Jafer: Welcome to the Minds and Markets podcast. I'm Jafer Naqvi, your host for the second edition in the Minds and Markets podcast. What we really try to do is dive into investment topics that matter to investors in a little bit more detail than you would get in a traditional conversation and really excited to have with me for episode number two, Andrew Croll, who leads our real estate team here at TD.
Andrew, welcome to the podcast.
Andrew: Pleasure to be here, Jafer.
Jafer: And I'm really excited to have you here. Andrew We've been working together. I think we're talking for almost 15 years. I always love the conversations we have because you really do bring with your unique background a different perspective to managing private markets than others. I was hoping maybe you could give the listeners a bit of a sense of your history because you've really come up from a client orientation, a solutions orientation, and really allows for a real client focused conversation.
And so, they walk us through the journey on how your path led you to leading global real estate.
Andrew: Yeah, thanks. Jafer So it has been a very interesting and unique journey. I started at Greystone as you did back in 2013, joined as a client portfolio manager, and really, I was brought on to be a client facing expert for our real estate and commercial mortgage business. Over time that business expanded into infrastructure with the acquisition of Greystone by TD Asset Management in 2018.
We expanded into private credit, and through that journey I began taking on more senior roles, both from a client product and investment standpoint, including joining the alternative or Private Market Investment committee back about five years ago. And really it was a natural fit to come in and lead the global real estate team. It's been two and a half years, and I think I bring, as you said, an interesting lens in that I understand portfolio management, the construction, the risk management side of things.
I understand what real estate means for our investors, many of whom are institutions and in nature and just more broadly, how real estate fits into an overall portfolio from an asset allocation standpoint.
Jafer: So, let's really start there, because I think that's an important point for investors today. There's obviously a lot of news around real estate, as there always is. It's been a stressed asset to a large degree over the last few years, particularly from COVID onwards. But let's take a step back. Why has real estate existed for decades in institutional portfolios?
What role does it play in that total portfolio context, in your view?
Andrew: I mean, ultimately real estate is about a piece of land, a building, a tenant, and you lease out your real estate, you earn an income stream and that income stream grows with inflation over time. And so fundamentally, you know, it's like a bond in the sense that you have very stable yield, but you also have growth like you do on the equity side of things.
And that's why, you know, real estate typically will fit in between an equity and a bond from an asset allocation standpoint. And that ability to pass on inflation and achieve growth beyond just the in-place yield really makes real estate unique as a as an asset class. From an asset allocation standpoint.
Jafer: I think a lot of the joy I've had in our conversations over the years is in that role that you get the income and stability. It's not to say you're going to have positive capital returns every year. Those fluctuate, but that income really contributes overall. You get that inflation adjustment; you get a bit of a premium for being in a private market.
And we did see that in 2022. And so maybe speak to 2022 and how real estate was able to mechanically hold its value when stocks and bonds were under duress.
Andrew: Yeah, I mean, I think the early part of the pandemic, you saw a period where stocks and bonds sold off at the same time. And so, you know, real estate, when you look at sort of the underlying fundamentals, you know, the leases in place, you know, we're backed by good credit. So, there was no sort of credit turnover on the income side of the ledger.
At the same time, you saw inflation starting to heat up and you actually saw, you know, not all in real time, but you did see leases start to adjust quite materially towards inflation. And I think one of the interesting things about the last several years on the real estate side of things has been that real estate income has actually been growing at a pace that is higher than inflation.
Andrew: So, you know, we have been in a period where, you know, elevated interest rates have created a repricing from a valuation standpoint, but at the same time, the income and the inflationary argument actually has held true. And in 2022 in particular, when a portfolio needed it the most, you know, Canadian real estate portfolio was up close to 10% in 2022 when you had that sell off in both stocks and bonds.
And really that's some of the value from an asset allocation perspective that you can see in real estate alongside other asset classes.
Jafer: And I think that brings us to today and I think we've maybe had the two of us in conversations of bit of a unique view on how real estate looks as a starting position today relative to maybe market consensus. One of the things you and I have worked on a lot of over the years is how do you think about real estate from forward looking perspective?
And we've often come back to that starting yield. And this is a really interesting point to me where you were sharing some data that showed, especially in the private space, the starting cap rate that we have in Canada, in particular in real estate is the highest we've been in 15, 20 years. What does that mean going forward?
Andrew: Yeah, it's interesting. So, if I go back to when I joined the team and we were looking at the role of real estate, I always used to say that 80% of returns came from income and that was true. If you if you look back sort of historically. But then we were in a period where you saw this significant decline in interest rates over the 15 years post GFC, and that created this massive tailwind for capital returns in real estate.
And although, you know, I would say 80% was more like 50% or sometimes even less, that actually coming from the income profile because you saw interest rates continuing to decline during that period. And so, we have certainly seen a reset in interest rates over the last five years, and that has created an environment where cap rates in real estate have expanded.
