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Canada’s biggest pension fund is riding China’s wave of urbanization for its next stage of real estate growth, as it looks to boost investments in emerging markets.

A property investment strategy that started with shopping centres in places such as Thunder Bay and Stoney Creek, Ont., in 2003 has now grown to $46.1-billion in commercial real estate in Europe, the Americas, Australia and Asia for the Canada Pension Plan Investment Board.

China and real estate have become critical parts of CPPIB’s vast $356.1-billion portfolio as the fund works to earn the returns needed to pay Canadians a monthly pension when they retire.

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Now, CPPIB is poised to invest even more of Canadians’ retirement savings in Chinese commercial property.

“There is huge demand for real estate and we see a great investment opportunity over the next couple of years,” said Peter Ballon, global head of real estate for CPPIB, which manages investments for 20 million Canada Pension Plan contributors and pensioners.

Part of its investment strategy is to hold up to one-third of its assets in emerging markets by 2025, with China, the world’s second largest economy, playing a vital role. The fund currently holds 16 per cent of its assets in emerging markets, which include China, India, Brazil and other countries.

There are risks: The Chinese commercial real estate market is opaque; state policies have caused overbuilding in some areas; the Chinese economy is swimming in high levels of debt; and businesses are vulnerable to government intervention and changes in policy.

But the potential for growth is big. The stock of premium offices in Beijing, Shanghai, Guangzhou, Shenzhen and a dozen other top urban centres is forecast to increase 75 per cent by 2022, according to commercial realtor Cushman & Wakefield, and retail is expected to expand by 30 per cent.

“A massive jump within just four to five years,” said Catherine Chen, Cushman’s head of forecasting for Greater China.

Real estate investments

CPPIB and other property investors have already benefited from the country’s decades-long plan to move tens of millions of people from rural areas to urban centres.

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The Canadian fund has a stake in some of the most prosperous cities, such as a shopping centre in Chongqing, distribution centres in the country’s financial capital of Shanghai and huge warehouses in Beijing’s only international air and road freight centre.

“China is a very policy-driven market with significant government intervention,” Ms. Chen said, adding that less experienced foreign investors may have a harder time adapting to “rapidly changing government policies” and intense competition from large Chinese developers and investors.

As its middle class expands, the Chinese government is under pressure to keep its economy humming and people employed. Ambitious plans are in the works to create an economic hub in southern China, build new trade routes to connect China to southern Asia, Europe and Africa, as well as to transform the country into a high-tech superpower.

“Although the growth is higher in China, there is more economic risk in China as growth is still heavily dependent on the government policy,” said Benjamin Abramov, fund manager with LaSalle Investment Management. China, he said, "is considered to be a semi-transparent property market to transact in, when compared to countries like Canada and the U.S.”

China has imposed population caps in Beijing and Shanghai and identified cities where it would like to grow. Its central bank recently pumped money into the financial system in an effort to counter negative effects of its trade war with the U.S.

The initiative to pull the economy away from lower-skilled manufacturing and into higher technology and artificial intelligence, known as “Made in China 2025," is seen boosting demand for industrial and R&D facilities. It may also create massive redevelopment opportunities.

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Chinese President Xi Jinping has selected places such as Chengdu and Guangzhou as pilot cities for the Made in China 2025 plan, but not yet the biggest employment areas such as Shanghai.

“With significant government support at their back, it’s more likely that these cities will be able to grow their current advanced industries base," said Joseph Parilla, a fellow at think tank Brookings Institution who co-authored a report on China’s urbanization. “Although, nothing is certain and there are some questions about the efficacy of the strategy in general.”

CPPIB has prime property in the biggest labour markets of Beijing and Shanghai. It recently made a US$817-million investment to build apartments and other rental homes in the country’s biggest cities after the Chinese government made a push to increase rental housing supply as a way to deal with the frenzied residential real estate market.

“Right now, the Chinese government is very supportive of creating a good environment to create rental housing. There is strong support for that and strong demand,” Mr. Ballon said.

Competition

As the opportunities in China grow, CPPIB is facing increased competition. Total investment in Chinese commercial property increased 40 per cent to a record high of US$639.5-billion last year, surpassing total investment in the United States, the world’s biggest and most liquid big real estate market, according to Cushman data.

But CPPIB can compete against foreign and domestic real estate investors with its cash, long time horizon and government ties and name.

Chinese property developers need foreign capital since the major lenders in the country tend to lend to state-owned enterprises.

CPPIB has funds and will soon have more cash to deploy as Canadians are set to increase their CPP contributions next year. It has the added bonus of being viewed favourably by Chinese operators because the fund is seen as an extension of the Canadian government and Chinese companies are accustomed to working with state-owned enterprises.

“They see [CPPIB] as more of a branch of the Canadian government,” said Gordon Houlden, director with the University of Alberta’s China Institute, which tracks Chinese investment in Canada. “I suspect the Chinese would see that and be reassured.”

CPPIB has formed a partnership with big Chinese developer Longfor Properties Co. Ltd. and has a dedicated team of real estate experts on the ground in China. It has about 30 commercial property complexes that are fully leased and producing revenue, as well as numerous projects under development.

CPPIB would not provide the total value of its Chinese real estate assets, arguing that it is competitive information. But across all asset classes, $22.4-billion, or 6.3 per cent, of the fund is in China, according to its annual report. About 15 per cent of the fund’s assets are in Canada.

Performance

Since CPPIB started investing in real estate after the turn of the century, it has become a major part of its portfolio. Commercial property now accounts for 13 per cent of the fund’s total assets, compared with about 1 per cent in 2005.

More importantly, real estate has raked in money for the fund. Real estate returns were in double-digit territory from 2011 through 2016, with one year hitting a whopping 18 per cent. The fiscal year ended in March showed real estate investment gains of 9.4 per cent.

CPPIB and much of the industry benefited from a decade-long bull market in commercial real estate, driven in part by low global interest rates. Those that made big acquisitions after the Great Recession, as CPPIB did, are reaping the rewards of the property boom.

It is unknown how CPPIB’s Chinese real estate assets are performing. The fund would not disclose its return on investment numbers in China, citing competitive information.

The fund’s chief executive officer has said CPPIB’s overall investment returns will be lower over the next five years compared with the past five. As for real estate, Mr. Ballon said, “we are feeling quite positive that right now real estate continues to perform quite strongly."​

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