Hello and welcome to The Download. I'm your host, Dave Richardson, and we are in our fancy studio, our fancy real estate that we have here, and it is commercial real estate. So that means we need to talk to someone who knows about commercial real estate, not residential, by the way. I just want to point that out for anyone listening we will not be talking about residential real estate. With Jennifer Schillaci, and we're going to talk about what she's doing and what you want to think about in terms of some alternative assets that you can get access to but perhaps haven't been doing as much of in your portfolio. But this is the idea. Hey Jennifer, thanks for coming.

Well, thanks for having me. Great intro.

Great to see you. And then of course we always have Jennifer with a backdrop of all of the buildings that she owns.

It's my favorite.

There we go. So the reason why you'd want to have this diversification in your portfolio, let's just lay the groundwork before we get into the specifics.

Sure. So as you said, we will be talking only about commercial, not residential. It's not our area of expertise. But commercial, let's talk about that all day long. So in terms of where real estate sits and particularly why now, because obviously we are in a very unpredictable period globally. It seems like every day you wake up and there's some news that's going to happen that's shifting markets. We can actually make real estate a great diversifier for your portfolio. So when we look at real estate, or any real asset for that matter, it really can be a safe harbor in these very uncertain times that we're living in right now where you don't really know which way the economy is going to go. And the reason for that, well, one, it's tangible. So it's an actual asset that you can walk into. And obviously we make our money from leasing space. So it's a thing that has value that people want to pay for. Owning land has been a viable path to wealth for a very, very long time. And we'll get through this period as well. And the other part of that is there's a scarcity element to real estate. There's only so much of it, which is really going to come into play in the next few years. And we can talk about that as well. But the fact that it's tangible, you have these contractual cash flows. So I spoke about this last time, in the core space that I'm talking about, I'm going to mention the 4 food groups again. You're going to hear me talking about that a lot. But we have office, industrial, retail, and multi-res. So the first 3, the tenants typically within core sign up for long-term leases. These would be 5, 10, 15-year leases. When you're in the better quality buildings and the better located assets, you're going to get the better quality tenants. So these are people that actually have a balance sheet that can pay the rent on time. So you have that stability of cash flow. And not only that, you're going to have escalators in there. So the rents are not just static over that term, but in office, you can go over a lease term like 5 to 7% growth over that term. In retail and industrial, you typically see annual growth, which can be anywhere from 2 to 4%. And again, that's contractual. So every year your income from these properties, from these spaces, are growing, which is great because another component that makes real estate great for this type of period is as an inflation hedge, which has been proven out, so as we see prices rise, we are getting the benefit of this contractual income. And as well, the way that most leases are structured on the industrial, retail, and office side is they're what we call net lease. So you pay your net lease and then you have your additional costs, which is the operating cost of the building, insurance, taxes, all that sort of thing. And that is passed through directly to the tenant. So if there are increases in the operating costs of the property, in the insurance premiums of the property— property taxes seem to be a hot topic— we can pass all those through to the tenant, and the investor gets to keep that net rent that grows, and it's not being eaten away by inflation, which is great for today. And then I would say one added benefit more throughout any cycle is just the tax advantage of real estate. So when we have our distributions, it's considered a return of capital. So anyone who, like myself, every spring gets really mad at the amount of taxes I have to pay, this is a great way to invest and not getting hit with other taxes. And Canada is proving to be, when you're looking on a global scale, a great place where people are coming to put their money. They like the political stability, they like the growth and everything. So it's really a great place to put some of your money for your long-term money right now.

Yeah, I think most people can already hear one of their grandparents or parents: «you can't build land, buy something that you can touch» kind of an approach to investing. And it makes sense. You likely have stocks and bonds in your portfolio, maybe you have some cash, but you mentioned all the advantages that real estate provides. And let's just put a little bit more emphasis on this. If we're watching markets over the 7 months we've been through so far this year, we've seen a boom-bust in gold, boom-bust in silver, which, by the way, are things you can touch. So your grandparents and parents aren't always right. Diversification is the right answer, not just things you can touch. But semiconductor chips, AI, we've seen have these massive runs up and then have fallen back a little bit at different points in time. And again, that's just in 6 months and just in some small sectors. You've got that volatility, you've got instability around the world, questions about what's going to happen with the war, which keeps going on, and oil prices up and down. So all of this stuff going on. And then you have the stability— when we're talking about predominantly Canadian commercial real estate— a nice kind of solid…

Stabilizer for your portfolio. With the contractual income for physical space that has a value.

