Hello and welcome to The Download. I'm your host, Dave Richardson. I am joined today by a new guest, but someone we hope to have on regularly. We had her on a broadcast with a few thousand advisors—nothing significant, really—and she was the hit of the entire day of a series of videos. And that's Jennifer Schillaci. She is—let me get this right, Jennifer—Managing Director and Head of Real Estate Equity Investments. That sounds pretty impressive.

Yeah. Well, thanks for having me. Flattery will get you everywhere. I'm happy to come to the podcast as much as you'd like and jog about real estate.

The only criticism we got, and maybe the only criticism we'll get on this podcast, is some of the Italian advisors who are watching the broadcast think that I mispronounced your last name.

That's true. I do get that a lot.

But we're going to go with the correct pronunciation. People mess up Richardson all the time, too, so I know how it feels.

I don't think so. Continue.

So why don't we start, Jennifer? We've had a couple of your colleagues on over the years talking about real estate. But at the core, because I know you really love real estate, why should a retail investor want to have real estate in their portfolio along with their stocks and bonds? Don't I already own a house if I'm investing and saving for retirement? Why should they be thinking about real estate and what kind of real estate are you talking about?

Sure. A bunch of great questions in there. Let me just start with «why real estate?». With a small caveat that I do get questions from people saying, should I buy a house in this neighborhood? My answer is, I don't know. I'm in commercial. It moves very differently than residential, and it is an investment. It's not where you're actually going to live, and there's a lot of other factors that would go into a residential purchase. So stripping that part away, focusing on commercial, there's two questions on that. Why do I like real estate as an asset class and why you should own real estate as an asset class? I think I'll start with why I like, personally, real estate as an asset class. There are some fundamental attributes here that are pretty exciting, which differentiate from stocks and bonds that you would hold within your portfolio. So when I'm talking about real estate commercial, within a core portfolio—we call them the four food groups—I'm talking effectively about office, industrial, retail, and multi-res. When you're buying those types of products, they can get anywhere from the lowest view, probably like 20 million, all the way up to maybe 500 million, when we're just talking about the magnitude of the size. But when you're looking at real estate as a whole, I guess the first thing is active management. Unlike a stock and a bond, where if you and I bought a stock, let's say we bought at Microsoft, day one, and we sold it a year later, ignoring tax impacts, we would have the same return. But if you and I bought an office building and we sold it a year later—which is not typically what you do, but let's say we did that—the returns could be very different based on how we actually operate the asset. When you want to think of these buildings, you think of them as a little business. You have your revenue, you have your expenses, and you have your capital. If we were both writing an office building and owning and managing it, it would depend on the leases we put in place, the lease terms, the types of tenants that we attract, the types of marketing that we can do, as well as how we efficiently run the building. The more efficient it is, the more likely you can push your rents and the more attractive it is to tenants. As well as capital. If you were crazy and put your lobby made of gold and put 100 million into that—no one would actually do that—you would destroy the value of your building. But you have to be really smart with the capital that you put in, the same as with your house. If you're redoing your roof, you would pick something that is economical but would also last a long time. That's the main part and why I love it because you really get your hands dirty and it's really about generating that operating income, which is the primary return part of a total return within a core portfolio. I'm just talking about core assets right now. That part is pretty exciting. You also have your contractual leases in there. So your income is contractually obligated by primarily large tenants that are in your space, so people with the balance sheet that actually pay it. Within these leases, you also get rent steps. It's not just a flat lease over, say, 5-10 years, but in office, it can step by 5% to 7% over that term. Then when you're looking at the other ones, your industrial and retail, those can grow anywhere from 2% to 4% the income annually, and this is contractually obligated. The other big thing that's different between the public markets and the private markets when you're looking at real estate is just the size of it. The size of the market that you can actually buy into within Canada—or I guess anywhere within the commercial market—is much larger on the private side. The buildings that are owned, like the office buildings, for instance, downtown, you can't buy those within the public market. They're really only available on the private market. It's large private institutions, including ourselves, who do own these assets. You just get access to a much wider investment set within real estate. I guess we'll get more into that, but that's why I love real estate. Then why real estate as part of your asset class? Again, obviously, you just have a wider opportunity set. So your ability to access product you can't do on the public side, which is great. And also how it behaves. So your risk-return is different than stocks, it's different than bonds. Remember, this is a private market. I can use material, non-public information all day long, and we do. Actually, the better the manager that you have—and management is extremely important in the private side—the more access they have to these private market makers, so you can know what rents are, what cap rates are, who's in the market, who's buying, who's selling. These are all things that do not tick across the ticker within Bloomberg. I need to be very well-integrated within the real estate community to understand what's happening, and that will set people apart. You have fundamental differences there, which all to say means that the returns are uncorrelated with stocks and bonds. Going back to your basic financial theory here is if you take assets that are uncorrelated, you put them together, you will have a higher return on average at the same or even potentially a lower level of risk. It's really helpful to provide that diversifier. The returns within the core sector, they're excellent returns over the long term, and you really see strong risk-adjusted returns. We do not typically have in the core space those large fluctuations either up or down, and this really acts as a stabilizer within people's portfolios. That was a long answer to your question.

