The Real Estate M&A and Private Equity Review: Canada
Overview of the market
i The Canadian landscape
Despite a slower start to 2019, where first quarter overall investment in the Canadian real estate market fell 20 per cent from the first quarter of 2018, the decade-long trend in producing superior total returns continues to be present.2 Since the global economic market crash of 2008 and 2009, Canadian real estate has experienced fairly significant price increases. This is in part attributable to Canada's continued low interest-rate environment, as well as the capitalisation rate compression seen across all real estate classes and most urban geographies including Toronto, Vancouver and, more recently, Montreal.
Overall in 2019, Canadian commercial real estate saw record volumes for transactions over C$40 million, coming in at C$21.3 billion, fuelled by continued low capitalisation rates resulting in part from the compression of industrial and multi-residential capitalisation rates in recent years. The multifamily sub-sector captured the largest transaction volume in 2019, with 42 per cent of the total volume traded.3 2019 showed signs of strength for the industrial sub-sector, with transaction activity forming the highest proportion of total volume since 2010, representing 14 per cent of total volume and exhibiting overall strong performance with average total returns of 32 per cent, the highest sub-sector among listed Canadian real estate investment trusts (REITS) and real estate operating companies (REOCs) (weighted).4 This showed a notable increase in transaction volume for this sub-sector compared to 2018, when the industrial sector experienced limited transaction volume at C$1.7 billion as a result of supply constraints.5 With the exception of Ventas REIT's acquisition of an 85 per cent non-managing interest in Le Group Maurice's Quebec portfolio for C$2.4 billion, the senior housing space was fairly quiet in 2019. The continuation of notable lows in office space vacancy rates seen nationally (10.4 per cent in the first quarter of 2020), and, more specifically, in Toronto (6.2 per cent at the end of March 2020), Vancouver (3.9 per cent in the first quarter of 2020) and Montreal (9.3 per cent at the end of March 2020),6 continued to stimulate the development of office towers in these cities in 2019 and into 2020. Downtown fundamentals of most markets remained strong in the first quarter of 2020 with Toronto and Vancouver having the lowest downtown vacancy rates in North America; the impact of covid-19 only started to take hold on leasing velocity at the end of the quarter. Taken altogether, these conditions provided a stable environment for both lease and sale transactions in all areas of the real estate sector in 2019, as evidenced by Starlight Investments' acquisition of a portfolio from Continuum Residential REIT for C$1.7 billion; the acquisition by Summit Industrial Income REIT of a portfolio consisting of 37 properties from Pure Industrial Real Estate Trust (PIRET) and Blackstone Property Partners (Blackstone) for C$588 million;7 the acquisition by Blackstone and Hudson Pacific of the Bentall Centre in Vancouver for C$1.07 billion, marking the largest office deal of the year; and acquisitions by Minto Apartment REIT (directly and with some partners) of over C$687 million of multi-residential rental properties including the acquisition of the Rockhill, Le 4300 and Haddon Hall properties in Montreal, and the Leslie York Mills and High Park Village complexes in Toronto.
The low value of the Canadian dollar and Canada's reputation as a stable nation and attractive place to live have, in recent years, attracted significant foreign investment in Canadian real estate and put increased pressure on the demand for new housing due to the significant pace of the population growth of Canada's major metropolises such as Toronto. In fact, the addition of over 77,000 persons into Toronto for the 12 months ending July 2018 made it, in absolute numbers, the fastest-growing city in all of North America and the second-fastest growing urban region.8 This heightened demand for Canadian real estate has had a significant impact on residential properties in particular. The effect of foreign investment on the residential real estate market was most significantly experienced in Toronto and Vancouver, where residential real estate prices were accelerating at an unsustainable pace from 2015 through to 2017. It was only after the provincial governments of both cities intervened, by way of imposing a foreign buyers tax (and in Vancouver's case, a vacancy tax) and expanded rent-control rules, that a slight cooling of the markets, in the form of reduced sale volume and a tempering in the cost of a single family home, was seen. Perhaps unsurprisingly, following the implementation of those government interventions in Toronto and Vancouver, foreign investment in Montreal's real estate market surged 183 per cent in 2018 over the previous year.9 To date, foreign ownership of real estate has not been an issue in Alberta, Saskatchewan or Newfoundland. In fact, following the oil price downturn seen in 2015 to 2017, property valuations in the three provinces declined. While there was some recovery of oil prices in 2018, prompting increased deal activity and a stabilisation of property prices, the occupancy levels observed across real estate sectors in these three provinces remain lower than those seen in the rest of Canada, a trend that continued throughout 2019.
