Wrapping Up Canada's Malls.

The most acquisitive pension funds in Canada have taken over the largest, bluest-chip shopping center portfolios, some of which include malls in the United States.

WITH THE ACQUISITION IN MID-MARCH OF CADIL-lac Fairview Corporation, Toronto, and its 60 market-dominant shopping Centers across North America, institutional-investor ownership of most of Canada's trophy malls is complete.

It began about five years ago, when mainly high school teachers' and public servants' pension funds started investing in leading real estate development companies with regional (400,000 to 800,000 square feet of gross leasable area) and super-regional malls (in the 1.5-million-square-foot range).

While shopping centers are an American invention and far more pension funds with deeper pockets exist in the United States, Rene Tremblay, president and chief operating officer of Montreal-based Ivanhoe Inc., a major mall investor, says the scope and pace with which domestic pension funds are investing in shopping centers in Canada is far greater and moving much faster than in the United States.

He predicts that Canadian pension funds will be persuaded even more to invest in real estate--and not just shopping centers--over the next few years. Why? For one thing, says Tremblay, Canada's economic fundamentals are likely to stay strong as long as the good times keep rolling in the United States. For another, real estate investment trusts (REITs) and public real estate companies are less able to compete for properties than they were a few years ago, when they were willing to pay higher prices than institutional investors.

"Now, probably the opposite is true," says Tremblay. "Pension funds can pay a fair price, and REITs are almost not in a position to do acquisitions as they were previously."

The pivotal acquisitions are:

* Ontario Teachers' Pension Plan Board (Teachers), Toronto, already invested in Cadillac Fairview Corporation (CF)-- Canada's shopping center industry powerhouse--recently bought 100 percent control of the publicly traded company for about C$2.3 billion.

CF owns, manages and develops commercial real estate in North America, with 102 office and retail properties encompassing 51 million square feet in its portfolio.

Teachers' assets, including those other than real estate, are nudging the C$70 billion mark with the CF deal--more than enough of a nest egg to secure the retirement income of more than 300,000 high school teachers and their retired colleagues in Ontario.

Since it was started nine years ago, the fund's real estate investment has ballooned to C$ 2.4 billion-C$ 1.7 billion in directly owned retail and office properties and C$ 700 million of equity in real estate companies and investment funds.

* In January 1999, Canada's largest pension fund (topping $C100 billion in assets earlier this year)--the Caisse de depot et placement du Quebec (Caisse), Montreal--more than doubled its stake in Cambridge Shopping Centres Limited, Toronto, and its 35 million square feet of gross leasable area (GLA), to 73 percent ownership.

The Caisse, a provincial government agency, invests the funds of pension plans, insurance plans, mutual funds, public and private bodies. It has accumulated the largest real estate portfolio; is one of the leading equity investors in Canada; ranks among the top portfolio managers in North America and is one of the largest sources of capital for private investments in Quebec and North America.

The Caisse's nearly C$ 5.9 billion investment in real estate, its management and development is mostly in retail, mainly urban shopping centers through its Ivanhoe Inc., Montreal subsidiary and in partnership with other investors.

* A few years earlier, the Toronto-based Ontario Municipal Employees Retirement System (OMERS) increased its 50 percent interest to full control of Yorkdale Shopping Centre and Scarborough Town Centre, the latter with 40 acres of land, in the greater Toronto area. They are among the busiest and highest-grossing malls in Canada.

OMERS was established to guarantee the retirement incomes of more than 270,000 active members and pensioners. In late 1998, it acquired the 3.5 million-square-foot Hammerson Canada portfolio of five shopping centers in Ontario. The flagship is Square One in Mississauga, adjoining Toronto.

About 67 percent of OMERS' portfolio is in super-regional shopping centers (800,000 square feet and more); some 28 percent in regional shopping centers, all dominant in their own neighborhood markets across Canada; and the rest in peripheral developments on leased land. By the end of last year its net assets were up to C$ 35.4 billion.

All these pension funds are managed by actuaries, accountants and MBAs, whose mentality is obviously more conservative than the often flamboyant and resolutely entrepreneurial mind-set of traditional shopping center developer/owner/managers.

Has it made a difference so far, and will it make a difference in the way these shopping centers will be run? Claude Lamoureux, Teachers president and chief executive officer, says of the fund's takeover of Cadillac Fairview, "It will be business as usual at the company," adding that Teachers wouldn't interfere, that the change in ownership for employees and tenants will be "seamless."

And what of the Caisse's control of Cambridge? "It hasn't made much difference in our management style," says Lorne Braithwaite, president and chief executive officer of Cambridge. "The Caisse has enough confidence to leave us alone to effectively manage the corporation," Braithwaite says.