No, if I fire five questions at you at a time, feel free to take as long as you want. That's a little bit unfair. Some very weak hosting here. You probably won't want me as a concierge in one of your buildings. But that diversification thing is so important, and I guess the history of this in the investment world is that a lot of large pension plans moved away from just stocks and bonds many, many years, decades ago. But you're really starting to see this asset get integrated into portfolios that are available to retail investors because they have proven to be excellent diversifiers. And as you say, the risk-adjusted returns are very attractive. And you're usually doing that through a professional manager like yourself who has lots of contacts, has worked in the industry, is very familiar with and loves real estate. I think we've clarified that. That makes a difference in terms of the access to the types of real estate that you can get and the ability to get into the best deals. Because as you say, who you're working with, who's managing the property, all of these factors play a big role in the ultimate return. As you say, two buildings side by side, exactly the same, one managed one way, one managed the other: different returns.

Yeah, it just keeps it very interesting. At my previous firm that I was in—a large life co—real estate was part of their portfolio. They had been managing it for 80 years. So this is a long established asset class. It really fits well with people who have their long-term time horizons. What was very beneficial for people who are backing the life insurance policies or pension plan, so people paying out. It works very well for people here on an individual level. I am for your excess liquidity, I'm not for your required liquidity. This would be something you would put towards your retirement income or your preschooler’s college fund. It really provides that long-term time horizon where you can really generate those strong returns over the period.

Yeah. As we've talked about on previous episodes, when we talked about real estate, I can go get a mortgage. And by the way, Jennifer, I get the same thing. Because people know I work for a bank, they ask me about mortgages and all these different things, and I go, I have a mortgage. I don't know. I was a financial planner once. I tried to do a mortgage. My manager said, don't ever touch credit again. That's why I'm on the investment side of the business. So I'm the same. I have to brush people off.

More fun on that side.

Oh, the investment side is way better, which is why there's no really good credit podcast. It's all about investing. That's why this podcast is so popular. But what I do know is with a good job, I can go to a bank, get a mortgage, and I can buy a residential property. But if I'm just wandering along the street or I'm watching this video and I see that big building behind you over your right shoulder, I go, oh, jeez, I'd really like to buy that building. And then I'm going to be told it's worth... What would that building be worth? 50 million?

That's a condominium behind me, but something that size in an office building, if you're located right here, King and Simcoe, you're looking at 250 to 300 million, assuming it's fully leased.

There you go.

So I'm sure you have that. It's no problem.

Well, let's see. I'll look in my wallet here. I got a couple of US dollars because I was down in the US. But no. And so that's why buying real estate through this mechanism, through a fund via a professional manager, works because you can get sufficient capital to invest in that building.

