I OVERVIEW OF THE MARKET
The Canadian real estate market has continued to produce superior total returns in the past decade.
Canada effectively avoided the global downturn at the end of the last decade, shielded by the then-strong commodity price rebound and a strong banking system that largely avoided the excessive lending and overheated price inflation for real estate, particularly residential purchases, that occurred in the United States.
However, in the continuing historically low interest rate environment that has persisted since the 2008–2009 global crash, the Canadian real estate sector as a whole has experienced fairly significant price increases, with capitalisation rate compression across all real estate classes and most geographies.
Recently, the low Canadian dollar (reflecting the drop in demand for commodities starting in 2014) and Canada’s reputation as a stable nation have also served to attract significant offshore investment. That investment has further increased demand for Canadian real estate investments, particularly with residential real estate prices in Toronto and Vancouver accelerating at unsustainable rates of increase in the 2015 to 2017 period to the point of frequent news coverage and increasing political handwringing, and then finally government intervention in both residential housing markets. The oil price turndown has, however, put some pressure on Alberta, Saskatchewan and Newfoundland property valuations during the same time frame.
Canadian domestic real estate investors can be broadly characterised as fitting within one of the three types of investors:
a institutional investors, comprising primarily pension plans and life insurers;
b public real estate entities, largely in the form of listed real estate investment trusts (REITs) with a smaller number of listed real estate operating corporations;
c private entities, largely family-owned businesses, that develop or manage their own properties (or both), which are of greatly varying scale.
Large-scale Canadian private equity investors in real estate are few in number and tend to manage funds that have a significant pension plan backing. However, very recently they have had a large role in several of the more prominent Canadian real estate transactions.
Canadian pension plans active in real estate consist of both the large, globally recognisable public plans making direct investments, smaller public plans that tend to invest through funds and external managers, and some significant private corporate pensions that invest both directly and indirectly. Over the past three decades, Canadian pension plans have commenced and increased the allocation of their assets to real estate. They are increasingly global in scope, but still in the aggregate are much more heavily weighted to Canadian real estate than Canada’s overall share of the global real estate market. A number of the very large plans that invest on behalf of various public sector employees significantly increased their allocation to real estate by privatising several of the largest public Canadian real estate companies in quick succession in 2000 and 2001. The big 10 Canadian funds had over C$1 trillion in total assets as of 31 December 2014, of which an estimated C$140 billion is invested in real estate, with five of those funds being among the top 30 real estate investors globally.
That has resulted, with continued investment through these entities and together with direct and indirect investment by other pension plans, in the large Canadian pension funds owning a very significant portion of both the Class A office space and the super-regional and premier urban shopping centre and office tower retail space in Canada’s major metropolitan areas. Pension plans have assets in all real estate classes and also indirectly engage in some development activities. Pension plans generally can hold Canadian assets on a basis free from Canadian income tax under specific tax exemptions for Canadian registered pension plans.
A very significant portion of publicly listed real estate entities in Canada are in the form of REITs. However, the total market capitalisation of all TSX-listed REITs (of which there are 44) is approximately C$100 billion as of 31 May 2017, a fraction of that of REITs in the United States. There are only four REITs exceeding a C$5 billion market capitalisation. In 2016, the TSX REIT index increased by just over 10 per cent and continued on an upward trend in 2017 through to 31 May, although it experienced a large dip in January and February 2016.
First appearing as a public vehicle in the 1990s, a REIT is a trust that is a flow-through vehicle for Canadian income tax purposes, provided it meets certain criteria under the Income Tax Act (Canada) (ITA). Canadian REITs own a full range of real estate assets classes, including office, retail, industrial and multi-residential. REITs own a range of office investments although, with one or two exceptions for Canada’s largest REITs, they own only a few Class A office towers, and in the retail class are concentrated in regional and local shopping centres, controlling significant portions of the larger open format retail space. BPO Canada Inc (now Brookfield Canada Office Properties REIT) (Box) consolidated a number of Class A office properties owned in corporate form and then converted to a REIT structure in 2010.
There are comparatively fewer public real estate companies (13) in Canada, although there is one exceptionally large publicly listed limited partnership (LP), Brookfield Properties Partners LP. It owns 83 per cent of Box and is global in its scope, with a market cap of approximately C$24 billion. Typically, to be competitive with REITs in terms of cost of capital, a public corporation requires large-scale and sufficient tax attributes to defer taxes over an extended period. Corporations tend to be more active in the development side of the real estate business, especially residential, due to both tax and fiscal constraints on REITs from undertaking too much development or other active income activities.
Private investors that are family-based tend not to be owners of top-tier office or retail properties (unlike earlier decades in Canada), but do have significant industrial, retail and multi-residential holdings. Canadian-based private equity funds that are materially engaged in real property investing, other than the pension plans, which are a form of private equity investor, tend to be focused only on real estate investment and generally are not part of broader private equity ‘conglomerates’ that invest across all economic sectors. Canadian private equity, if funded by pension funds as their investors, do compete in the office asset class, although more rarely in Class A offices, and are often engaged with real property assets that require active management and repositioning. One such entity, Kingsett Capital, has, however, been active in large-scale public deals involving REITs.
ii RECENT MARKET ACTIVITY
Large-scale property acquisitions and mergers driven by REITs and foreign investors (and in particular private equity firms) had been a characteristic of the Canadian market in 2015 and 2016, with many direct property purchases by smaller private equity funds whose limited partners are largely medium-sized and smaller pension funds. Total transaction volume in 2016 was C$11.4 billion, which was roughly equal to the 2015 transaction volumes. Acquisitions of or mergers between REITs slowed in 2016 and in the year to date in 2017, with only three public transactions during that period, down from an average of five per year in the prior three years.
Canadian corporate real estate entities have been developers rather than buyers in Canada for the most part in the past five years. Brookfield affiliates have completed two major downtown Toronto office towers, and several of the pension funds through their corporate real estate arms have also built office towers in Toronto, expanding the downtown core south towards the waterfront. There were also some acquisitions and rebalancing among pension funds, with CPPIB increasing its exposure of Toronto and Calgary offices, making purchases of interests valued at C$1.2 billion from Oxford, the real estate subsidiary of the OMERS pension plan. Hospitals of Ontario Pension purchased a 50 per cent interest in a new Calgary office tower from H&R REIT for C$257 million. However, generally the large Canadian pension funds are increasingly more globally focused than focused on real estate in Canada.