You know, I would argue that in Canada, you know, it has been a little bit slower in terms of that expansion. So, you've seen over maybe a period of four years a more gradual expansion of real estate yields. But if you sort of compare where we were pre-pandemic to where we are today, we are very much back in that environment where the majority of returns can come from income.
You don't need to rely on that interest rate declining scenario to achieve a high single digit type of return profile on a core real estate investment. I think that's really exciting because it allows you to achieve a return threshold without taking on additional risk, whether that is leverage or, you know, higher returning strategies to try and meet a return threshold, We are really back into an environment where yield and the current cap rates of real estate are going to drive underlying performance irrespective of whether or not you have this environment where interest rates come down.
I think that's really exciting. I do think the second point is that, you know, if we have some continued low to moderate inflationary environment, you're going to see that continued pass through of inflation in rental rates at a time where you don't see the capital values declining. So last five years we saw income growing, but you didn't experience that in your portfolio on a total return basis because you had negative capital values as the market was resetting to a higher interest rate environment.
And today you don't have that noise, and you have a much higher income yield from a starting point. And that's very exciting for returns in real estate going forward.
Jafer: And I think that's what gets buried, right? We see those negative returns. But when you look under the hood, what I'm hearing from you is the income has been resilient and actually growing. And in some ways, you can look at it as buying high quality, resilient income streams at a lower price, now, relative to history, but let's be balanced here as we always want to be with investors.
To be clear, is there a difference? Right now, we talk about Canada between commercial real estate, which is often where institutions are and what we're seeing in the residential market and condos. That really is one of the main, I think, headwinds. Maybe the multi-unit residential space is related to commercial real estate. There're always stories around retail and industrial.
Walk us through the challenges we see in real estate, but then also why you maybe think at a total portfolio level income will still be resilient?
Andrew: Yeah, I mean, I think there's a couple of things. So, if you if you go back over the last 15 years and just think about the different cycles that we've seen in real estate, you know, 15 years ago it was no one wanted old generation industrial and then it was super regional shopping centers. During the pandemic, the flight to quality was apparent.
But on the office side of things was really challenging as people weren't physically in the office. And it really challenged the need for companies to lease out office space. Fast forward to today and you have a I would say, a softening in multi-unit residential demand. I think it's important to look at what the drivers of that are.
And in particular, if you look at office, clearly the driver was the pandemic and shifting behavior of people and whether or not they're physically in the office that has come full circle where a market like Toronto, but even in Manhattan, you are really at pre-pandemic levels in terms of office occupancy and you're actually seeing very strong leasing dynamics.
You fast forward to the multi-unit residential sector and there was a change in immigration policy at the federal government level that led to a decline in population, and that's the first decline in population that we've seen in decades as a country. We've been running at a pretty steady clip of sort of one and a half to 2% population growth.
Andrew: During COVID, we were up to 3, 3.5, 4%, and it became a little bit unsustainable. Like you had a period of four years where the Canadian population grew by about 10% on a cumulative basis and although there is a shortage of housing in the market, at the same time you have a massive surge in population which created this extreme growth in rental rates and kept what was a low vacancy rate in the multi-unit residential sector very low.
That stimulated lots of construction activity both on the condo and the apartments side of things at a time when some of those units are completing. You've had this change at the federal government level and that has reduced the population. So, there's a demand side shock that has taken out some of the growth in multi-unit residential with the reduction of the of the population.
We see that is a very temporary or short term impact similar to, you know, the impact of the pandemic on an office in the sense that, you know, the long term immigration policy hasn't materially changed for the federal government and that will lead to this recovery in underlying demand. And so, I think what's really interesting right now in terms of where we are from a cycle perspective is that you're coming out of this environment where, again, yields are elevated, the valuations have reset.
And if you look at the supply side of the equation, there really is a significant reduction in construction activity of multi-unit, residential industrial, where 50% off of peak construction activity there really hasn't been any new retail purpose built or standalone retail being built in Canada in the last 15 years in office because of the elevated vacancy coming out of the pandemic, new construction activity is really at a standstill as well.
And so, on the supply side of things, with the exception of industrial, you're typically four or five, six years out before you start getting a new supply response. And so, again, you're at this really interesting point in the cycle where you have a yield or an income story. You've got inflation protection and you have a supply shortage across every sector in the market, including multi-unit residential, despite the sort of short-term headwinds that we've seen in terms of population.
And so that creates a really productive environment from a forward-looking performance standpoint.
Jafer: You know, the neat thing every time I hear you talk about that, a common mentor of yours, and I would always remind us that we think of real estate as one asset class, but it really is a diversified exposure to the economy. And if you go through time, it's all a sector of the real estate market that has headwinds and tailwinds.
Jafer: But it's really about looking at that total portfolio CEO and the income resiliency. And so, I feel that's a really good snapshot of where we are with Canada. But the other unique thing about your perch is you have a global perspective with global real estate strategies. And the one thing I want to expand, though, that you talked to me about a few weeks ago is how global might be a little bit of the positive canary in the coal mine in terms of showing what happens in real estate starts to lead.