Yeah, and then if I'm moving into retirement or I'm looking to generate income in my portfolio, again, great place for income. And as you mentioned, the tax advantages.

Yeah, we typically like to say that real estate is the white space between bonds and equity within your portfolio. You have these contractual income, which is very bond-like, of getting those premiums. And then you also have an asset that can rise. You can get the equity kicker as well. So it's a nice middle ground there.

Now, all being said, coming out of COVID there was one point where people thought that we weren't going to need commercial real estate at all anymore. You'd never go to the mall again, you'd never go to the office again. So all these buildings and that, of course, has borne out to be a foolish thought or crazy idea because everyone's back in the office now and people still go out and shop. So this is still important stuff. But how would you describe the run of commercial real estate if we go from the pandemic through to today, the big rise in interest rates. Now interest rates are down, but we're not sure where they're going to go. So how would you sort of walk through the last few years in commercial real estate for people?

You're right, real estate's been on a ride for the last few years, and we've been hit by a bunch of large impacts, basically. You have the COVID pandemic, and like you said, interest rates, inflation spikes. So real estate is not shockproof, it's shock absorbing, and we're kind of coming out of that period right now. So I would actually say that this cycle— a couple of months ago I'd probably say is turning— now I would say it has turned. And there's a couple of reasons for that. And one, you point out, malls are not dead, office is not dead. I say this a lot on your podcast, we are a social beings and this is going to be especially true as we head into a new world with AI. We can talk about that as well. But people need to be together and that's really driving the need for space. When we're looking at NOI, the net operating income that's generated by buildings, that is up and that continues to be up. So in our portfolio over the last few years, what we've come out of basically a 3-year repricing exercise and now we're returning to growth, that's been up single digits, sometimes double digits in terms of what people are signing up to, especially in office. And they're signing long-term leases. So on average, I think in the last 6 months, our leases have been 8 years in length. So people do see the value in space. They're committed to it. They're signing up and paying the rents. And then again, the next thing that we see is valuations. So the valuations were under pressure during that period. That has now turned. So we're now seeing positive valuations actually over the last 3 quarters. And we've seen that, one, because NOI is growing— so you're capping a bigger number— and two, the debt has come down. So we're now in positive leverage territory, which reduces the pressure on the valuation metrics that go into that. So we're seeing it's no longer a drag on income, it's actually a plus. And we're seeing actually quite a catalyst in our office portfolios, which is great. And then the debt market is wide open. So if you have quality assets in Canada. Like, there's a lot of lenders out there that are competing to put money into places that are safe, like the buildings that we have within our portfolio. So there is a massive amount of competition. Really, you can see it across the board. So office is no longer a four-letter word. You can get debt and you can get attractive debt on the right kind of office. This is not a blanket office statement. This is in the high-quality, good-located office. And then the same side, our fund is unique that we can access the unsecured market as well. So to your diversification point, like you want asset diversification, you want debt diversification, you also want equity diversification. But when we look at our debt diversification, it's not just putting mortgages on properties. It's also the unsecured market, which we've done a couple raises in, and we continue to monitor that market. And despite all the volatility right now that we're seeing, that has done a crazy amount of volume that we've seen year to date. And our pricing that we get from the brokers in that space is actually declining. So we are going to be able to access relatively cheap debt that's available because again, the investors need someplace to put this large amount of capital that is not as risky as what we've seen. There's been a risk-off momentum and hard assets provide that. So we're seeing the debt markets wide open, which is also allowing transactions. So transactions, they're not back to where they used to be, but they are moving in the right direction. So we've seen industrials trading, retail trading, office trading. We actually saw 3 large transactions happen in Toronto, Vancouver, Montreal. And the interesting thing about these assets is they're all bought by foreign buyers. So the foreign buyers are coming in, they see the stability of Canada, and these are well-located large assets in centers in the metropolitan areas of the cities that I mentioned. And the foreigners are coming in and buying it, which is great because it really provides more liquidity within the market, which is helping also with valuations because you can point to where things are actually trading. And then everyone's off the sidelines. So when you get into any sort of ambiguity, sometimes with institutional buyers, they just do pencils down and wait it out because they can. There's not stress. So we saw the private buyers usually come back in first. Now the institutions are back. The asset managers were actively out in the market buying and selling, which is great. It's good to be able to find assets, but some of them like retail assets, if you want like a non-discretionary grocery anchored retail asset. There was one that actually came to the market earlier this year in the spring. It was GTA— so not Toronto— but it had your grocer, your pharmacy, your bank. A smaller deal, about $30 million, and that got 23 bids on it which is a record amount in any cycle that we see. But the private buyers are there, the institutions are there as well. And you can get really cheap debt for real or for retail as well. So you can really see where the conviction lies within the market. But we're seeing that broadening out, which is exciting. I feel like I ramble a lot on your thing, but I'm going to say one more thing. And this is the sleeper cell of the whole market turning, and that's supply. So we touched on it. You cannot build buildings quickly. It's not a fixed income instrument where I can write some words on a piece of paper and all of a sudden I have something new to buy. These take a while to actually build. Industrial is probably the quickest, and that's 18 months. Office would be 4 to 6 years to actually build. And we are at a 23-year cycle low on the office side in terms of building across the country. No one is building anything of scale, which is really going to come into play as the demand grows for high-quality office space, as businesses grow. And that's going to really distort the supply-demand equation in the landlord's favor in '28, '29. That's what we're expecting. And then in terms of the cycle turning, we've started to see the institutional capital come back. So for the last few quarters, we've seen some good inflows from that and we've been out there buying.

