Unlike most pension fund lenders, CPP Investment Board aims to take more risk for more return. Daniel Cunningham meets the European private real estate debt team.
CPP Investment Board is not the most prolific provider of real estate debt in the European market, but when it does loan deals they tend to be interesting.
Last year’s included a £240 million ($295 million; €276 million) mezzanine piece to back Quintain’s Wembley Park development in London, representing a significant commitment to the UK’s fledgling build-to-rent residential sector. Another was its €150 million participation in a bond issuance to finance a portfolio of offices in the Romanian capital, Bucharest, a market few lend into.
The CPP of its title refers to the Canada Pension Plan, a public retirement fund into which 19 million Canadians contribute. CPPIB exists to invest the plan’s assets. While the majority of pension fund money invested in real estate lending tends to favour long-term, vanilla senior loans, CPPIB aims to write property loans with a higher risk/return profile.
That is because CPPIB, founded in 1997, remains in ‘net raise’ mode. A total of C$300.5 billion ($230 billion; €216 billion), as at September 2016, of Canada Pension Plan funds are not yet needed to pay out to retirees. The expectation is that it will collect excess contributions until 2021, when it will start using a small amount of investment returns to pay its beneficiaries.
“We can take on more risk than the average investor because we have a long-term horizon and we do not need to cover current pension obligations with current investment returns,” explains CPPIB’s managing director of private real estate debt, Geoffrey Souter.
Singapore’s GIC is perhaps a good comparison. Although it manages foreign reserves rather than pension contributions, its relatively young investment business also invests on behalf of a major sovereign wealth fund, seeking good long-term returns including through high-yielding property lending.
“A younger investor should have the ability to take on a little more risk in their portfolio because they have a longer time frame in which to absorb changes in the market,” says Souter. “If you’re already paying out retirees from existing funds, your strategy should probably be more conservative. We have a fairly unique advantage where we have a very certain pool of capital that is supporting a retirement system that is statistically solvent for the next 75 years.”
Across its business lines, the board has a target portfolio that can, in theory, be comprised of passive, index-linked investments. However, CPPIB’s mandate is to maximise returns without undue risk of loss, meaning it seeks to actively invest for higher returns. For the real estate finance group, that means only lending when it can offer large-scale customised financings that can generate higher returns.
“CPPIB being an ‘AAA’ entity doesn’t mean we are allocated a particularly cheap cost of capital,” says Souter. “On a risk-adjusted basis, we need to generate returns that exceed the returns that the fund can generate with passive investments.”
Target net risk-adjusted returns are typically within 5-9 percent. On the basis that these returns are achieved, and provided the underlying real estate is of a quality that CPPIB would actually buy itself, the team can lend across the capital stack, across varying jurisdictions and for a range of tenors. For CPPIB, real estate debt fits into one of four business segments investing the C$300.5 billion fund. The public markets investments division, which invests in securities and fixed income, accounts for C$125.4 billion. Investment partnerships, its funds and secondaries business, accounts for C$71 billion, while private investments accounts for C$38.1 billion.
Real assets, comprising real estate and infrastructure, is C$66 billion of the book. Within that segment, real estate is a C$42.5 billion global business, primarily targeting equity investments from offices in Toronto, New York, London, Sao Paulo, Hong Kong and Mumbai.
“Typically, we are a direct real estate investor,” explains Souter. “We invest with strong operating partners, usually in a 50-50 joint venture. What we do on the equity side helps to define what we like in the real estate debt space.”
The property debt business stands at C$4.5 billion, around 10 percent of the overall real estate investment book. “My sense is that 10 percent is probably where our book belongs,” says Souter.
“Given the long-term nature of our broader organisation, investing in the real estate equity portion of the capital structure often makes a lot more sense than debt as it gives us the ability to control our exit strategy. However, in many circumstances, the opportunity relating to debt may be more attractive on a risk-adjusted basis and we position ourselves to take advantage of that. We think about ourselves, first and foremost, as real estate investors.”
CPPIB began property lending on an ad hoc basis in 2009, simultaneously in North America and Europe, with European deals initially handled from Toronto. A real estate debt team was formally established in 2010, with expertise on the ground in London from 2012.
Souter is based in Toronto, but frequently visits London. His team of four in the UK incudes director Rawle Howard, who joined in November 2015 after more than seven years at BlackRock in New York and London, and portfolio manager Constantin Mayer, a former Barclays Capital investment banker who joined in 2013.
CPPIB’s initial real estate debt investments were made in the US first mortgage market, which back in 2009 was underbanked and generated returns of 6 percent-plus. Around $1 billion was deployed into that market, although CPPIB moved on when it became more liquid.
To date, CPPIB has deployed around C$1.6 billion in real estate debt in Europe since 2009 in minimum investments of £/€50 million.
Early European deals included a £100 million mezzanine financing to Hercules Unit Trust in 2009 (see table on p. 31). A £100 million investment was made into PGIM Real Estate Finance’s (then Pricoa) maiden debt fund in 2010, although CPPIB has not since invested in property debt funds due to the inability to access high-yielding deals on the scale it needs through that route. Spain was a target from 2013, with around €400 million deployed there in 2014 and subsequently paid back within a year as the market opened up.
In any deal, an element of complexity is needed, be that a borrower needing subordinated debt to supplement an existing financing structure, a lending deal across multiple jurisdictions, or a deal in which a large cheque is needed in an illiquid part of the market. The guiding principle, Souter stresses, is that his real estate equity colleagues endorse the underlying property.