Canadian REITs have ridden a high demand for yield in a low interest rate environment, with their cost of capital at times allowing them to compete with pension plans even in the Class A office space: see, for example, the purchase of the Scotia Plaza tower in downtown Toronto by a partnership of Dundee Office REIT and H&R REIT for C$1.27 billion in 2012. Most market observers had expected ScotiaBank (the last Canadian bank to own its own headquarters) to sell to a pension fund or foreign investor. Interestingly, H&R exited Scotia Plaza in June 2016, roughly at cost, to a consortium led by private equity sponsor Kingsett Capital (through its funds) who partnered with AIMCO (the investment manager for the Province of Alberta pension and investment funds). They purchased a 50 per cent interest in Scotia Plaza (33.3 per cent from H&R and 16.7 per cent from Dundee Office REIT, now known as DREAM Office REIT). Kingsett, Canada’s most active privately managed real estate private equity firm, agreed to purchase the balance of Scotia Plaza from DREAM in June 2017.
As for foreign investors, while European investors, particularly UK and German investors, have long had real estate investments in Canada, their more prominent properties have been largely repatriated to Canadian hands over the past decade or so. However, Asian-based investment into Canadian real estate surged in the period from 2014 to 2016. Based on published news reports, it is likely that Chinese investors may slow the pace of their investment in foreign real estate in 2017.
i M&A transactions
There has been some consolidating merger activity in Canada between REITs in the past few years, but overall, less has occurred than some had expected, as there have been few REITs trading significantly below net asset value. Mergers between REITs typically take place though a plan of arrangement, the steps of which conform to the provisions of Section 132.2 of the ITA allowing a tax deferred disposition of units to ultimately receive units of another REIT as consideration.
The acquisition by Northern Properties REIT of True North REIT in 2015 created the third-largest publicly traded multi-residential REIT. Northern/True North shows the advantage of an agreed transaction in which, in part because of the tax deferred consideration structure available to the acquiring REIT, it is much more difficult for an entity other than a REIT to competitively intervene. Northern agreed to acquire True North for Northern REIT trust units while concurrently acquiring C$535 million of multi-residential assets from Starlight Investments (a party associated with True North) and a joint venture of Starlight and a subsidiary of the Public Service Pension Investment Board (pension plan) for cash and Northern units. True North had previously issued exchangeable LP units from an LP subsidiary on a purchase of assets from its sponsor (an affiliate of Starlight). Northern issued exchangeable LP units of a Northern REIT subsidiary LP for such True North LP units.
Northern offered 0.39 Northern REIT units for one True North unit (or a 16.4 per cent premium to the True North Unit closing price), which it paid to True North in exchange for the True North assets. True North then distributed those Northern units to its unitholders, all as prescribed under Section 132.2 of the ITA to allow the exchange on a tax-deferred basis. Northern financed the cash portion of the concurrent Starlight/PSP investment with a C$326 million secured bridge facility with its two advisee banks. Often, the cash elements of merger consideration might be financed with a ‘bought deal’ in the capital markets launched concurrently with or shortly after the merger announcement. The initial market reaction to the deal made this a less attractive proposition in this case. Northern units dipped in price on announcement, but despite that, the transaction was strongly supported by Northern unitholders (87.8 per cent in favour of 71.8 per cent voted).
REIT-to-REIT mergers with other parties also occur although, as the REIT market is relatively small, there are typically only one or two such mergers a year. They are usually sector-consolidating transactions such as office REITs (Dundee Office REIT–WhiteRock REIT) or multi-residential REITs (CAP REIT–Residential Equities REIT), or more recently in 2015, the C$2 billion merger of NorthWest Healthcare Properties REIT (NWH) with a related REIT, NorthWest Healthcare Properties International REIT (NWI). Both REITs were associated with same sponsor and manager and, while in similar health-related realty spaces, NWI had assets outside of Canada and NWH’s assets were in Canada. It was also a unit-for-unit exchange on a tax-deferred basis designed to comply with Section 132.2 of the ITA with NHW as the surviving REIT. Such merger transactions under Section 132.2 are subject to land transfer tax on their Ontario and Quebec properties, and so it made sense that the larger NWH (holding Canadian properties) was the acquirer of NWI (which held foreign properties).
ii Private equity transactions
When REIT trading prices dip significantly below their net asset value (NAV) or stay below NAV for an extended time, they can become targets for acquisition. Private capital often plays a role in such transactions.
An example is the going-private transaction for TransGlobe REIT, a multi-residential REIT taken private by a consortium led by the original sponsor of TransGlobe, Daniel Driminer, through his Starlight Investments. Starlight manages its own capital and acts as sponsor of several private equity funds and several small public REITs. Starlight owned about 20 per cent of TransGlobe and offered, with a consortium of its own funds, another private equity fund – TimberCreek Asset Management – and PSPIB, a large pension fund and a large REIT, to privatise TransGlobe in a complex multi-stage multiple series of purchases. CAP REIT agreed to buy 14 TransGlobe properties, TimberCreek 26 properties, and the PSPIB/Starlight JV acquired 72 properties for cash, with Starlight acquiring the residual REIT and its remaining 62 properties. The aggregate price was approximately C$1 billion, representing a 19 per cent premium to market. An interesting feature was a go-shop period without a match right that could inhibit prospective buyers, and with Starlight and PSPIB agreeing to tender to a superior bid if one was found. An alternative transaction did not emerge.
One of the largest real estate transactions in the last decade was the sale and split up of Primaris Real Estate Trust, a holder of enclosed urban and regional shopping centres, which was also private equity-driven. It was precipitated by a hostile takeover bid led by Canada’s most prominent real estate private equity investor, Kingsett Capital (acting through one of its funds), which partnered with one of the larger pension funds, Ontario Pension Board (OPB), and another large REIT, RioCan REIT. Kingsett offered C$4.4 billion cash, or C$26 per unit (each 12.9 per cent premium), through a ‘hostile’ takeover bid supported by the OPB. RioCan agreed to buy one of the larger Primaris properties from the Kingsett consortium. Parties other than REITs cannot easily offer non-cash consideration to other REITs on a tax-deferred basis. Unlike the United States, Canadian boards, whether of REITs or corporations, have a very limited ability to prevent takeovers, as Canadian securities regulators have historically struck down shareholder rights plans after 60 to 120 days. However, Primaris was successful in that time frame in attracting a white knight offer from a large (then primarily) office REIT, H&R REIT. H&R was able to offer its own REIT units on a largely tax-deferred basis, with a cash component of up to 25 per cent of the consideration that would be taxable to those electing cash (in whole or in part).
The white knight offer was valued at C$4.6 billion or C$27.13 per unit (assuming full proration, a 16 per cent premium). In contrast to the hostile bid, it was to be structured as a court-approved plan of arrangement subject to approval of Primaris unitholders. As H&R was to issue REIT units in excess of 25 per cent of its capital, H&R unitholder approval was also necessary under the TSX listing rules. A somewhat controversial break fee involving both cash and an option to purchase a key property (the one to be purchased by RioCan under the Kingsett offer) was agreed. Ultimately, no challenge to such fee was made, as Primaris allowed Kingsett and its joint actors to partner with H&R in a further enhanced offer value at C$27.92 per unit (C$5 billion) involving both increased H&R units and increased cash (subject to dual proration, roughly 55 per cent cash and 45 per cent units). This was stated to represent a 22 per cent premium to the unaffected Primaris trading price prior to the original hostile bid. It too was structured as a plan of arrangement using Section 132.2 of the ITA, with Kingsett, RioCan and OPB purchasing 18 shopping centres from Primaris for cash (used to redeem Primaris units from the holders electing cash) and then H&R exchanging its REIT units for the remaining assets of Primaris (25 properties and the platform), with Primaris then distributing those H&R units to its unitholders on a tax-deferred basis. As a result, Primaris unitholders received both increased cash and H&R units representing about 16 per cent of H&R.