So something really interesting is that foreign buyers are in Canada. We've talked about it from a commodity perspective. So oil, natural gas, some of the other minerals that we have here in Canada that you don't have everywhere else, and Canada becomes a very attractive place to come and invest to get access to those things. But commercial buildings are kind of everywhere. And there's lots of politically stable places, but it's interesting to hear that the money's coming back to Canada. This might be more residential, but we always hear that Canada is somewhat overvalued. But clearly that's not the case if foreign buyers are coming in.

Yeah, on the commercial side, most of the properties have been repriced, especially on the office side. And you're right, they like the political stability. They also like just the stability of the assets. They like the demand, they like the long-term GDP growth perspective, the long-term population. We also have a very young population relative to the other G7 countries, which is going to work well in our favor when people are scanning the globe on where to put money. And then we're also very disciplined. So it comes back to the supply. So versus in the US where they are a little bit more supply-friendly, I should say. I used to cover the US and we would look at Chicago and every time the vacancy went under 20%, someone would put up a new office building. We don't do that here in Canada, which is great, which provides that stability for the foreign buyers who want to come in here and really have a great asset.

Yeah, the other thing. You called it rambling. I wouldn't. I found it quite interesting, and I'm sure the listeners found it quite interesting. But the other big takeaway— we were actually talking about this before we started recording— is the whole idea that everything moves in cycles. You think about copper. Or oil. Oil, let's do oil. Or gold would be a better one. I'm going to get this; I'll nail it down. We're going to finish off on gold. So again, the price of gold starts skyrocketing, and you want to increase the supply of gold, but you've got to spend a lot of money, it takes a lot of time to get that new gold to market. So the price spikes up, but then at some point all that gold starts to hit the market and the price comes down. Maybe have a little lapse in demand. And commercial real estate is no different. No one's ever going to come into the office again. All these buildings, we don't even need them anymore. And then all of a sudden, well, actually it's pretty important that we come into the office. Hey, I want to see Jennifer from time to time, just check in on what she's up to. And the boss wants to see the whites of your eyes. And so people start coming back, and then everyone's back, and then, wow, we don't have enough space anymore. We need more office space. When are we starting that building? And then we got to go through the process, in Canada, which is always a little bit…

Yeah, permits, entitlements, everything. It's a longer process. And during that whole period until you get new supply, existing investors can push the rents and really capture that demand. Because right now we're below replacement costs, so it's cheaper to buy the yield than build the yield. So as long as we're in that part of the cycle, landlords are going to push the rents.