Yet there is a difference. "The Caisse is the largest pension fund in Canada, which makes it much easier when organizing financing for different projects. Other capital providers derive a great deal of comfort that a major shareholder of that size is backing the corporation," says Braithwaite.

The Caisse, in fact, made a $C150 million revolving line of credit available over the past year, outbidding two other potential sources of capital. The short-term construction facility was used to support Cambridge developments and will be replaced by longer-term financing when the projects are opened.

Fernand Perrault, the Caisse's senior vice president presiding over the fund's $C14 billion real estate portfolio, reveals how an investor, rather than a developer, thinks, when he says, "We wanted to invest, through Ivanhoe [which owns more than 20 million square feet of GLA in Canadian and U.S. portfolios], in one company rather than buying centers one by one. Our portfolios were quite complementary because Cambridge had few centers in Quebec."

The Caisse owns 96 percent of Ivanhoe; four small Canadian pension funds account for the rest. Operationally, Ivanhoe has for the most part restricted itself to eastern Canada and the ownership and management of 40 shopping centers in Quebec and Ontario and 20 centers in the United States, in partnerships with General Growth Properties Inc., Wilmorite Group Inc., The Rouse Company Inc. and Connecticut General Life Insurance Company CIGNA.

Each pension fund's partnerships and investments in shopping centers are on the record, but nobody had put it together as a universe of major ownership until Ivanhoe did an internal survey of the role of REITs and pension funds as institutional investors.

The survey, completed in November, focused on the four largest pension funds--the Caisse, Teachers, OMERS, the Ontario Pension Board (a public service pension fund whose eight regional shopping centers across Canada represent all of its real estate investment of about Cs85o million out of its C$12 billion in total assets)--as well as Morguard Investments, which represents smaller pension funds.

The survey found that, collectively, the five pension funds:

* are invested in Ontario (39 percent), western Canada (29 percent), Quebec (27 percent) and the Maritime provinces (5 percent);

* own 19 percent, or 68 million square feet, of the total square footage in 176 shopping centers in Canada of more than 50,000 square feet of GLA (see Figure 1);

* own 83 percent of the square footage in regional malls, 15 percent in community centers and 2 percent in neighborhood malls (see Figure 2); and

* own a stake of 50 percent or more ownership in 53 percent of malls larger than 800,000 square feet.

If you add in all the smaller funds--CN Pension Fund and British Columbia Investment Management Corporation fund, for example--they would together own a half interest in two out of every three of the largest shopping centers in Canada.

The Ivanhoe survey included REITs' ownership of shopping centers in Canada, which showed that RioCan Real Estate Investment Trust, Morguard REIT, Summit (Avista), CREIT--all based in Toronto--and other REITs together owned 28 million square feet in the 50,000-square-foot-GLA-plus category, or 8 percent of the total.

The centers they invest in tend to be much smaller than the typically large shopping centers pension funds covet, hence the larger number of 247 centers compared with pension fund ownership. Sixty-five percent of the REIT-owned shopping centers are in Ontario and Quebec.

RioCan is way out in front on the REITs list, with ownership of 15.6 million square feet--more than triple the space controlled by CREIT. It is also developing a new generation of centers closer to a regional shopping center in scale, but with its constituent retail parts not enclosed under one roof but rather dispersed around the perimeter of the parking lot.

Shopping centers are attractive investments for pension funds and REITs because they generate revenues that are stable and much less vulnerable to the vagaries of the economy. Nonetheless, pension funds didn't really become interested in that sector until the early 1990s. For example, Dale E. Richmond, OMERS president and chief executive officer, says that up until then OMERS only "dabbled" in various types of real estate.

"Before that, you almost had to shoehorn your way into the real estate market," Richmond says. "All the big developers and big real estate companies were closely held. They only let certain people play in their sandbox."

Ten to 15 percent of OMERS' asset mix is in real estate worth about C$4 billion--with 9.9 million square feet of net retail area in 18 properties and 7.6 million square feet in 19 office properties. Pension funds tend to favor more office and less retail investment, in total square-foot volumes.

OMERS, much like many of the pension funds, prefers to hedge its bets with partnerships. "Our strategy was always to co-invest, because we invest to pay pensions, for what owning bricks and mortar does for pensions," Richmond says. "We have to create value, and two stabs at due diligence are better than one--and often better than just deep pockets."

R. Michael Latimer, managing director of OMERS Realty Corporation, Toronto, says the company's investment in shopping centers "is part of a bigger strategy, not acquisition for the sake of acquisition."

OMERS is also just as likely to invest huge sums in keeping its malls fresh and outfitted with the latest traffic-building attractions as the other pension fund owners. Most of the hundreds of multiplex cinemas--many with interactive game arcades, some with theme restaurants--are popping up across Canada in pension fund-owned shopping centers, rather than on free-standing sites.