And it might be an indicator of where Canada's going to go but talk to listeners through global real estate dynamics and where that is in the cycle.
Andrew: Yeah, so I think it's true every property type goes through its own cycle and every geography seems to go through its own cycle as well. And so, if I look at starting with Asia Pacific, so markets like Australia, Singapore, Korea, Japan, interestingly, you know, not as much of an impact to the pandemic environment. You know, work from home wasn't really a significant thing in that part of the world.
You saw really a stronger, more stable period during the pandemic. And so, you didn't see the decline, but you also don't see the snap back from a performance standpoint. And so interestingly, you know, in the last five years, that's been some of the better performing, more stable part of our portfolio internationally has really been kind of an anchor for diversification.
Meanwhile, you look at a market like Europe and you've seen a decline in pricing that probably preceded the Canadian market by a good year and a half to two years. And so, from an allocation perspective, I think that is something that is very interesting. The ability to be able to allocate at different places in the world at different points in the cycle, because we did see an earlier decline on the European side of things largely driven by quicker valuation or devaluation of assets in response to, you know, the broader market.
And that led to, you know, more capital coming back into the system and into a recovery in prices. And that is really followed in the US as well, where, you know, we saw, you know, perhaps a year or so ahead of the Canadian market, you know, some more interesting pricing opportunities in terms of just putting capital to work.
And I think that one of the common themes that we've seen in Canada and internationally is that right now there is a strong ability to make investments that have very high cash yields. And so, again, you don't need to take the development or opportunistic risk today to earn high single digit, low double-digit type of return profile. And so, I think really the advantage on the international side of things is that we are a little bit agnostic to the market itself.
We want broad diversification, but we can be very tactical in finding bottom-up opportunities. I would say that compared to Canada, there is an environment that has pockets of more distressed opportunities, whereas in Canada you saw the reset in valuations, but you don't see a lot of distressed sellers of real estate. And part of the reason is that you've had a lot.
Jafer: Of…
Andrew: Domestic institutions, including groups like TDAM, but also a lot of the pension funds that have long term investment horizons that haven't been forced sellers of real estate. That environment there are, I would say, more opportunities abroad to have more of those, you know, tactical, opportunistic or distressed opportunities to be a provider of capital. And we've been able to take advantage of that, in particular in Europe as we've gone through that recovery.
And we've been more active more recently in the in the U.S. as well.
Jafer: And so maybe as we end the conversation, a lot of chats on how to figure out where we are in the cycle and where we're going and looking for some leading indicators, return. Interesting one to me. And so, I did want to get your perspective on rates. They've really had some strong returns in recent quarters. Traditionally, is it good to look at those as leading indicators of where we might be going in private commercial real estate?
Or how do you look at real REITs versus private markets and the fact that they're not always performing the same?
Andrew: Yeah, I mean, I think that the advantages of REITs is that they have, you know, daily liquidity versus a private market investment. The challenge is that that liquidity isn't always there at the price that you want when you want the liquidity. And so, you know, during periods of extreme dislocation, you would need to sell REITs at a level that was a significant discount on the underlying net asset value or underlying income stream of the REITs.
When I think about REITs, one positive indicator would be the M&A activity that we're starting to see where there is more interest from private capital to take out REITs at a premium valuation, sort of indicating some support for the overall underlying sector. And I think it provides good support for private valuations as well. If you have sort of that private capital that's able to sort of rationalize the pricing on the on the public side of things.
But there are there's no question that there can be periods of time where you have dislocation between REITs and private capital. And I think that it comes down to liquidity at a price in terms of the ability to trade REITs. The other thing that is interesting with REITs is that if you look at the U.S., most of the REIT sector in the US is not office, retail, industrial and multifamily.
It is other alternative real estate sector. And so that is an area to watch as well as that as new sectors in the real estate market or subsectors emerge. You know, the ability to leverage listed REITs to gain that type of exposure is an interesting option because it's not always found within a private portfolio.
Jafer: Well, Andrew, maybe to close it as we're coming up on time, I was thinking we could do a rapid fire round here to try and summarize things for our listeners. So, I'm going to lay out a topic in three words maximum to help summarize things for us. Okay, So first: strategic role of real estate in a portfolio.
Andrew: Diversification, Inflation, risk management. Okay. I guess that's four words.
Jafer: Yeah. Okay. I'll give you a pass on that one second: why now? To consider building real estate positions.
Andrew: You're going in... Yield is attractive. The supply is a unique period of time that the supply taps are being shut off. And again, I think diversification.
Jafer: Okay. And then the final one, you've got two young daughters. Best things to do in the GTA in the summer when your kids are at home.
Andrew: Well, I actually just took them to a Blue Jays game in which we had a blast doing although they lost in the gave up a couple of big runs in the eighth and ninth inning, but it was a lot of fun.
Jafer: I think Blue Jays are one, two and three in my heart as well. Andrew, thank you so much for your time today. We hope the listeners have enjoyed our Minds and Markets podcast on the topic of Canadian and global real estate and hope to see you again at the next podcast.
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