Commercial real estate slump slams pension plans

All those empty seats at the office are taking a bite out of Canadian pension funds.

This week, the Ontario Teachers Pension Plan reported it had missed its investment target for 2023. The biggest offender? OTPP’s real estate portfolio which saw a negative return of 5.9 per cent. But Teachers is not the only big pension plan which has seen a fall in the value of real estate investments.

The Ontario Municipal Employees Retirement System reported its real estate portfolio had a return of -7.2 per cent in 2023 and the Canada Pension Plan Investment Board saw its real estate investments drop by 1.2 per cent in fiscal 2023.

What was once a stable, safe investment category, finance and real estate experts say, has been pushed onto shakier ground by a combination of hybrid work, expanding online retail, and high interest rates.

And two of those three factors — hybrid work and online retail — are here to stay, says Peter Norman, chief economist at Altus Group, a real estate analytics consultancy.

“There’s going to be a lot of sorting out over the next decade or so,” said Norman. “There are millions of square feet of functionally obsolete office space in Toronto alone. That’s a structural issue, not a cyclical one.”

Erin Stafford, managing director for North American real estate at ratings agency Morningstar DBRS, said real estate in the retail sector has already taken a hit, but added there’s more change to come in the office sector. “We just don’t need as much office space,” said Stafford. “Over the next three to five years, we’ll have a better sense of the haves and have-nots.”

Over the last year, said Stafford, getting a sense of what commercial real estate is worth has been tricky, because there haven’t been many big properties changing hands.

“There really haven’t been nearly as many big transactions as we’d normally see,” said Stafford.

Some of that hesitation has been because owners of large properties are waiting for the U.S. Federal Reserve and the Bank of Canada to start cutting interest rates. Once interest rates start to come down, real estate values could come back up. But with less overall demand for office space, not all properties will benefit from the bounceback, Stafford said.

In an emailed statement, an OTPP spokesperson acknowledged that it’s been a “challenging couple years” in real estate and expects it to remain challenging in the nearterm. While keeping a close eye on its investments, and valuing them conservatively, the spokesperson said the OTPP is still optimistic about the sector in the long-term.