That isn't going to change with a new pension fund regime. OMERS, for example, is completing a redevelopment of Square One into a 1.5-million-square-foot super-regional mall. It spent nearly C$200 million redeveloping Yorkdale Shopping Centre and Scarborough Town Centre in Toronto. Teachers is heading into the final phase of a C$300 million redevelopment at its aging Chinook Centre in Calgary, to be completed by year end (see Sidebar 2). Cambridge has embarked on a C$150 million upgrading of some of its centers.

"We come in and make sure the centers have all the competitive features, but we put more discipline into creating more value day in and out. At the end of the day, this is about investment return," says OMERS' Richmond.

The recession in the late 1980s and early 1990S led to opportunities to have a more balanced portfolio for pension funds, Richmond adds, with acquisitions in real estate and shopping centers.

But they can't just let them sit there, not in a terribly competitive industry. Ivanhoe Inc.'s Tremblay speaks of trends that emerge every 10 years. "Consumers are looking for a good experience," he says. "We have to find tenants who can bring back the magic within our malls--that's how we can compete."

One of the trends Ivanhoe considered but let pass several years ago is the "big box" discount department store/hardware/electronics retailing phenomenon. According to Tremblay, Ivanhoe worried there would be too many players and the weaker ones wouldn't survive, potentially leaving Ivanhoe stuck with yawningly empty, not-easily-recycled--and therefore high-risk--retail space.

"We want tenants to stay with us for 20 years and prefer not to have to find replacement and reinvest," Tremblay says. As it turned out, Ivanhoe missed that particular boat-- notably the good ship Wal-Mart, docking at just about every important city in Canada.

Richmond says OMERS' asset mix for real estate--in the 10 percent to 15 percent range--was unheard of for pension funds back in the early 1990s and is still relatively rare for pension funds in North America today. Canada has followed the U.K. pension funds' example with that percentage. Investment in real estate is favored in both countries because it can appreciate much like stocks, can offer a steady income like bonds with a lot less volatility than other investments and is usually a good hedge against inflation.

"Before Michael [Latimer] came on board in the late 1980s, the proportion of OMERS' investment real estate had always been in the 9 to 10 percent range," says Richmond. "The market opened up [with properties coming on to the market in the wake of real estate company bankruptcies], and we had opportunities to acquire office and shopping center properties we never dreamed we would have.

"If we look 100 years into the future, we will have acquired shopping centers at major transportation intersections, often with land which, even if it didn't produce what we thought it would, we still have prime locations in all urban areas of the country," says Richmond.

Yorkdale, Scarborough Town Centre and Square One are good examples, Latimer says, of a "compelling investment, in moving from a suburban to an urban or quasi-urban environment, with town centers and the infrastructure for government, office and residential development."

The first two of those three centers were also good examples of OMERS' co-investment strategy. The centers were once 50 percent owned by a developer, and that partnership would have continued except that the developer was bankrupted and OMERS bought full control from the receiver.

"We don't invest to own bricks and mortar or for the results of that ownership, except what it does for pensions," says Richmond. "We are still applying the same strategies, still diversifying, and we still don't want sole ownership.

"Our diversification is by type of asset, by regions across the country, by joint venture partners and even property managers. We buy and manage instead of buying and selling, because we're in it for the long term and we pay cash so we don't have all the usual investors' debt-to-equity problems," says Richmond.

"Over the past two and a half years, economic conditions have been good for reinvesting capital, and we have an ongoing program," says Latimer. "We're reacting to the marketplace and consumers' demands with expansions of our centers, all of which is accretive to our general yield to assets."

Accretive is the word for the 1.5-million-square-foot York-dale Shopping Centre, which Latimer describes as the benchmark for sales performance for the industry in Canada, doing better than C$800 a square foot in sales.

"It's all about overall performance, about return on investment. Asset classes don't necessarily move in tandem," says Latimer. (They are currently about 50-50 split between retail and commercial, although he says OMERS is considering further diversification into industrial and multiunit residential properties.) "They move to create value, and we have to think about how we get appropriate return," says Latimer.

Would OMERS go shopping for properties in the United States? "That's not part of our strategy," says Latimer. "The Canadian market is the one we know. It's better for us to buy securities of companies in the United States rather than have people on the ground representing us second or third hand. We do the same internationally, although we periodically review our strategy to see if there are significant shifts where we can make money."

(Ontario Teachers' Pension Plan Board is more active than OMERS in the United States. It invested $75 million in U.S. REITs last year, for example, and also acquired a 10 percent interest in The Macerich Company, Santa Monica, California, for $150 million. Macerich is also a REIT, with interests in 47 malls and seven community centers.)