Yeah. And you also get the diversification, which is really key within core portfolios because we have, like I mentioned, the four food groups. You have your property type diversification. Within Canada, you have your geographic diversification as well. Within core funds, you typically stick with the top six cities within Canada, which I think I mentioned this before, but we call them VECTOM. Vancouver, Edmonton, Calgary, Toronto, Ottawa, and Montreal. That's primarily where you see a lot of core funds operate in the suburban areas around that. Then you also have diversification, not only in the geography and the property type, but also in the tenant type. So the industry that the tenants are exposed to are diversified. Investing in a fund like this rather than just going out and piecemeal buying individual assets will provide you with that. Because what you really want for the long term is to reduce the downtime or the downturn within returns when something happens. And something is going to happen. We've been through this before. We were in the dot-com bubble, we were in the GFC, we were in the pandemic, the following interest rate spikes and inflation spikes as well. We know something is coming but we don't quite know where exactly it is coming from. That's where the diversification is really key. Within our portfolio and within most core portfolios, there is a conscious effort in providing that diversity and distribution of the returns. Just so that when something does happen, when we take the pandemic, for example, and we’re looking at what happened there, the first property type that got hit was retail. If you were 100% a retailer, you were going to get hit. Then following on that, what we've seen—but what we are coming out of, which is very interesting—is the office. The office then took a hit. But on the other side, industrial just went gangbuster during that period. You really want to have that diversification because you never really know where either the up or the down is going to come from with any major certainty. So you diversify away from that, and then you tilt the portfolio when you're making active bets in terms of where you think the next return is going to come from, which protects the downside.

Yeah. I think maybe the first one we'll address is a question that I get quite frequently when I'm traveling and talking to investors is the whole idea, coming out of the pandemic, that we were not going to need as much commercial real estate and commercial space and office space as we had before. Of course, we all went from working zero days in the office in the midst of the pandemic to maybe coming back one, two, three days. And now myself and my team here in Toronto are back five days a week. So is that fear gone? How did you manage through that whole process to protect clients who were invested with you and to take advantage of what ultimately—I'm going to guess—you would say was a little bit too much fear mongering, that we were always going to return back to normal and everything was going to be okay.