While in the previous decade there were a number of acquisitions by US health or senior care REITs acquiring Canadian senior REITs, Ventas/Sunrise REIT and Welltower/HealthLease, in the past two years, Asian private investors and insurers (primarily out of China and Hong Kong) have been paying what some market commentators regard as record-setting CAP rates for the direct purchase of office buildings in Toronto and Vancouver. Anbang Insurance based in China purchased the four office tower Bentall complex in Vancouver from a Canadian pension fund and a Canadian insurance company, reputedly for over C$1 billion dollars; and a land lease on a secondary downtown Toronto office building reported at C$110 million. Asian investors have also been buying Canadian hotels, including BlueSky, a newly incorporated Hong Kong company (also reported to be associated with Anbang), which recently purchased InnVest REIT, the largest Canadian hotel REIT (109 properties) for C$7.25 per unit (a 33 per cent premium: high for REIT transactions) or C$2.1 billion (including assumed debt). The transaction included a C$100 million deposit (unusual for a public deal) and a C$32 million reverse break fee.
The largest public REIT transaction in 2017 involved a foreign private equity buyer, with Starwood Capital acquiring Milestone REIT for C$1.7 billion cash. It was executed using a plan of arrangement. Starwood raised its price marginally (C$0.10 per unit) after some grumbling from institutional shareholders and an initial rejection recommendation from Institutional Shareholder Services. Milestone’s assets are all located in the US.
iii REAL ESTATE COMPANIES AND FIRMS
i Publicly traded REITs and REOCs – structure and role in the market
There are approximately 56 publicly listed real estate entities in Canada, of which approximately 40 or so are REITs (as defined in the ITA) and a dozen are corporations. There are also a few listed trusts that have a significant real estate component, and that are often referred to as REITs but, because of their active business activities (senior homes or hotels), may not be technically qualified as REITs (as defined under the ITA). These are taxed under the ‘specified income fund trust’ or SIFT tax regime, which is not a flow-through regime and thus is not as favourable as the REIT tax regime.
There are also a number of very large private real property corporations owned by family groups that are very active developers of office towers, condominiums and malls in particular. There has been massive condominium development across Canada during the past decade, especially in Toronto and Vancouver, driven mainly by pension fund and private capital.
As noted above, many of the listed real estate structures are in the form of a REIT. A REIT is governed by the terms of its trust deed as a matter of the law of the province in which it is formed. There is no statutory framework for trusts similar to corporate statutes, although securities laws apply to publicly traded REITs. Investors can purchase units of a trust as they would purchase shares of a corporation, and legislation has extended limited liability protection to investors. Most REITs do not have some of the rights and remedies provided to shareholders in corporations, such as the oppression remedy, dissent rights and rights to call meetings or make proposals. Pressure is mounting from some institutional governance groups for REITs to adopt more uniform trust deeds and rights fully parallel to those available to corporate shareholders, and an increasing number of REITs are adopting some of those rights.
The REIT is designed to be a ‘flow-through entity’ investment, meaning that a trust meeting the ITA REIT qualifications pays no Canadian income tax provided that the REIT distributes its annual taxable income to its unitholders. In the case of REIT units held by a non-resident, distributions of income to the non-resident unitholder by the REIT are generally subject to withholding tax at a rate of 25 per cent (subject to reduction under a tax treaty); however, the gain realised on a disposition of REIT units is generally not subject to Canadian tax provided that the unitholder and those persons not dealing at arm’s length with the unitholder hold less than 25 per cent of the units of the REIT.
Typically, rather than owning a beneficial investment in property directly (although a REIT can do so), there will be an LP or multiple LPs below the REIT that own the properties. Among other things, an LP can issue LP units to the persons from whom a REIT wants to purchase property on a tax-deferred basis, whereas REITs cannot issue REIT units to property sellers on such basis. Such LP units are typically exchangeable into REIT units on a taxable basis, and often are associated with special voting units that provide such LP unitholders with a vote in the REIT as if they held an equal number of REIT units.
The criteria for ‘REIT’ status under the ITA has been altered several times (the last time in 2012). Essentially, to qualify as a REIT, the trust must limit its activities primarily to owning real estate as capital property, and receiving passive rental and interest income, with limited baskets for non-capital real property, other non-cash assets, and income from business activities such as third-party management or development. REITs typically cannot own real estate-based operating businesses such as senior facilities or hotels. To the extent that a trust not qualifying as a REIT for ITA purposes has sufficient non-cash deductions such as a capital cost allowance on its buildings, it may be able to reduce its current taxable income substantially in the short run and make tax-deferred distributions to its Canadian resident unitholders to achieve a similar outcome to REIT treatment. REITs also have foreign ownership restrictions, as REITs must also qualify as ‘mutual fund trusts’ under the ITA so that they cannot be operated primarily for the benefit of non-residents. As a practical matter, this typically translates into a 49 per cent foreign ownership limit in REIT constating documents.
The management of a REIT can be conducted internally through its own employees or externally by a manager under contract. While sponsors typically prefer the ongoing fees flowing to them from external management arrangements, the ‘market’ tends to favour internalised arrangements.
Most Canadian REIT’s are the product of smaller IPOs (typically under C$300 million). However, a few were created by a conversion of existing corporations or a spin out from existing corporate entities, such as Brookfield Canadian Office Properties REIT, which was formed in 2010 through the conversion of BPO Properties Inc into a REIT as part of the ongoing consolidation of Brookfield’s Canadian real estate properties into one entity. The REIT is 83.7 per cent-owned by Brookfield Property Partners LP, itself a spin-off of Brookfield Asset Management’s property division into an LP based in Bermuda, which is by far the largest publicly listed property entity in Canada.
Corporate spin-outs by REIT IPO
Two of the largest real estate IPOs in the past five years were REIT IPO spin outs of the real property assets of two of Canada’s largest domestic retailers. There is no easy tax-efficient manner in which to distribute assets to stockholders under the ITA so such spin-outs in Canada have happened by IPO. The first, Choice REIT, was created to hold one local shopping centre owned and anchored by Loblaw grocery stores. The second, CT REIT, was created to buy a portion of Canadian Tire’s anchored local shopping centres. In each case, the sponsor selling retailer was itself a listed public entity, and the IPO served to fund the cash portion of the purchase price of the property transferred by the parent to the new REIT. Unlike the BPO Properties REIT conversion, where the Brookfield’s tenant base is exceptionally diverse, in these two retail spin-outs there was essentially one tenant occupying over 90 per cent of the leasable space. In those two instances, the fact that the sponsors of the IPO (and principal REIT tenants), Loblaw and Canadian Tire, were investment grade-rated was key to the ability of the underwriters to achieve the pricing that the sponsors desired.