Beyond that, CPPIB has few constraints. Loans can be either fixed or floating rate and tenors can be anywhere up to 20 years. Bridge finance and construction loans are possible. Lending can be senior, mezzanine, preferred equity or in bond format.
“The mandate’s pretty broad, as long as it is supported by strong real estate,” says Souter, although he admits that mezzanine is often the preference because that is where CPPIB gets paid incrementally more for the risk it is willing to take.
“There are situations where, frankly, the banking market is non-existent,” says Mayer, “Spain three years ago was a great example. We were able to focus on the best quality real estate with great sponsorship and achieve the risk-adjusted returns that we were looking for.”
The ability to be flexible on loan length is another factor which allows CPPIB to root out its optimum deals, adds Howard: “The fact that we can go from one year all the way to long-dated debt is a crucial advantage for us. If the opportunity is right, we can invest.”
A good example of CPPIB’s approach to property lending was its role last December in the £800 million financing of the Wembley Park scheme, located on 85 acres of land surrounding the English national stadium. The £240 million mezzanine piece was structured as a part-corporate and part-construction loan for the sponsor, Lone Star’s Quintain. It backed perhaps the boldest example yet of private rented sector (PRS) residential development in the UK, a market which remains largely untested.
“Wembley was an opportunity which came to us early last year through our existing relationships with Lone Star and Quintain,” explains Howard, who led the deal for CPPIB. “They were looking for a debt package to support the long-term plan around Wembley and they needed to find someone prepared to provide a hybrid of a construction loan and a corporate facility. They considered us one of the only shops that could do it.”
US lenders Wells Fargo and AIG provided a £560 million, five-year revolving loan. The overall facility is secured at the corporate level by Quintain shares and by a mortgage against existing assets. CPPIB is an investor in the US multi-family market and so was comfortable backing the UK PRS sector. “We had been exploring investment opportunities in UK PRS on both the equity and the debt side, so when we saw this opportunity, we were well-educated about the sector and thought that it made a lot of sense from a risk-adjusted returns standpoint,” says Howard.
Another recent deal was CPPIB’s involvement last May in €150 million of a €180 million bond issued by AIM-listed Globalworth Real Estate Investments, backed by high quality property in Bucharest. The deal was done alongside Cairn Capital, which provided €30 million and requested the bond format due to its funds aiming to invest in listed securities.
“In a constrained local lending market, the borrower wanted a large-scale financing solution without going out to several parties,” says Mayer. “We went over to Romania multiple times to sit down with the management team and for us to understand what the market was all about.”
Looking forward, Souter says that CPPIB is committed to the UK and Europe, including central Europe. “Due to the uniqueness of the mandate, we don’t have a specific annual origination target. We have a target range for what we’d like the portfolio to look like over time. At the moment we’re somewhere in the neighbourhood of C$4.5 billion and we are targeting close to C$7 billion on a global basis.”
That target, in the next three to four years, will include around 15-20 percent secured on European property. The European real estate debt portfolio is currently C$750 million, so the growth plan would see that roughly double, equating to more than €1 billion.
“My sense is that the European book should be between 15-20 percent of our target global debt portfolio. However, given our experience to date, it’s going to be a struggle to get it to that figure and keep it there. We want to look for opportunities where we think there’s an ability to get paid for taking on the additional risk, but we’re not going to chase the market.”
Howard adds: “The great thing about being a long-term investor is that we can pause when we think the market is getting ahead of fundamentals.”
CPPIB’s centrally-directed investment mandate has determined its real estate debt activities, meaning that it has been able to take an opportunity-led approach. Italy, for instance, is a market CPPIB hasn’t been in yet, but nothing is off the table, Souter explains, provided the right investment criteria are met.
“We do rely on the expertise of our equity team and they are much more broadly exposed than we are, so there are plenty of jurisdictions that we would still like to participate in, if and when the opportunity arises.”
Wembley deal puts CPPIB in the game
CPPIB’s role in the £800 million financing of the mixed-use Wembley Park development project in London is its highest-profile European property debt deal so far.
When US private equity giant Lone Star swooped for UK property company Quintain in September 2015 it did so primarily to gain exposure to the London residential development sector through the 85-acre Wembley Park, which represented more than 80 percent of Quintain’s portfolio.
At Wembley Park, Quintain plans to invest between £800 million and £1 billion over the next five years to develop a mixed-use village including shops, work space and, crucially, 4,850 homes, many of which will be available through Quintain’s private rented sector brand, Tipi. Last year, around 141 PRS apartments were let through Tipi at prices of more than £20,000 per year for two beds.
Simon Carter, Quintain’s finance director, worked with CPPIB in 2009 on the financing of Hercules Unit Trust when he was at British Land.
CPPIB’s £240 million mezzanine tranche was structured to allow it to be drawn down incrementally over three years, Quintain’s strategic finance and investment director, Catherine Webster told Real Estate Capital last December.
The £560 million senior loan – provided by Wells Fargo and AIG – is fully revolving. As elements of the scheme are completed they will be refinanced at the asset level with longer-term finance.
CPPIB Private Real Estate Debt at a glance
Lending since 2009 in North America and Europe
Team formally established in North America in 2010 and London in 2012
Led by Geoffrey Souter, managing director
European team comprises: Rawle Howard, director; Kelin Ye, analyst; Constantin Mayer, portfolio manager; Souter; Adrien Aubague, associate
Real estate debt portfolio stands at C$4.5 billion globally. European book stands at C$750 million
Deployed around C$1.6 billion in Europe since 2009
Can do senior, mezzanine, preferred equity, bonds, bridge finance,
Lends on a fixed/floating basis on tenors up to 20 years