This article is sponsored by Macquarie Capital Real Estate Advisors.
Canada Pension Plan Investment Board is one of the largest investors in global real estate, with a total of C$46.2 billion ($35.2 billion; €30.6 billon) of assets under management in the sector. It is also one of the biggest investors in developing markets. China, where CPPIB has invested close to C$28 billion, is a crucial part of the group’s strategy, so Michael Chan, head of Asia at Macquarie Capital Real Estate Investments, took the opportunity to talk with Guy Fulton, managing director, Real Estate Investments Asia at CPPIB, about the group’s strategy there, with PERE in earshot.
Michael Chan: How does the China real estate portfolio fit with CPPIB’s overall strategy? We increasingly hear a number of concerns about where we are in the cycle and the potential effect of rising global interest rates; how concerned are you about this and how does it affect your approach to investments?
Guy Fulton: CPPIB recently announced plans to boost our overall allocation to emerging markets to around one third by 2025, with a significant amount of the overall portfolio to be in China. This allocation makes sense when you consider the scale of the market: there are now 14 cities in China with an annual GDP of more than 1 trillion yuan ($144 billion; €125 billion), larger than many countries. Each of these are cities with large-scale diversified economies, which will drive China’s future growth.
We have positioned our China portfolio around the theme of consumption and linked it to fundamental demand. So our retail assets are positioned as mid-market, our logistics portfolio is in the non-bonded sector and the residential developments we’ve invested in have mainly been mid-market. We’ve sought to align to that fundamental demand, which we believe is still structurally supported and less vulnerable to cycles.
Our China portfolio is also relatively conservatively geared. We frequently stress test our assets and look at coverage ratios under various scenarios. We also look at our partners’ balance sheets. Having said that, you talk about raising interest rates, but, if anything, in China we’re seeing loosening of monetary policies. However, we recognize that globally we are at the late point in the cycle.
MC: Let’s talk a little about some of the sectors you invest in; in June CPPIB announced a $817 million partnership with Longfor Group, one of your existing partners in the retail sector, which will invest in for-rental residential. How did you approach this investment into what is a new sector in China?
GF: We had some exposure to for-rental residential through our mixed-use projects, which allowed us to dip a toe in the water and learn a little bit about it. We obviously also take comfort from the government policy tailwinds in the sector. It is the third leg of the government’s housing policy and a critical one. Throughout the recent history of property investment in China, having support from the government for a sector has been a huge driver of growth. Another supporting factor for us is that we have big rental housing portfolios in the US, so we have in-house expertise. Obviously, what applies in the US does not necessarily apply in the China market. However it is very useful to have in-house sector experience and knowledge.
MC: Logistics has been a major sector for CPPIB in China through your partnership with Goodman Group. How large is your commitment now and what are your thoughts on that sector?
GF: We recently announced an increase in the allocation to our partnership with Goodman, now $5 billion in total. When you look at the data on logistics supply in Chinese cities compared to US cities, it is clear China still has a long way to go and continues to be structurally underserved. However, not all markets are growing equally in China. We see much stronger rental growth in the major consumer centers, the first and major second-tier cities. Growth is, however, slower in some smaller cities, particularly those where there is some short-term oversupply. China logistics is fundamentally a play on consumption and we are continually shown just how broad and diverse that consumption pattern has been.
MC: Continuing the theme of consumption, you’ve also been in retail for a long time in China and worked with a couple of major partners in that space. Across the globe, retail has suffered strong headwinds, particularly given the adoption of e-commerce. How have you positioned your retail portfolio for this and what’s your view on the outlook for China retail?
GF: The big picture, again, is very positive because demand for retail property will continue to be driven by increasing consumption. What’s interesting about the retail sector in China is that it has been ahead of most of the world with regard to e-commerce, because the online format came of age in China at the same time as the mall format. China malls were created with more experiential retail, more F&B, more children’s entertainment, all the factors needed to attract footfall today. Retail sales also continue to grow in China, unlike in many other markets around the world where e-commerce sales are taking a much bigger share of a static pie.
Management is a big differentiator in retail and we’ve had two strong major partners in the sector: CapitaLand and Longfor. A good manager can attract brands and make an asset work even in a market with challenges. Some cities in China have faced oversupply issues in recent years and strong management makes all the difference between the winners and losers in this environment.
MC: Looking at CPPIB in China, we see that you have done a lot with a very select group of partners. How much work goes into selecting that partner? What are the most important factors in partner selection?
GF: Sector expertise in a given market is key. Secondly, we try to spend a lot of time with the management team prior to doing the first deal. The first deal is the toughest one to get done. Then, as the relationship grows, the subsequent deals become easier as the two parties come to understand each other better.
“We have positioned our China portfolio around the theme of consumption and linked it to fundamental demand”
We’ve invested with both overseas and local partners; the local players clearly have become bigger and bigger since we started investing. They’re a much larger part of the market now, so we want to work with them to grow our business. As these companies have become bigger, they’ve also become more sophisticated as they’ve dealt with more partners. Particularly interesting are companies that are developing investment properties, as opposed to the pure developers. I think if you’re developing investment properties, that will lead you to a longer-term mindset.
MC: The pool of domestic institutional capital in China is increasing rapidly, so we now have around $2.5 trillion of insurance capital. This represents a great opportunity for selling assets but is it also a challenge, due to increasing competition, to your investment programs?
GF: It’s a bit of both, but more domestic capital being allocated to real estate is an inevitable consequence of a maturing market. Look at the Australian market, for example. There’s a lot of local capital that invests into the Australian real estate market, but we still invest successfully there. We expect more domestic institutions to invest in the Chinese market and in some cases we’ll partner with them. The process of institutionalization also means more mature capital markets, with products such as REITs available, and this is all positive.
Challenges and surprises
MC: What would you view as the biggest challenges facing the real estate sector in China and for your investment program in particular? What have you seen that surprises you?
GF: The pace of change is something to always watch in China. Cities are developing quickly. Infrastructure can change and supply can change. The pace of consolidation in the market has also surprised us, so there are now fewer developers, but they are larger and better capitalized.
There’s also willingness from the consumer in China to try new things, especially when it comes to trying new app-enabled and technology-enabled experiences. The ability to deal with and profit from technological changes will be a differentiator going forward; the managers and the developers that survive will be the ones that embrace technology and make it work for them. The ones that don’t will suffer.