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Falling property values across the commercial real estate sector put a dent in the Ontario Municipal Employees Retirement System’s investment returns last year, but chief executive officer Blake Hutcheson predicts that “the worst is behind us.”

OMERS investments gained 4.6 per cent in 2023, or $5.6-billion after expenses. The pension fund manager’s results were buoyed by strong gains from stocks and bonds, but its real estate portfolio lost 7.2 per cent as higher borrowing costs and operating expenses drove down commercial property values.

OMERS missed its internal target to earn 7 per cent for the year. But its longer-term returns have cleared that mark, with the fund averaging an 8-per-cent annual gain over the past three years, after expenses, and 7.3 per cent over 10 years.

It has been a harrowing year for commercial real estate investors, and OMERS’s business in the sector “got hit hard,” Mr. Hutcheson said. High interest rates drove up borrowing costs, inflation increased operating costs and vacancy rates climbed higher. That has forced investors to sharply mark down property values after many had stubbornly stuck by higher valuations even as central banks ratcheted up interest rates.

Much of the angst has focused on office buildings and retail outlets such as shopping malls, as hybrid working arrangements took hold and consumer purchases tilted more toward e-commerce after the COVID-19 pandemic.

But Mr. Hutcheson said OMERS felt the impact on property values across its real estate portfolio in 2023, including for industrial properties that have generally been more resilient. That was in spite of a 9-per-cent increase in income from properties owned by its real estate subsidiary, Oxford Properties.

“This year it was pretty universal,” Mr. Hutcheson said.

With interest rates likely at their peak, however, he predicted that capitalization rates – the ratio that measures the annual yield from an investment property, and gives an indication of how risky it is – have hit a high, meaning that property values could soon start to stabilize, easing the risks to investors.

“As the cost of money comes down, by definition appraisers bring cap rates down,” Mr. Hutcheson said. “We think, on a go-forward basis, real estate as an asset class will start to pick up. … The worst is behind us from a valuation perspective.”

That doesn’t mean the pain is over for real estate, as some property owners will struggle to refinance expensive debt and to off-load lower-quality buildings, except at bargain prices.

That could create buying opportunities, not only in real estate but other sectors as well, and OMERS has stockpiled capital to take advantage as assets come up for sale at attractive prices.

“We didn’t see any of it in 2023, of note,” Mr. Hutcheson said. “We do expect more of that in the next year and two years.”

Last year, OMERS had a wide divergence in performance between publicly traded stocks and bonds and privately held investments. Stocks gained 10.4 per cent and bonds were up 5.8 per cent. By contrast, OMERS had gains of 5.5 per cent from infrastructure and 3.9 per cent from private equity, which are lower-than-normal returns that compounded its real estate losses.

That was a reversal from 2022, when gains from private investments boomed and public equities and bonds lost money, adding up to an overall return of 4.2 per cent.

OMERS also shifted about $4-billion into bonds and private credit last year, seeking to take advantage of stronger returns from fixed income while rates are at their highest level in two decades. Most of that sum was moved out of investments in equities.

“When the markets soften, we think our focus on credits and privates will outperform, and that’s what we’ve experienced over the past three years,” Mr. Hutcheson said.

OMERS invests on behalf of approximately 600,000 Ontario public-service workers, including nurses, firefighters and police officers. It now manages $128.6-billion of assets, up from $124.2-billion a year earlier.

The plan is 97-per-cent funded and inching closer to being fully funded, up from 95 per cent at the end of 2022.

“All things considered, we’re feeling good about the way we’re positioned,” Mr. Hutcheson said.

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