Sellers retain a large majority interest in the REITs in the form of tax-deferred exchangeable LP units and REIT special voting units, with cash, notes or preferred securities being paid up to each seller up their tax cost base in the assets they sold to their REITs. In each case, various arrangements exist around the sale to the REITs of a future pipeline of properties retained or to be developed by the sellers, as well as sponsor or seller governance rights. The Choice REIT IPO raised C$460 million, while the CT REIT raised C$303 million from the public, with the sponsors retaining an initial interest of just over 80 per cent of the REITs in each case.
Typical Canadian REIT IPOs are generally much smaller than those in the United States, and interestingly, as a result, have attracted a number of US-based cross-border REITs (also known as ‘foreign asset income trusts’) (Canadian-formed REITs owning foreign assets) such as Milestone REIT that are smaller than a typical REIT IPO in the US capital market. These are typically REITs for Canadian income tax purposes and, in some instances, are also qualified as REITs under US tax law.
ii Real estate PE firms – footprint and structure
The dominant private equity real estate players in Canada, with the exception of Kingsett Capital, are Canadian pension plans with specialist real estate subsidiaries or divisions. Many of the largest have at their core properties obtained and personnel gained from taking private the largest public real estate operating companies. The top 10 plans have some C$140 billion dedicated to real estate in Canada and abroad (as of December 2014). There are also privately controlled private equity sponsors, with the best-known and likely the largest by far being Kingsett Capital: it regularly transacts in billion dollar-plus transactions in both the publicly traded REIT market and direct private transactions involving high-profile real property. Unlike Kingsett (the largest specialist real estate private equity investor) and the large pension funds, which operate both the public markets and in private direct real estate, most Canadian real estate private equity funds operate in the private real estate market with direct acquisitions of real property. There are fewer such private equity funds in Canada compared to the US, and the equity raised for most individual funds tends to be the hundreds of millions, and not billions.
Almost all privately sponsored private equity pools (versus pension fund-owned real estate corporations) are held in the form of LPs, as an LP wholly owned by Canadian residents is a flow-through entity for income tax purposes. The typical LP has a general partner owned by the sponsor and a limited number of limited partners, which are typically pension plans but occasionally are high net-worth entities.
There has been a limited amount of activism in the REIT space, but what exists has largely been driven by private equity. In fact, one entity – Orange Capital – was behind both of the two campaigns in the space. One such foray in 2014 resulted in Orange, together with Kingsett Capital (an existing holder), gaining representation on the board of InnVest REIT together with the internalisation of management that had previously rested externally with the sponsor and another shareholder of the REIT, Westmont Hospitality. While the new board undertook a series of refinancing and acquisitions and dispositions, the trading price of InnVest did not move markedly until the BlueSky acquisition of InnVest in June 2016 at a large premium to market.
Orange also successfully challenged a transaction involving Partners REIT, where a large acquisition, allegedly involving an undisclosed insider, was reversed as a result. As part of its campaign, Orange, which was not then a unitholder, launched an innovative mini-tender for Partners REIT at a small premium to market. As it was only for only 10 per cent of the units, the offer was not subject to the takeover bid rules. Orange sought a proxy from all tendering shareholders in respect to any and all REIT units deposited that it sought to vote at the Partners REIT AGM in favour of a competing slate of Orange nominees. The proxy was stated to be effective whether or not Orange actually took up under the offer or prorated the tendering unitholders. Partners REIT complained to the Ontario Securities Commission (OSC) that, inter alia, the offer was so conditional it was an option. As a result, inter alia, Orange agreed that if 10 per cent of the shares were tendered, it would be obligated to take up under the offer and to allow the withdrawal of tenders. Strangely, the OSC staff did not strike the proxy provisions as part of the settlement with Orange, so that Orange would have been permitted to potentially vote a massive number of REIT units without any ownership. Interestingly, Partners nominated new independent directors, and the Orange offer did not receive its 10 per cent threshold and was terminated. Orange did effectively cause Partners REIT to put forward new directors and to reverse the disputed transaction.
i Legal frameworks and deal structures
While several different methods exist to acquire control of a Canadian public company, M&A transactions in Canada are most commonly effected by a ‘plan of arrangement’ and less frequently by a ‘takeover bid’. These transaction structures, which are not unique to public real estate M&A, are outlined below.
Plan of arrangement
A statutory arrangement, commonly referred to as a ‘plan of arrangement’, is a voting transaction governed by the corporate laws of the target company’s jurisdiction of incorporation. It is first negotiated with the target board of directors and remains subject to the approval of the target security holders at a special meeting held to vote on the proposed transaction. Notably, an arrangement also requires court approval. Due to the ability to effect the acquisition of all of the outstanding securities of a target in a single step and its substantial structuring flexibility, the majority of board-supported transactions are structured as arrangements.
In the REIT-to-REIT merger context, the use of a plan of arrangement necessitates the presence of a corporate entity somewhere in the structure, such as a corporate general partner of an LP subsidiary. Courts have to date been quite accommodating in the use of the plan of arrangement structure even where the transaction is primarily a REIT-to-REIT merger transaction.
The target entity applies to court to begin the process of effecting the arrangement. An initial appearance will be made before the court for an interim order setting the procedural ground rules for the arrangement, which is almost always uncontested. The interim order will specify, inter alia:
a the manner in which a special meeting of the security holders will be called and held (e.g., the form of proxy solicitation materials and disclosure documents to be sent to security holders, record date for establishing security holders entitled to vote on the transaction, applicable notice periods, time and place of meeting);
b the persons entitled to vote at the meeting;
c whether any class of persons will be entitled to a separate class vote; and
d the requisite approval thresholds required to approve the arrangement.
Securities legislation sets out the required disclosure and disclosure standards. Once the meeting of the security holders is held and the arrangement resolution has been approved by the requisite majorities of security holders, the target seeks a final court order approving the arrangement. The final order will be granted if the court is satisfied that the arrangement is ‘fair and reasonable’. While disaffected stakeholders can appear at the final order hearing to challenge the arrangement, the vast majority of arrangements are approved without opposition.
Although the shareholder approval threshold for an arrangement is generally subject to the discretion of the court and addressed at the procedural hearing when the interim order is sought and obtained, an acquirer will typically propose that it seek the same approval threshold as would be required under the applicable corporate law statute governing the target company involved in the transaction if the arrangement steps were effected outside the arrangement process. In most Canadian jurisdictions this threshold is 66⅔ per cent of the votes cast at the meeting of the target security holders. The approval of a majority of the minority shares voted at the meeting may also be required in circumstances where the business combination rules under securities law apply to the transaction. Other convertible securities such as warrants and convertible debentures are typically not given the right to vote in an arrangement unless their rights under the applicable indentures or contracts are being altered as part of the arrangement in a manner that is not fair and reasonable.