Yeah, it's funny when you see the psychology when these things happen and people think it's going on forever, but you really have to remind yourself with anything that this too shall pass. How we look at our portfolio is we really try to be in the highest quality product within the property types and within the locations that we're going to. When we're looking at office, we want to be in the class A or the trophy AAA class within major urban centers within Canada. That's where we have focused all of our investments. We have some select bets on suburban office where there are strong nodes, but again, you're surrounding those major employment centers from that. I'll take it in twofold. The first one, going into the pandemic—I'll talk about Toronto specifically—the vacancy rate was 2 to 3%, which is way too low for a functioning market. Then you're going to have distortions the other way between demand and supply. We're probably going to come to that again, and I'll get to that within my next comments. But here, what we're seeing is it basically was a rising tide for all boats. So buildings that were class C and class B that were within the core were propped up effectively by this lower vacancy rate when they should have been coming out of the market and repurposed, torn down, converted to res, long before the pandemic hit, in the 5-10 years before that. But they weren't. They were artificially propped up. When we did have this large impact on office, all of a sudden you see vacancy go up to—I'm not sure how high it went—but 25, 30%. And people think, oh, no, the sky is falling. But what's really happening is that these buildings that should have been out of the market in the first place are now getting hit with these higher vacancies. The higher-class buildings within the markets are actually not doing as poorly as what the overall numbers would look like. You're getting that dichotomy within the market where some should be closed and shouldn't be around, and then the other ones are actually doing fairly well. Now, that's not to say that they weren't impacted. We did see impact within our office portfolio as we went through this pandemic. It's interesting to think that people—I'm not sure how to phrase this—thought they could stay at home forever and think that that would be a good operating model. We, as humans, we're very social, and in my personal opinion, we do better when we are together, when we are able to bounce ideas off each other and be in the same room with each other. It's a palpable difference, and it really helps to drive growth. If you're looking at the whole market, for a year or two, if you have experienced employees that already have developed relationships, you could probably go work at home. But is that going to work for the long term? No. Is that good for our young people coming out of universities and getting into office employment jobs? No. The last thing we need from a societal standpoint is a whole cohort of people working from home in their parents' basements or living at home. That's not how we develop a good society that can really grow and adapt. We need to come together That's what we're seeing now. That's what businesses are seeing. Over the short term, yes, it works great, but over the long term, when we need to grow, we need to innovate, these are all knowledge-based sectors that typically house in office properties. When you look at the office properties and the businesses that are in them, their assets go up and down the elevators every day. This is really a people business, and bringing them together is extremely important. We're social. Will some buildings have that vacancy that will be elevated? Yes, but they'll be taken out. What we're seeing in our buildings now, especially, there's a palpable difference in the last two months since the banks—including RBC—as well as the government and some large employers, are recognizing this and calling people back. Our activity is way up. The demand for space is way up. We've been doing leasing, and then we're pushing our rents and our terms literally week over week, which is not something that we have seen previous to this, but it's a pretty exciting time as people come back. The space that everybody needs for their people has grown. Because the businesses actually have grown during that period. Not only do they need the space that they have, but they also need the future growth expansion space for the people that are coming back. People sometimes ask me, well, we could just hotel the whole building, and then that way you can work with people who are coming in and out. That, in our experience, doesn't work. Because hoteling is not a new thing. Hoteling is something that came and it was very popular—I’m probably dating myself here—but 12-15 years ago, that came in with a big wave, and they tried it. What happened is it works well with people who need to come in one day a week, so maybe on the fringe, your consultants or people who are spending time with clients. But if you're in the office three, four, five days, people need their own space because not only are people social, they're territorial, and they like to have their own space where they can come and sit, and that's where they can be their most productive. You want them surrounded by the same people that they can feed off of. You want them within the teams. You don't want one person sitting on a different floor from the people that they actually need to work with every day. This is all resulting in firms needing more space, which is why the office space is going to be very interesting to watch. We're seeing this now in the AAA class, the trophy top-of-the-line stuff here in Toronto, in office space, there is sub 5% vacancy. We're already starting to see the pendulum swing in another way. Effectively, when you're reading headlines, they're going to be deceiving. You're going to see headline market vacancy number of 20%, but at the same time, we're going to be out of space with the space that people want to be in.

That's right, if I'm coming into the office five days a week. You look at some of the premium office towers in large cities—even in medium-sized cities—but the premium space, you've got a nice coffee shop or a nice restaurant in the bottom. It's a beautiful space. You have proper space to work and function, proper Wi-Fi. Everything is at a level that you expect if you're working for a really high-level organization. You want people to want to come in and be in a great frame of mind. That's what I love with my team right now with people coming in. As much as it did work in the short term, being apart, we're really enjoying being back together, and you just see the way it builds culture and creativity and just unlocks everything that you can do within your business. But there's a big difference between being in a building like we're in and being in a building that maybe hasn't had a whole lot of investment in it over the last 30 years.

Yeah, exactly.

That's what you're talking about, the distinction between the really good commercial real estate, that A-level, there's not enough of that, but there's quite a bit of the other, and then you see the turnover. How did you play the market through all the fears? Is it safe to say that people who have stuck by the idea of investing in office space have done very well over the last couple of years from where it bottoms out and are about to see likely even a better place for office space?