Latimer notes that there are only a few pension funds bigger than OMERS in Canada, but up to 50 that are bigger in the United States. The U.S. funds generally don't have as much real estate commitment as their Canadian counterparts do because they have had other real estate instruments available before they surfaced in Canada, including REITs.

"We are in it more directly than they are in the U.S., with OMERS Realty Corporation, for example," says Latimer. "In the U.S., they often use consultants, so they're structured differently--as are property tax laws and evolving asset mixes. In Canada, we have to have the money to pay for them, and don't risk creating an unfunded liability."

"We had a big scare a few years ago, when other pension plans were underfunded [didn't have enough cash in the till to pay future pension obligations], but we had managed to produce a small surplus," Latimer says. "After that, we spiked the surplus well beyond what we needed."

OMERS and the other pension funds that have invested in shopping centers are not likely to have to worry about underfunded liability in the near term--not as long as people continue to shop and spend on entertainment.

Albert Warson is a Toronto-based writer and editor specializing in real estate--related subjects.

Caisse Makes the Case for CMBS 

CANADA'S LARGEST PENSION FUND, THE CAISSE DE DEPOT ET placement du Quebec (Caisse), is more than a passive investor in real estate. Last May, for example, it initiated a C$254.l million issue of commercial mortgage-backed securities (CMBS)--the first to be distributed on the public market in Canada.

It is secured by 99 commercial mortgages, in turn secured by 114 properties--hotels, office and other commercial, industrial and residential buildings in Quebec. All the secured loans constitute full-recourse obligations for borrowers and, with few exceptions, cannot be prepaid.

The securities are divided into 12 tranches whose returns are tied to the bonds' risk and maturity dates. The Caisse will hold tranches of subordinated securities, maturing between 2002 and 2009.

Caisse Chairman and Chief Executive Officer Jean-Claude Scraire says the issue is in line "with our policy of diversified investment vehicles, greater liquidity and a high overall return. We also want to offer the market a new value-added product and develop our position as a Canadian real estate leader."

Jean Pinard, president of CDPQ Mortgage, Montreal, a Caisse Real Estate Group company, says this first public CMBS "meets the needs of today's portfolio managers because it is rated by recognized services and issued on the public market." Premiums on mortgage bonds and commercial mortgage loans in Canada, he adds, had declined toward the end of 1998, which made mortgage-backed securities an attractive investment vehicle in 1999.

The Caisse is the leading investor in Quebec and Canadian equities and Quebec government bonds; its commercial, residential and office building portfolio is the largest in Canada, with operations in more than 40 countries on five continents.

When the Caisse wanted to expand out of Quebec in 1996, it invested C$50 million in Bentall Corporation, Vancouver, through subsidiary SITQ Vancouver, Inc. That effectively gave it control over the company and its operations in British Columbia and along the U.S. West Coast.

In the United States, Ivanhoe Corporation and Cadim Inc., Montreal, another real estate subsidiary, have been buying into ventures in partnership with American and Montreal investors who know the U.S. market.

The Albertosaurus Is Back!

JUST BECAUSE PENSION FUND INVESTMENTS ARE HANDLED PRUDENTLY by bottom line--driven managers doesn't mean they are unmindful of promotion as a key ingredient in the way shopping centers perform in their real estate portfolios.

Ontario Teachers' Pension Plan Board, Toronto--or more specifically, its subsidiary, Toronto-based Ontrea, Inc.--for example, is two-thirds of the way through a C$300 million expansion and renovation of its nearly 1 million-square-foot Chinook Centre in Calgary.

It isn't the sheer size of that remake that is so impressive, but rather what Ontrea has approved and is financing for the new central rotunda off the main entrance. Russell Zeid, a Toronto-based mechanical engineer/inventor/artist, has created a 30-foot-long replica of an Albertosaurus dinosaur, which will stand nearly 20 feet tall on a plinth. He designed and built the creature, with the help of a fabricator, out of 2 1/2 tons of parts he selected from scrap yards near Edmonton and Red Deer, Alberta.

"Since it was an Alberta dinosaur, I wanted to build it out of parts of tractors, oil derricks, pickup trucks and other machinery that were there before the shopping center and represents a history of the area," Zeid says.

That dinosaur species once roamed the prairies, including the site of the shopping center, about 75 million years ago.

The architects of the redevelopment, MMC International (Canada) Architects, Toronto, backed Zeid's proposal, and he persuaded pension fund managers--who are by nature not terribly adventurous--to proceed with the idea.

The dinosaur is surrounded by whimsical flying machines revolving overhead on a monorail. One of the six artists involved also produced a "solar vine" set against a window, with 150 leaves and robotic insects that will be activated by sunlight.

There is also a fiber-optic installation on the ceiling that depicts the constellations exactly as they were on December 31, 1999--directly above a 4-foot-diameter time capsule in the floor that is timed to open on December 31, 2099.