CPPIB’s Bold Office Tower Deal Raises Concerns Among Longtime Buyers

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Canadian pension funds have led the way in global real estate acquisitions, sparking a worldwide trend among retirement plans to follow their lead. However, the largest of these funds is now taking measures to reduce its risk in the most vulnerable property category — office spaces.

The Canada Pension Plan Investment Board has executed three transactions at reduced rates, divesting its stakes in two Vancouver skyscrapers, a business complex in Southern California, and a redevelopment project in Manhattan. The Manhattan stake was notably sold for a mere US$1, raising concerns that these transactions might serve as a precedent for other significant investors looking for an exit strategy amidst the chaos.

John Kim, a real estate analyst for BMO Capital Markets, commented, “This is hardly a show of support for office spaces. The question is, who will follow suit?”

The financial sector has been gripped by unease over office properties as the continuation of remote work and increased borrowing expenses undermine the economic principles that previously made these assets attractive investments. A number of banks from New York to Tokyo have recently admitted that their office-backed loans may not be fully recoverable, leading to a drop in their stock prices and sparking worries of a wider credit crisis.

The real challenge, however, will be the actual trading price of office buildings, of which there have been scarce examples since the rise in interest rates. This is why industry observers view CPPIB’s discounted transactions as a foreboding indicator for the market.

In terms of reallocating funds, the pension fund is not actively distancing itself from office spaces, but it is not seeking to expand its office portfolio either, according to an insider. If a property necessitates further investment, CPPIB may choose to sell in order to invest that money in areas with higher potential returns.

Peter Ballon, CPPIB’s Global Head of Real Estate, refrained from commenting on the recent transactions but confirmed that the fund continues to invest in office buildings, including a newly finished 37-story tower in Vancouver.

“Divestment is a crucial aspect of our investment approach,” Ballon stated. “We divest when the asset has reached its peak value, and we can reinvest the proceeds into other assets, sectors, and markets with higher potential returns, including office buildings.”

With a fund worth $590.8 billion, CPPIB is one of the largest capital pools globally. Its $41.4 billion real estate portfolio spans from Stockholm to Bengaluru and comprises nearly all property types, from warehouses and life sciences facilities to apartment buildings. While this scale could offset any potential losses from individual deals, even a minor shift in CPPIB’s office preference could trigger market fluctuations.

In the final quarter of the previous year, the fund sold its 29% stake in Manhattan’s 360 Park Avenue South for US$1 to its partner, Boston Properties Inc., which also agreed to take on CPPIB’s portion of the project’s debt. The investors, which included Singapore’s sovereign wealth fund GIC Pte., acquired the 20-story building in 2021 with plans to transform it into a contemporary workspace. Boston Properties disclosed last month that the divesting partner, whose identity was not revealed, had already invested US$71 million in the project, but cutting ties freed it from a commitment to contribute an additional US$46 million to the initiative.

Simultaneously, CPPIB divested its 45% interest in the Santa Monica Business Park, a property it co-owned with Boston Properties, for US$38 million. This represents a nearly 75% markdown from what CPPIB initially paid for its share in 2018. The transaction was finalized shortly after the landlords entered into a lease agreement with Snap Inc., a social media firm, which necessitated further capital expenditure to enhance the campus, as stated by Boston Properties CEO Owen Thomas during a conference call.

The situation with the two Vancouver skyscrapers, jointly owned by another Canadian pension fund, was distinct in that they did not require significant additional investment and already had Amazon.com Inc. as the primary tenant. However, the sale price last month of approximately $300 million was over 20% lower than the property’s valuation in 2023, according to data from Altus Group. This sale coincided with the completion of a new office tower in Vancouver last year, developed by CPPIB in partnership with the same pension fund. The partners aimed to prevent their collective exposure to the city’s office market from escalating, as per an individual privy to their strategy.

With the advent of hybrid work models expected to reduce the demand for office spaces in the long run and rising interest rates escalating the cost of continuous upgrades needed to attract and retain tenants, even the most premium office buildings may struggle to compete with other investment opportunities.

Matt Hershey, a partner at real estate capital advisory firm Hodes Weill & Associates, commented, “To enhance the returns on your office investment, you’ll need to modernize and invest significantly more into the office. At times, it’s more beneficial to cut your losses and reinvest in a venture that promises superior performance.”

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