I would say over the longer term, you're definitely going to see that positive return from office. But the last 24 months have been challenging for office, and we have seen the values reset as the vacancy did go up. We're turning a corner now, and that's why I think going forward, we're actually going to see perhaps the strongest returns coming out of office. That's not only the NOI growing, people looking at taking more space, but also the debt has become more conducive. We've had 8 rate cuts over the last 18 months or so, which has really brought, obviously, the interest rate down and the financing ability back to office is positive. We're dealing with positive leverage, which is very helpful for this asset class, which typically has leverage on it because it's backed by those contractual leases within the buildings. Not only are the actual interest rates down, but the interest rates being lower reduces the valuation metric pressure on these properties as well. Typically how they're valued, you use your cap rate—it's the same thing that when you're valuing any other asset class, when the cap rates go up, the values go down—and right now, we're seeing less pressure happening on office space from that dynamic where the cap rate isn't being pushed up by interest rates. We've already gone through that period over the last 24 months. Now, do I see what we call the cap rate theory coming back and squeezing that? Probably not. We're going to be focusing on the operating. Back to just fundamental real estate. We're looking at NOI, we're looking at leases, we're looking at pumping out growth, we're looking at making sure our buildings are the most attractive to tenants within the space and what they're coming back to. We've actually been investing in our buildings. We have our class A and trophy buildings. We want to make sure that we are having all the amenities that tenants are looking for. What we see in markets that have a little bit of elevated vacancy is an amenities arm race, as we call it. Buildings need to have a conference facility. They need to have gyms. They need to have retail on the bottom, so people just pop in and out to get lunch. That's really what we're focused on, to make them more attractive, and we've been seeing the benefits of that within our portfolio. We have come out of a tough period, but we are moving forward. Do you want to know what the trendiest amenity is right now that's being demanded by people? Doggy daycare. Doggy daycare is now the it thing. Now, are we going to move our buildings to accommodate that? This is likely a short-term fad, but we might do that a little bit more in our suburban office that we have a couple holding there versus the downtown one. But it's just interesting to see what's on the checklist now for tenants.

It's always amazing when I'm talking to portfolio managers, regardless of the space, there's something going on, something you wouldn't think of. But again, this is what being a professional investment manager is. You need to be on top of these trends to understand the direction the market's going.

Yeah, make sure our buildings are attractive to the widest swath of tenants.

Yeah. Let's go into the other one that people get concerned about and get a status update there just to finish off. And that's retail. Here in Canada, we saw Nordstrom retreat back to the US. We've seen Hudson Bay and Sacks go under. These would be what you’d call anchor tenants in a mall. So what's the future of retail? Is that an area that you like or don't like? Does it tend to be a full weighting in your portfolio or is it underweighting? Did I get five questions in there?

