hedge against inflation. Although rising inflation and higher interest rates can have a negative impact on real estate values due to the levels of mortgage debt commonly used in commercial real estate, rents typically rise in line with general inflation, allowing investors to potentially increase rents and grow income from the property in accordance with inflation.
What to look for in a commercial real estate fund
As with most investments, diversification is key. We believe a good fund should be diversified by geography (if a fund has all its assets located in only one mid-sized city in Canada, you may want to think twice about investing!) and asset type. Typically, a core fund will invest in four key asset types: multifamily; office; industrial; and retail properties. These four major asset types typically offer long-term secure leases and security of income over time. Here at Manulife Private Wealth, we work with the Portfolio Managers to ensure that the pooled fund we offer to our customers have properties which are spread across Canada. We also work to diversify the fund assets by provincial gross domestic product, so the entirety of the Canadian economy is represented in the fund’s asset base. Another factor to consider is the level of debt the fund is utilizing. Typically speaking, if a fund is below 50% leverage, then it’s generally regarded as more secure. As levels increase past 50%, so does the risk involved.
The outlook for Canadian real estate
With the impact of COVID-19 largely behind us, stores are open, and workers have returned to offices across the country. Furthermore, soaring house prices and rising immigration mean demand for multifamily rentals is likely to continue for the foreseeable future.
Canada has always been known to be a relatively secure market for commercial real estate, and institutional investors such as pension plans have been investing in the asset class for decades. Although the return profile may not be as high compared to other markets around the world, it is generally regarded as a low-volatile market. In our view, core investments offer steady long-term performance and can deliver diversification and strong investment returns on a risk-adjusted basis.
Real estate investments have a long history of generating stable yet appreciating income and capital growth while providing the potential for portfolio diversification, lower volatility, and inflation protection. By leveraging our long-standing industry relationships and boots-on-the ground presence, we continuously source opportunities to create value on behalf of our investors. Our expertise, size, and global scale combined with our investment approach can offer a compelling opportunity to partner with an industry-experienced real estate investor.
Should you wish to learn more about Manulife Private Wealth’s specific investment platform or for more information on our investment process, please reach out to a member of the Manulife Private Wealth team.
Important disclosures
A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other preexisting political, social, and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment.
This material was prepared solely for educational and informational purposes and does not constitute a recommendation, professional advice, an offer, solicitation, or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security. Nothing in this material constitutes investment, legal, accounting, or tax advice, or a representation that any investment or strategy is suitable or appropriate to your individual circumstances, or otherwise constitutes a personal recommendation to you.
Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments.
Past performance does not guarantee future results, and you should not rely on it as the basis for making an investment decision.
Diversification does not guarantee a profit or protect against loss in any market.
Neither Manulife Private Wealth nor any other companies in the Manulife Financial Corporation (MFC) group are acting as an advisor or fiduciary to or for any recipient of this report unless otherwise agreed in writing. Neither Manulife Private Wealth or its affiliates, nor any of their directors, officers, or employees, shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained here. Manulife Private Wealth does not provide legal or tax advice, and you are encouraged to consult your own lawyer, accountant, or other advisors before making any financial decision. Prospective investors should take appropriate professional advice before making any investment decisions.
The opinions expressed are those of the author(s) and are subject to change without notice. These opinions may not necessarily reflect the views of Manulife Investment Management or its affiliates. The information and/or analysis contained in this material has been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use of the information and/or analysis contained. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and is only as current as of the date indicated. The information in this document, including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Private Wealth disclaims any responsibility to update such information. Should you have any questions, please contact or ask to speak to a member of Manulife Private Wealth.
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