A unique feature of REIT-to-REIT mergers is that to achieve a tax deferral if offering REIT units for consideration, the steps within the transaction must take place in the manner required under Section 132.2 of the ITA and requires a plan of arrangement.
A takeover bid is a transaction by which the acquirer makes an offer directly to the target company’s security holders to acquire their securities. A takeover bid is the substantive equivalent of a tender offer under US securities laws. Although the board of directors of the target company or trustees of a REIT have a duty to consider the offer and an obligation to make a recommendation to security holders as to the adequacy of the offer, the takeover bid is ultimately accepted (or rejected) by the security holders. As the support of the target directors is not legally required, a takeover bid is the only practical means to effect an unsolicited or hostile acquisition. Takeover bids are also used infrequently for friendly transactions in Canada. However, as most transaction between REITs involve an equity consideration and there is no tax deferral for a direct exchange of REIT units for REIT units, hostile takeovers are comparatively rare in the REIT space.
Takeover bids are regulated under a uniform regime adopted by each Canadian province and territory.
A takeover bid must be made to all registered holders of the class of voting or equity securities being purchased (and sent to all registered holders of securities convertible into or exercisable for such voting or equity securities). The same price per security must be offered to each holder of the class of securities subject to the bid.
There are also minimum standards relating to the conduct of the bid, including disclosure requirements, the timing and delivery of takeover bid materials, and rules designed to ensure the equal treatment of all security holders.
A formal takeover bid is made pursuant to a disclosure document commonly referred to as a takeover bid circular. This document must contain prescribed information about the offer, the offeror and the target company. When the offered consideration consists (in whole or in part) of securities of the offeror, the circular must also include prospectus-level disclosure about the offeror. It is generally not necessary to pre-clear the contents of a takeover bid circular with the securities regulators in Canada, and the takeover bid circular is not generally subject to their review once it is filed, absent a complaint being made.
Effective 9 May 2016, fundamental changes were made to the Canadian takeover bid regime. The new provisions increased the amount of time afforded to a target issuer to respond to a hostile bid, effectively resulting in a 105-day ‘permitted bid’ regime. The regime will have important implications for both tactical and strategic rights plans, and may also influence how transactions are structured in the future.
Under the new takeover bid regime, all non-exempt takeover bids (including partial bids) are subject to the following requirements:
a takeover bids are subject to a mandatory, non-waivable minimum tender requirement of more than 50 per cent of the outstanding securities of the class that are subject to the bid, excluding those beneficially owned, or over which control or direction is exercised, by the bidder and its joint actors (the minimum tender requirement);
b following the satisfaction of the minimum tender requirement and the satisfaction or waiver of all other terms and conditions, takeover bids will be required to be extended for at least an additional 10-day period; and
c takeover bids will be required to remain open for a minimum of 105 days unless the target agrees to a lesser time period for the bid or another transaction.
Determining whether a takeover bid exists is based on objective factors and, in particular, on the percentage of voting or equity securities beneficially owned or controlled by the offeror (and any joint actors) plus the number of additional securities subject to the takeover bid (as opposed to the more subjective factors used in the United States, such as the method and timing of an acquisition). The takeover bid threshold is 20 per cent of any class of voting or equity securities. In determining whether the threshold level of ownership by the offeror will be crossed, the number of securities beneficially owned by the offeror includes securities that the offeror has a right or obligation to acquire within 60 days (e.g., through options, warrants or convertible securities), and securities held by affiliated entities and joint actors.
An arrangement is usually the preferred transaction structure for friendly transactions due in part to the ability to effect the acquisition of all outstanding securities of a target company in a single step and in part to its substantial structuring flexibility. In particular, arrangements are not circumscribed by the takeover bid rules (e.g., there are no prohibitions against financing conditions, collateral benefits or paying differential consideration to shareholders) and, importantly, can facilitate tax planning objectives by enabling an acquirer (and a target) to set out the precise series of steps that must occur at and following the effective time of an arrangement.
Where there are lengthy regulatory approvals, the ‘fiduciary out’ ends at the date of the shareholders’ meeting, whereas in a takeover bid the fiduciary out effectively ends at the date all bid conditions have been satisfied or waived.
Unless the target is a US registrant, there is no Securities and Exchange Commission (SEC) review of the proxy circular for an arrangement in certain circumstances where a takeover bid circular to acquire the same securities would be subject to SEC review. Further, there is the potential availability of a registration exemption under US securities laws in securities exchange arrangements.
In addition to the flexibility of an arrangement for implementing complex transactions, the directors of the target company may take comfort from the fact that an arrangement has been court-approved and determined to be fair and reasonable, potentially insulating the transaction and directors of the target from criticism or post-closing liability.
ii Directors’ duties
The corporate statutes in Canada impose two principal duties on directors: the fiduciary duty and the duty of care. Directors cannot contract out of these responsibilities and may be held personally liable for any breach of these duties. REITs are trusts, and although there is not a direct equivalent standard by statute, the common law applies at least a similar standard to that applied to corporations (and in theory a higher one). REITs have generally adopted the corporate standards applicable to directors in their trust deeds. Although not yet subject of an express definitive decision, Canadian courts have typically treated trustees of public REITs by the standards applied to directors of public companies.
Directors and trustees are fiduciaries of the entities they serve.
The Supreme Court of Canada set out the scope of the fiduciary duty in the corporate context in its decision in BCE Inc. The key principles from the decision are as follows:
a the fiduciary duty is owed to the corporation, not to any particular stakeholder;
b the fiduciary duty of the directors is a broad, contextual concept. It is not confined to short-term profit or share value. Where the corporation is a going concern, it looks to the long-term interests of the corporation. The content of this duty varies with the situation at hand;
c in considering what is in the best interests of the corporation, directors may look to the interests of, among others, shareholders, employees, creditors, consumers, governments and the environment to inform their decisions;
d the duty of the directors to act in the best interests of the corporation comprehends a duty to treat individual stakeholders affected by corporate actions fairly and equitably based on those stakeholders’ objectively determined reasonable expectations; and
e where stakeholders’ interests conflict, there is no principle that one set of interests should prevail over another set of interests. In particular, unlike the Revlon duties under Delaware law, there is no principle that shareholder interests in maximising shareholder value prevail over other stakeholder interests in a change of control transaction. Everything depends on the particular situation faced by the directors and whether, having regard to that situation, they exercised their business judgement in a responsible way and resolved any conflicting interests fairly and equitably based on an objective determination of such stakeholders’ reasonable expectations.