By the way, I'm just going to shift to residential. If you are involved in 500 and 600 square foot condos and the prices are collapsing right now, don't worry. There will come a day when there won't be enough of those either and people will come back to them. Everything moves in cycle. But the commercial real estate, as you say, is in a fantastic position. And then I guess the big thing that we try to get across when we have you on to investors out there is this is not something that you can just go and decide to buy yourself. I've got $30 million kicking around in my wallet, I'm going to go and buy a mall with a grocery store. There are some people who do have that, but not many. And so what you're able to do for people is to pool the assets together. And then as well, if I'm just an individual out there, I may not be aware of what's available. I've got to do all the work to analyze what the quality of it is. Is this the right property? Is this going to generate the right amount of income? Can I get the right debt on it? And this is what you're able to do because as a major player in commercial real estate, you get to see everything that comes to market and you get to pick and choose what the best properties are, what the best opportunities are. And then, you've got the pool of cash to act if you need to.

Exactly. You get that benefit of diversification. You get the benefit of geographic diversification, product diversification, tenant diversification. And this really is an active market. You actually have to manage these buildings, which you need experience to do. And you get this experience over decades, as well as the actual just being in the market. So remember, everything that we do is off market. So we can use material non-public information. We can have conversations. Nobody really does this anymore but we used to be able to buy and sell buildings over lunch sort of thing. That's a little bit more old school. We do have a lot more of a financial process in there now. But individuals can't do that. You can't access that. You need to have relationships that have been built over decades. You actually have to run properties. So if you did buy that grocery-anchored retail that I mentioned, if you did have $30 million, you have exposure to one market and then you would need to know, like, when do I replace the roof? What happens if my pipe bursts? What happens if my tenant just goes dark? You need to have that expertise, which is really key on the active management side. So not only do we have the expertise here within RBC, but we partner in our fund with QuadReal who is the real estate arm of BCI, the British Columbia Investment Management Corporation. The pension plan of British Columbia, it's pretty self-explanatory. However, within their real estate team, there's 1,200 people that we rely on, we work very closely with, and I have relationships with these people for— I don't want to date myself— but a very long time. And you have full engineering teams, you have full like research and economic teams. You have obviously your leasing teams, property management, asset management, full ESG teams, which is not just a buzzword within real estate. This is a tangible thing. Like we cannot buy assets if they have any sort of environmental concern that cannot be remediated. So we need the specialists that can help us make those investment decisions.

Yeah. And so again, it's just an asset— we've talked about this before when you've been on. By the way, if you ever want to go back and listen to Jennifer's previous appearances or any of the guests that we have on, wherever you get your podcasts, just follow the Download. And as you can see, you definitely want to be in for this backdrop with Jennifer. You can see her with all the buildings she owns if you subscribe to us on YouTube. But you mentioned the BC Pension. And we think of Canada Pension or Ontario Teachers' Pension, these are assets that these pension plans have had in their portfolios for years. And it's for all the reasons that you've articulated.

Exactly. They provide that inflation hedge, that stability of income. It's a tangible asset that has scarcity to it. So when you're looking at the downtown Toronto office buildings, those are held primarily by the major pension funds in Canada and they will not trade. So if you need to get access to how that market moves— and that's really where demand is going to concentrate— it's a fund like ours where you can get that. There's no individuals except for the one guy who owns Zara, who does own a billion-dollar building within Toronto. So there's one person in the world who does that. Everybody else, you need to get with a fund like ours to get access to that.

Okay, let's finish off. You mentioned your four areas, your four food groups. But now you've moved into dessert, as you call it. And this is a new area for you. First of all, why haven't you gone there before and why are you doing it now?

