You would be hard-pressed to find a real estate portfolio that hasn't been impacted by the events of 2020. Even so, a snapshot of players within this asset management space reveals that agility and resilience are not in short supply.
Between office closures, retail disruption, and commercial shutdowns, Canadian real estate stakeholders have felt their share of disruption. It's understandable, then, that many of them also express a similarly more pessimistic attitude, compared to the prior year, as 40 per cent of asset management leaders generally in our Asset Management Opportunities & Risks 2020 report. Anxious as they may be, however, we are witnessing trends and transformations among our real estate clients and partners that bode well for the sector's future health.
Canada's real estate asset managers are not standing idle. Many hit pause on investing at the onset of the pandemic but have spent the following months assessing the resiliency of their real estate assets. Now that they have a better handle on the risks and vulnerabilities within their portfolios, institutional investors and real estate funds are readying their large pools of capital to move aggressively on opportunities as they emerge.
There are ample opportunities coming online. A quick scan of the environment reveals strong appetites for more resilient real estate assets, including necessity-based retail (e.g., groceries, drug stores, banks, etc.), given their importance among Canadian consumers; multifamily properties, given their levels of stability from a cashflow perspective; and industrial assets, led by mounting e-commerce activity and the demand for fulfillment and logistics facilities. Interest in data centres is also exploding as the digital impact on operations and the economy has been supercharged by the pandemic.
The ability to move fast on these investments is one thing. However, in times of increased volatility, making the right investments that will hold their value through current and future uncertainties places a premium on enhanced due diligence. To that end, a majority of asset managers in our Canadian study (77 per cent) are planning to increase their annual investments in digital technology over the next two years to enhance their front, middle, and back-office capabilities (e.g., due diligence, accounting, marketing, etc.) in a bid to beat competitors to the best deals and manage their portfolios with greater digital efficiencies.
Savvy real estate asset managers are also following suit. Like their peers in other sectors, they're adopting the systems and people to connect and power their operations in ways that will enable them to respond faster and smarter to the real estate market. At the same time, they're using data and analytics to conduct due diligence on potential investments (e.g., demographic trends, tenancy rates, competitive assets in the marketplace, and—especially under the current circumstances—tenants' dependency on government support) and gauge their existing portfolio's ability to adapt to trends as they develop.
Through data and analytics, they are also generating insights that have proven key in determining which real estate asset classes are more promising, which sectors are more volatile, and ways in which their portfolios can be weighted to cushion their investments against current ebbs and flows.
We've seen this movie before. Back in the early 2010s, cap rates for real estate remained stable despite the impact of the Global Financial Crisis. And while asset values declined, this was largely due to reductions in expected cash flows.
The reason cap rates remained stable was that interest rates declined significantly, effectively widening the spread between the cap rates and the risk-free investing rates. As a result, real estate became relatively more attractive and values surged as the overall economy recovered, creating the conditions that resulted in the formation of a large number of REITs.
Could we see a repeat of this movie? With interest rates at record lows, and as the economy recovers post-pandemic, we can anticipate that the risks inherent in real estate assets will diminish and real estate will once again be seen as an attractive investment among people looking for yields that they can't get through bonds, long-term treasuries, and other financial instruments. The difference now is that the rest of the world has not gone through an extended period of deleveraging, so there are massive amounts of liquidity available for investment.
It's true what they say about current conditions: the only certainty is a lack thereof. It may be a while before the landscape for Canada's real estate asset managers can be characterized as "normal." Nevertheless, players within this asset management space have an opportunity to learn from the past, make greater use of the data in their organizations, and reinforce real estate as a crown jewel asset in their portfolio.