Although the court in BCE did not specifically endorse a duty to maximise security holder value, equity security holders obviously have a great deal at stake in a change of control transaction, and have a reasonable expectation that directors will give considerable weight to their interests when considering how to respond to an acquisition proposal. Accordingly, determining whether an acquisition proposal delivers the best value reasonably available to equity security holders should remain a central focus of directors’ and trustees’ deliberations.
Duty of care
In discharging their duties, directors must also ‘exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances’. This standard of care can be achieved by any director who devotes reasonable time and attention to the affairs of the corporation and exercises his or her informed business judgement. The standard of care is measured against the objective standard of what a reasonably prudent person would do in comparable circumstances. Failure to meet the standard often stems from passivity and a failure to inquire.
In BCE, the Supreme Court of Canada confirmed the existence of a Canadian ‘business judgement rule’ under which courts will defer to directors’ business decisions as long as they are within a range of reasonable alternatives. Courts defer to decisions of directors taken in good faith in the absence of conflicts of interest, provided the directors undertook reasonable investigations and considerations of the alternatives and acted fairly. Courts will not subject directors’ business judgement to microscopic examination and will not substitute their view for that of the directors, even if subsequent developments show that the directors did not make the best decision.
In discharging the duty of care, a threshold consideration is whether a board should constitute a special committee of independent directors or trustees to review and consider a takeover bid or credible acquisition proposal.
Where there is a true conflict transaction that engages the procedural protections contained in MI61-101 (e.g., because the potential acquiring party is a related party of the target company), then a special committee of independent directors with independent legal and financial advisers should be, and may be required to be, established to review an acquisition proposal, supervise and direct any negotiations, and make recommendations to the board.
In other circumstances where the conflict is not as acute, such as where there is a perception that management may be influenced by considerations relating to their continued employment, the board will need to consider how best to address the conflict. In some cases, the conflict may be addressed by excluding management and any potentially conflicted director from those portions of the board’s deliberations as considered appropriate in the particular circumstances.
In other cases, the board may choose to establish a special committee. Canadian courts have looked favourably upon the establishment of special committees as a means of addressing potential conflicts. A special committee may also be desirable as a matter of convenience, depending on the relative expertise of the directors and their differing time commitments and availability.
iii Acquisition agreement terms
As previously noted, most public real estate merger transactions take place under a plan of arrangement. The acquirer and target will enter an arrangement or a merger agreement with all of the typical terms found in any merger agreement.
Common deal protections in supported public transactions, whether real estate or non-real estate, include non-solicitation (‘no shop’) provisions in which the target company agrees not to solicit or negotiate other offers, as well as a commitment to recommend the supported transaction and pay a break fee if the agreement is terminated in certain circumstances. The non-solicitation provisions generally permit the board in the exercise of its fiduciary duties to engage with a rival bidder that makes an unsolicited acquisition proposal that is likely to result in a superior proposal. The fiduciary duty of the board of directors also typically permits the board to change its recommendation and enter into an agreement to support a superior proposal. What constitutes a superior proposal is a matter of negotiation, but it is almost invariably defined to include a requirement that the acquisition proposal is more favourable from a financial point of view to the target security holders than the existing transaction. A break fee is permissible under Canadian law, provided that it represents a reasonable commercial balance between its negative effect as an auction inhibitor and its potential positive effect as an auction stimulator (including if the fee was necessary to induce a bid). Break fees typically range from 1 to 4 per cent of deal equity value.
In defending against hostile bids, target boards have also employed a number of defensive tactics. The most common is the use of rights plans or poison pills, although under the new rules these will be void after 105 days. Additional defensive tactics include issuances of treasury securities to dilute the bidder or potential bidder (often by placing the securities in friendly hands), a sale of assets, recapitalisations and asset lock-ups.
The main difference in a real estate merger context is the specific step mechanics of the plan of arrangement itself must conform with the edicts of Section 132.2 of the ITA to ensure a tax deferred rollover for any trust unit consideration offered by the buying REIT. A full cash deal is typically not different than any merger transaction. It would be typical to enter such agreements only after all diligence was conducted as in any public transaction. Conditions in public real estate mergers are typically similar to any public merger transaction, although there might be a condition addressing the necessary percentage level of mortgagee consents to the assumption of mortgages that is not typically present in non-real estate public deals.
iv Hostile transactions
Hostile transactions do take place in Canada but they are very rare. They are even rarer among REIT-to-REIT transactions, as a tax-deferred unit consolidation transaction is only available through a plan of arrangement conforming to the requirements of Section 132.2 of the ITA. A plan generally requires target board cooperation. As a result, almost all REIT-to-REIT transactions that occur are by plan of arrangement. Even the rare ones involving cash for units that start out as a hostile transaction generally end up as a negotiated plan of arrangement transaction for an increased price.
v Financing considerations
Public REIT-to-REIT mergers are typically unit-for-unit transactions with the assumption of the underlying mortgages of the target REIT. The cash portion of a transaction not sourced from funds on hand might be bridge financed through a bank facility to be subsequently repaid through public debenture or equity issue.
However, the Canadian bought deal underwriting structure, whereby underwriters guarantee their underwriting, offers certainty of funding to public REIT acquirers who, as a result, will often arrange a bought deal financing concurrently with the merger transaction announcement. Such bought deals can be through a subscription receipt structure, which allows the financing to be contingent on the closing of the merger.
Private equity acquirers will draw down equity commitments of their LPs or pension funds will draw on their vast reserves of liquid securities to fund the equity portion of transactions and assume underlying mortgages. Credit lines or fresh mortgage alternatives must be available to refinance mortgages that have provisions requiring repurchase upon change of control (which is common), but most mortgagors tend to consent to the assumption of their mortgages, especially if the buyer is a significant player in the real estate market.
vi Tax considerations
Canada’s tax regime is primarily governed by the federal ITA (Canada), as well as the sales tax, corporate tax and other tax laws of the provinces and territories. The ITA imposes income tax for each taxation year on the taxable worldwide income of every ‘person’ resident in Canada in that taxation year, which includes corporations. Corporations, trusts and individuals are persons for this purpose (although a trust is not a legal entity). At common law, a corporation will generally be resident in Canada if its ‘central management and control’ is located in Canada. Further, under the ITA, corporations, if incorporated under Canadian federal, provincial or territorial law, are deemed to be resident for this purpose. Provincial corporate income tax regimes generally follow the ITA rules.
The ITA also imposes taxes on non-resident persons who carry on business in Canada. There are also withholding taxes on certain types of passive income, including rent, interest and dividends. In addition, the disposition of ‘taxable Canadian property’ (as defined in the ITA) may result in a non-resident being subject to tax in Canada. Therefore, the tax treatment of an investment made by a non-resident in Canadian real estate will depend upon whether the investor makes the investment directly or through a Canadian entity, such as a corporation. If the investment is made directly by the foreign investor, the tax treatment will vary based on whether the Canadian real estate generates business income or property income.