I got to start writing these down here. So let's talk about retail. Within our portfolio, we are underweight retail. However, retail is segmented into two sections. You have your grocery-anchored retail, which is non-discretionary. These are typically strip centers that you see surrounded by the populations that go there. You'd have grocery, you'd have a bank, you'd probably have a Shopper's Drug Mart or a Dollarama. Those did really well during the pandemic and the following period. Obviously, you would expect that people need their non-discretionary items. Those ones we would like to add to. But I think your question focuses more on the other side, which is the enclosed mall, which has obviously more of a discretionary side to it. Yes, we did see a lot of the anchors, I guess, exit Canada or exit existence, which when you're looking at a mall, they do provide a benefit. But what we have seen, and especially with The Bay—we have a couple of those within our portfolio, so we have more of a first-hand experience there—typically, anchors pay really reduced rents. When we're looking at The Bay, typically how those were structured is they were paying 85% less than what the market rate is for that particular space. They also would typically have extensions. This is not just us, this is just in the market. They would have extensions that would run for 60, 70, 80 years. They would have leases that would maybe run out in my lifetime, but maybe not. Hopefully, they would run out in my lifetime, but we're talking like 2084, 2086. That’s when the leases expire. They also have restrictions on that space. Some of them are punitive. The Bay had to approve on who you could actually put in stores around them. They have no builds on the parking lot, or a big part of the parking lot. When you did this lease in the 50s, well, we were in a very suburban area. That's fine. But now, fast forward 50 years on these leases, some of them you can actually get some pretty good density. Now, the condo market's gone a little sideways and that'll come back, but in general there is value to the density. It can be not only condos, actually, but it could also be pad sites which are popping up, and they're very popular on the enclosed mall section. This would be putting in a Keg or a Moxy or even a bank because they do like to have their drive-through centers there. That's actually an opportunity for us to put in retailers that will actually draw more tenants as well as bump them to market rent. If you have a center that's in a good location—we're actually already speaking with future tenants to come in and backfill the space—they're reaching out to us because they see it in the news and they're like, okay, well, now that space is available, we'd like to go into your enclosed mall. Really what we've seen with enclosed malls, I'd like to say even before the pandemic, is they've gone from a place where you just go and buy clothes or shoes or whatever you need, to a more experiential dynamic. This is where people go to eat, to go to the movies, to have more of an experience, like a social experience, which is what we're finding with the tenant that we're putting in as well. We're putting in a lot more tenants that do cater to that. Come into our space and have an experience. An interesting one that we're putting in is called Activate—I think they have spots all over Canada—but it's like an interaction, an active video game where you go in and kids love it and you actually interact. I'm doing a horrible job explaining it, but it's actually very cool. We've actually seen an increase in our per square foot sales. We've seen an increase in foot traffic. People would say to me, isn't the mall dead? I would respond two things. One, you've never been a primary caregiver of a newborn because then you would know that the mall is definitely not dead. Then two, we went through the perfect social experiment to kill malls. If malls were going to die, they would have died in the spring of 2021 when they all shut down, especially here in Ontario, when we had our stay-at-home orders and everything was closed. But what's happened is they've come back. In Ontario as well as within other provinces, try to go to Sherway or Yorkdale on a Saturday afternoon, and you tell me how easy it is to get a parking spot. This is back. Again, this speaks to people are social. They want to go to a place where there's other people and where they have events. Malls have taken advantage of this. So not only have the tenants cater more to the experiential, but the malls are doing this as well, to try to get people in the space, and that's really working. In Sherway, when you look at that mall in particular, they put in a science center pop-up there. So that all of a sudden brings families and kids into the space. If you have young kids, if you've ever been in a mall, you know that they want everything that's in there. Typically—and I'm guilty of this as well—you come out with one or two things, and then you want to go back. All that's to say retail is evolving. It'll continue to evolve. We like to say that retail is detail, so it is about the small little things that go into that. But as an asset class as a whole, it is something that we think there is some value on. Now, will we add to the position? In well-located centers with strong sales, we might look at adding to our position. We won't go into any tertiary parts, but it is an area where you could take that contrarian—not even, it's not really contrarian anymore—where enclosed malls as a social hub is a place that you want to be in.

Yeah. You mentioned condominiums in Toronto. I just think every generation is going to be different. They're going to do things differently. The millennials want to live in 500 square foot condominiums right in the heart of the city because that's where all the action is. But then they have that first child. We weren't going to need neighborhoods and houses out in the suburbs? We weren't going to need malls? All of a sudden, those millennials, just like every generation previously, they need a little bit more space. And that's where they go. Like you say, the social hub within those communities. It's often overstated, just like any fear in downturns in almost any market. Again, this is where a professional investor always sees through that short-term noise and finds opportunities for investors, which is what you do in the real estate space.

Yeah, this too shall pass. Invest for long term.

Yeah, that's great. Well, Jennifer, look, we only got into two food groups in detail. We'll get in the other two food groups and get you on soon. But I always learn so much when I just spend a few minutes with you. It's incredible. And of course, I think if I'm an investor, I'm investing somewhere, I want to invest with someone who has a passion for what they're doing like you do. It's really amazing. So, Jennifer, thanks.

I really do. Thank you for having me. I really do love it. What's not to like about buying up the skyline? It's just incredible being able to do this. So thank you very much for allowing me to speak about it.

Do you walk around with your family and friends and point to a building and say, we own that?

Oh, I do. All the time. I'm like, that's my building. We put in this tenant here. This just sold. I say it to my kids all the time. I was actually driving on the 401 yesterday. I'm pointing out industrial properties, and they're rolling their eyes. But I'm like, this is exciting. Look at that location right off the 401.

I love it. Jennifer, thanks so much.

Thank you.