Yes. So we are very excited. We've added a couple portfolios of self-storage assets and we're very excited about this asset class. And the reason that we haven't gone in there before is because it's hard to get access too. So it is a very fragmented market when you look at who actually owns these properties. I think 80% of this is all mom-and-pop properties versus the institutions that are starting to actually get into this market in a big way. We're one of the first ones to get in on a fund basis. We're the only fund within our peer group that actually has self-storage. And there's a lot of compelling reasons that you'd want to get into self-storage. The first one that we really like is that it's uncorrelated to the economy. So when the economy goes up, self-storage goes up. When the economy goes down, self-storage goes up. And the reason for that is the buyers are different. So when the economy goes up, it's going to be the guy who bought a second jet ski and he needs to store it somewhere because his wife won't let him put it in the garage and he needs the self-storage. When the economy goes down, it's the guy who was based in Ontario who now has to move to Alberta for a job and he takes everything from his apartment, puts it into storage for a few years while he's out west. So it provides more of that stability of income regardless of what the economy is doing, which is great. Also, we think the demand potential within self-storage within Canada is actually quite great. When we look down to the South as a barometer, they have about 8 square feet per person of self-storage. Canada, we're about 2. So there is that room to grow. Now in Canada, we think we'll get to 4. I don't think we'll ever get to 8. We have a thing here called basements, which a lot people in the US do not have. However, getting from 2 to 4, that's a big supply-demand imbalance that we can think we can take advantage of. And then the last thing, building on that fragmented comment, we really want to institutionalize this particular asset class, which is a little bit more operational heavy. So we saw this with industrial products 20 years ago. We saw this with multi-res products again about 15 years ago. But you're really going to professionalize how you operate these products. And this is as simple as having a functioning website that you can go to and have the prices that can move in real time. Because remember, you typically sign a 30-day lease or a 4-week lease, and we can change those rents pretty much whenever you want. So it's a lot more dynamic. So we're able to really push in certain areas, in certain units, to really capture that demand and get the benefit of it. So it's simple things like that that we'll be adding. And then also the economies of scale. So we now have 20 self-storage assets, 20,000 units. So you get diversity and then you can just consolidate the back office. So we don't need a single HR person or a single accounting person that just builds into the system that the institutions have, because they're the professional money managers here.

The old economies of scale.

Yes. It's very simple. The math behind real estate, the ideas are very simple, but it works. So being able to capture that. But you need scale in order to do that and it's been harder to access. But we have a phenomenal team. We work with BCI in order to get these portfolios, a lot of them off market, which is key.

Really? So coming soon, a spinoff YouTube show, Jennifer Schillaci’s Storage Wars. She's got lots of storage space. Did you actually get to go in?

I have asked the question about the Storage Wars, and apparently it's not as exciting when we get some of the units back. It's usually nothing that's of any value. But we do ask that question.

And if something was found, would it contribute into the fund?

That's a good question. I don't know. Let's see. I would think so. If we're able to sell it. I'm not sure we would ever come across a situation like that, but you never know.

There we go. So an even more exciting reason to invest. We'll try and close it off here because I know you've got to get back to checking out those storage bins, but we talk about the dynamic pricing, which gets my mind thinking about the impact that artificial intelligence can have in this space. And this sounds like an area where you're going to be able to improve returns by employing artificial intelligence within the space.

Yeah. That's a much bigger topic, but we are implementing AI across the whole portfolio. But self-storage is really one that's conducive to do to-the-minute pricing that an AI is doing across our portfolio. What we're seeing in addition to just scraping competitors' websites to see what other people are offering. And now you do need to still call to get that information because websites sometimes are wrong. And then we have our summer students doing that, which has been a great learning experience for them. But yeah, AI has been phenomenal and just being able to almost price to perfection where we can get these leases signed.

And that's really everywhere though. As you say, it's not just in storage. And I was thinking more broadly across the whole portfolio, this is something that's going to really help you either drive efficiency or drive better returns within the portfolio.

Exactly. Because our data is so fragmented, there's no central repository for that anywhere. So if you're able to actually create your own through all the different avenues that you have to be able to collect data, through your appraisals, through broker pitches, through just research reports and consolidate that and act on it, that's really where we see a lot of potential for AI. So it's actually very exciting how we're implementing it throughout portfolio.

Awesome. Well, Jennifer, always great to catch up with you. As I say to so many of our guests, we've got to have you here more often because there's so much stuff going on in your world. But it's always great to catch up with you, and we'll hopefully see you very soon. And good luck with all the new stuff you're doing. It sounds again like it's a really interesting time to be in the space that you work in.

Oh, well, thank you. Always glad to come in and talk about real estate. It is exciting.

But not residential.

But not residential, only commercial.

There we go. Only commercial.