As of 31 May 2017, the basic Canadian combined federal and provincial tax rate for general income earned by corporations ranges from 26 per cent (British Columbia) to 31 per cent (Nova Scotia), with Ontario at 26.5 per cent and Alberta at 27 per cent. The basic Canadian combined federal and provincial tax top bracket rate for income earned by individuals including trusts ranges from 44.5 per cent (Nunavut) to 54 per cent (Nova Scotia), with Quebec at 53.51 per cent, Ontario at 53.53 per cent and Alberta at 48 per cent.
Canada is a party to approximately 90 income tax treaties with other jurisdictions. These tax treaties often reduce the withholding tax rate imposed under the ITA and the branch tax rate described below.
If a non-resident invests through a Canadian corporation, the corporation will be subject to tax on its business profits as determined in accordance with ordinary commercial principles. For this purpose (subject to the thin capitalisation rules discussed below), an interest expense is generally deductible if it is reasonable in amount; it is incurred pursuant to a legal obligation to pay interest on borrowed money or the unpaid purchase price; and the underlying debt is used for the purpose of earning income from business or property. In lieu of book depreciation, the ITA sets out a capital cost allowance that provides taxpayers with deductions that they may take on a discretionary basis.
The thin capitalisation rules disallow the deduction of interest payable by a Canadian corporation on debts owing to ‘specified non-resident persons’ (being various non-arm’s-length parties) to the extent that the ratio of such debts to the corporation’s equity exceeds a ratio of 1.5:1.
Subject to treaty relief that may reduce or eliminate withholding tax, a Canadian subsidiary must withhold tax at a rate of 25 per cent on several types of payments to non-residents, including dividends, interest paid to non-arm’s-length parties, participating interests, and certain management or administration fees, rents and royalties. Treaties provide extensive relief for dividends, often at a rate as low as 5 per cent (if the recipient holds over 10 per cent of the voting shares of the issuer) or otherwise at a 15 per cent rate.
Most interest payments and commitment fees payable under a traditional loan from a foreign arms-length lender are now exempt from withholding tax. However, loans with participating interests and loans between non-arm’s-length parties are still subject to withholding taxes in Canada, although again treaties can reduce the rates on non-arm’s-length interest to as low as zero per cent in the United States, and to 10 to 15 per cent in most other treaty jurisdictions.
If a non-resident invests directly in Canadian real estate and such investment constitutes the carrying on of a business, the non-resident will be required to file a Canadian tax return and will be subject to tax based upon the non-resident’s taxable income earned in Canada.
Taxable income earned in Canada is generally calculated on the non-resident’s business profits from its operations in Canada and based on rules similar to those set out above with respect to Canadian corporations; however, the thin capitalisation rules applicable to Canadian corporations would not apply.
A non-resident is required to remit withholding tax in respect of payments made to other non-residents if such payments are deductible in computing its taxable income earned in Canada. Examples include participating interest or interest paid to non-arm’s-length parties. In addition, if the non-resident is a corporation it may be subject to branch tax, which is designed to approximate the withholding tax that would have been owed on dividends if paid by a Canadian subsidiary. If the non-resident is not a corporation, it generally will not be subject to branch tax; however, it will be required to pay tax on its business profits at individual tax rates, which are typically higher than corporate tax rates.
If a non-resident investor earns income from property (e.g., rental income where the investor did not provide a level of service beyond that normally associated with a rental property), the gross amount of rental income will be subject to a 25 per cent withholding tax (subject to reduction by tax treaty). Non-residents have the option, however, to elect to file a Canadian tax return and pay tax based on the profits from the Canadian rental property. Such tax would be calculated in a manner similar to that described above in ‘Carrying on business directly in Canada’.
Canadian real estate and shares of corporations that primarily derive their value from Canadian real estate, except for certain shares of public corporations, are taxable Canadian property such that tax is payable under the ITA on the disposition of such property. In the case of property held for resale or as an adventure in the nature of trade, the full amount of the gain is subject to tax at normal rates under the ITA.
Where an investor directly holds land and buildings that are not held for resale or as an adventure in the nature of trade, the gain on the sale of the land is generally taxed as a capital gain such that only 50 per cent of the gain is included as income. On a sale of a building, the amount of capital cost allowance previously claimed by the seller is included in the seller’s income to the extent that the sale proceeds are greater than the un-depreciated capital cost of the building and less than the original cost of the building. To the extent that the sale price exceeds the original cost of the building, only 50 per cent of the gain is included in income. On a sale of shares, a gain is typically treated as a capital gain such that only 50 per cent of the gain is included in income unless the shares were held for resale or as an adventure in the nature of trade.
Typically, a purchaser will not buy taxable Canadian property from a non-resident until the non-resident obtains a certificate from the Canada Revenue Agency certifying that all relevant taxes have been paid or that the seller has furnished security for such taxes. If the purchaser is not provided with such a certificate, it would be liable for tax equal to 25 per cent of the purchase price in the case of land or shares held as capital property, and to 50 per cent in the case of buildings or property held for resale or as an adventure in the nature of trade. Under these circumstances, the purchaser is entitled to withhold from the purchase price and pay to the Canada Revenue Agency the amount required to satisfy the tax liability of the purchaser under the ITA.
Transfer taxes assessed upon disposition of real estate
In Canada, real estate transfers also trigger land transfer tax, which the purchaser must pay when a real estate transaction closes. The tax is a provincial tax, and the rate varies depending on the province (and there can be additional municipal surtaxes). The transfer tax is stratified depending on the total value of the consideration paid, which normally includes the cash paid for the land in addition to the debt assumed and all other benefits transferred to the seller. The tax is payable on the fair market value of the real property, and there is a general anti-avoidance regime. Exemptions from land transfer tax are also available: for instance, certain inter-corporate transfers between affiliated corporations are exempt provided the transfer is not registered. Ontario and British Columbia have the highest rates. Ontario also recently revoked a widely utilised exemption that was available to purchasers of certain partnership interests.
British Columbia has instituted a 15 per cent surcharge on certain foreign non-residential buyers of residential real estate in Vancouver in 2016, and Ontario introduced a similar 15 per cent surcharge in April 2017 on certain foreign non-residential buyers of residential real estate in Toronto and surrounding areas.
Pursuant to municipal by-laws, the cities of Montreal and Toronto and certain other cities have implemented municipal land transfer surtaxes to be paid by a purchaser in addition to the provincial land transfer taxes discussed above. The municipal land transfer tax applies to all purchases of real property within the city limits and is charged on a graduated basis depending on the value of consideration paid for the property.
A purchaser of real estate in Canada may be required to pay GST or harmonised sales tax (HST) (described below), subject to certain exceptions. In the provinces and territories where GST is levied, the rate is 5 per cent. Sales of used residential housing and certain sales of farmland are generally exempt from GST. Further, a purchaser is generally not required to pay GST if registered for GST purposes under the Excise Tax Act (Canada) and the purchaser intends to use the real estate for commercial activities. Commercial rents are also subject to GST in Canada, and a collector of such rents (including a non-resident collector) must generally remit GST to the applicable taxation authority. Many businesses can recover GST that is related to commercial activities through a system of input tax credits.
In Canada, a seller has an obligation to remit GST that it has collected from a purchaser. If a seller is a non-resident, is not a GST registrant in Canada and is not carrying on a business in Canada, the purchaser may be required to self-assess for GST payable on the transaction. Non-residents must register under Canada’s GST legislation and charge and collect GST if they make taxable supplies in the course of a business carried on in Canada. A foreign firm with a permanent establishment in Canada is deemed to be a resident of Canada for GST purposes with respect to activities carried on by that establishment in Canada. A business with a Canadian branch may be required to register for GST and collect GST on supplies made through the permanent establishment. Non-resident registrants that do not have a permanent establishment in Canada are required to post security with the Canada Revenue Agency to meet collection and remittance obligations.
In some provinces, provincial sales taxes have been ‘harmonised’ with the GST and are collected by the federal government as a single tax: HST. In provinces where the HST exists, HST (which includes the 5 per cent GST) is applied to the purchase of real property, rather than GST alone. The application of HST generally parallels that of GST; for instance, HST does not generally apply to the sale of used residential housing, but HST can apply to the sale or lease of commercial properties subject to the ability of the payee to recover portions of the HST through input tax credits. As of 31 May 2017, four provinces will charge HST at the following rates: Nova Scotia at 15 per cent; and Ontario, New Brunswick and Newfoundland and Labrador at 13 per cent. In the provinces where the HST does not exist, provincial sales tax does not apply to the purchase of real property.
In Ontario, the Municipal Act allows municipalities to charge an annual tax on real property. This tax (known as realty tax) is calculated by multiplying the assessed value of the real property by the ‘mill rate’, which is established yearly based on the financial needs of the municipality. Such taxes can be substantial.
vii Regulatory considerations
Ownership of real property is generally a provincial rather than a federal matter in Canada. British Columbia, Ontario, Newfoundland, New Brunswick and Nova Scotia do not have restrictions on foreign ownership of land.
Alberta, Saskatchewan, Manitoba and Prince Edward Island (PEI) have rules restricting land ownership, generally aimed at farming lands. Alberta restricts the purchase of farmland over a certain size by foreign residents or foreign-controlled corporations. Saskatchewan restricts the acquisition of farmland by non-residents, and even by certain Canadian-owned entities, to 10 acres. A Canadian pension fund and Canadian corporations whose primary business is not farming or are not 100 per cent owned by Canadians are deemed to be non-Canadian-owned entities under the Saskatchewan rules.
Manitoba also restricts foreign ownership of farmland to 40 acres. Quebec has even more parochially regulated farmland ownership, prohibiting non-Quebec residents from acquiring more than four contiguous hectares (about 10 acres). PEI restricts non-PEI residents from owning more than five acres or 165 feet of shore frontage.
General regulatory regimes
The acquisition of real property can give rise to a pre-acquisition filing with the Canadian Competition Bureau if both the transaction and the parties to the transaction exceed certain asset size or revenue criteria. Generally, a pre-closing filing must be made if:
a the acquired business or assets in Canada have a value or generate gross revenue in Canada in excess of C$88 million (in 2017); and
b the parties to the transaction (and their affiliates) have aggregate assets in Canada (book value); or gross revenues in, from or into Canada in excess of C$400 million.
The initial review period is 30 days, although extensions are common if there are any competitive concerns.
If certain thresholds of book value or gross revenues of either party are exceeded, the Competition Bureau examines various factors to determine whether an acquisition will result in a substantial lessening or prevention of competition in the relevant market. A purchaser or seller may be required to provide prior written notice to the Competition Bureau of a proposed transaction. Real estate has not been historically a sector that has given rise to refusals or divestiture orders.
The direct acquisition of control of a business in Canada by a non-Canadian may require the prior approval of the Minister of Industry under the Investment Canada Act depending on:
a the enterprise value of the business (if the acquirer is not a state-owned enterprise);
b the book value of the business (if the acquirer is considered to be a state-owned enterprise or is not a World Trade Organization (WTO) investor); or
c whether the business is in a sensitive sector (real estate is not a sensitive sector for this purpose).
The current enterprise value threshold is now C$1 billion (dramatically higher as of June 2017 than the previous C$600 million threshold) so only very large-scale transactions would typically be caught. The enterprise value of a business or property in broad terms is the sum of debt assumed and amounts paid.
The book value threshold applicable to acquisitions of Canadian businesses by state-owned enterprises, based on the prior year financial statements of the target Canadian business, is C$379 million for 2017 (and C$5 million for non-WTO investors).
Whether real estate assets constitute a ‘business’ is a question of fact and will largely depend on whether employees are acquired along with the real estate. A hotel is typically a ‘business’ whereas an office tower may not be a ‘business’ if all services are outsourced and no employees are acquired.
If the transaction results in the acquisition of control of a Canadian business by a non-Canadian but does not require prior approval (i.e., the value of the assets is below the applicable threshold), a notice of investment must be filed within 30 days after closing.
All acquisitions of a Canadian business by a non-Canadian can be subject to review on national security grounds at the discretion of the federal government regardless of the value of the acquisition.
Property prices in Canada continue to climb, so we are expecting Canadian pension plans to continue to lighten their Canadian real estate allocation to foreign buyers prepared to pay exceptional premiums in the context of a lower Canadian dollar. The absence of US REITs in this mix has been notable. We also expect to see weaker-performing REITs consolidated by their more strongly performing competitors. However, the whole Canadian real estate sector has had a spectacular decade, driven in part by historically low interest rates. Whether the ability to refinance mortgages at historically low rates will continue indefinitely, and whether yield-hungry investors will go elsewhere if Canadian rates rise on the back of a stronger US economy, remains to be seen.
1 Chris Murray and Jack Silverson are partners at Osler, Hoskin & Harcourt LLP.
2 OMERS/Oxford; Teachers/Cadillac Fairview; Caisse de dépôt/Cambridge.
3 Boston Consulting Group, ‘Measuring the Impact of Canadian Pension Funds’, October 2015, www.bcg.com/en-ca.
4 CIBC 2016 Real Estate Year in Review.
5 Examples are Orlando Corp (the Fidari family), Tridel Corporation (condominium developer), Great Gulf Homes (residential and condominium) and Triple Five Group owned by the Ghermezians (West Edmonton Mall and the Mall of America).
6 BCE Inc v. 1976 Debentureholders  3SCR 560, 2008 SCC 69.
7 Multilateral Instrument 61-101 – Protection of Minority Security Holders in Special Transactions, Ontario Securities Commission.
8 Such as developing property for resale, or investing in a hotel, assisted living facility or any rental property where the level of service goes beyond that typically associated with a rental property (for instance, the cleaning of individual suites).