Actual sale activity for residential real estate for 2019 increased approximately 1.2 per cent in 2019, with rising interest rates and the B-20 mortgage stress test offsetting the otherwise severe impact of continuing population growth. Year-over-year sales activity for 2019 increased in New Brunswick, Quebec and Ontario by 3.2, 2.2 and 1.4 per cent respectively. On the other hand, the year-over-year sales rates of Newfoundland, British Columbia and Nova Scotia declined by 7.1, 5.2 and 4.3 per cent, respectively.10 Prior to the onset of the global covid-19 pandemic, house prices in Canada were expected to continue to rise. Specifically in 2020, national average prices were expected to increase by 6.2 per cent to C$531,000. However, as of April 2020, as countries around the globe, including Canada, issued lockdowns and other critical emergency orders in an effort to address covid-19, record lows have been recorded for Canadian home sales and listings, with national home sales falling over 56.8 per cent on a month-over-month basis in April.11 Covid-19's impact on the Canadian real estate market will certainly include short-term disruptions in the housing market. These effects are most likely to be felt in oil-producing regions such as Saskatchewan and Alberta, but areas across the country are also expected to see an impact. The Canada Mortgage and Housing Corporation is forecasting that it will take until mid-2021 or 2022 for housing prices in Canada to recover to pre-pandemic levels, and the longer term impacts on all sectors of real estate in Canada remains to be seen and is one aspect of the economic fallouts from the covid-19 pandemic that are being watched carefully by analysts and market participants.
Real estate investors in Canadian real estate can be broadly categorised as being one of three types:
- institutional investors, consisting primarily of Canadian pension plans and life insurers;
- public real estate entities, most significantly in the form of REITS with a smaller number of listed real estate operating corporations; and
- private entities, such as family-owned businesses that develop or manage their own properties of varying scale, and, increasingly, large-scale Canadian and foreign private equity investors or other institutional capital funds.
Those Canadian pension plans that invest in real estate typically comprise:
- large, recognisable public pensions, which make direct investments in both domestic and global real estate;
- smaller public plans that rely on funds and external managers for their investments; and
- private corporate pensions that partake in both direct and indirect investing.
Over the past three decades, Canadian pension plans have commenced, and subsequently increased, their investments in real estate, driven in part by low interest rates, changing demographics and longer life expectancy.12 As of October 2017, the top 24 Canadian pension funds owned C$188 billion in real estate, which amounted to an allocation of 13 per cent of their C$1.5 trillion assets in the real estate sector.13 The real estate allocation targets of Canadian pension funds was projected to increase anywhere from 1 to 3 per cent from 2017 to 2022,14 fuelling speculation that the trend towards continued investment by these pension plans in real estate, including Canadian real estate, will continue at a steady pace.
These large Canadian pension funds have assets across all real estate classes, with prominent investment historically focused on Class A office space, premier urban shopping centres and office tower retail spaces in the major metropolitan areas of Canada, with some indirect engagement in development activities. A number of the large public pension plans that invest on behalf of various public sector employees significantly increased their allocation to real estate by privatising several of Canada's largest real estate companies in 2000 and 2001.15 While these investments have become increasingly global in scope, the Canadian pension plans have continued to demonstrate a heavy inclination to invest in Canadian real estate. This may be in part due to the ability of pension plans to generally hold Canadian assets on a basis free from Canadian income tax under specific tax exemptions for Canadian registered pension plans or the favourable market conditions for promising returns in the Canadian real estate space.
Public real estate companies and REITs
Public real estate entities in Canada commonly exist in the form of a REIT. A REIT is a trust that, upon meeting the criteria outlined in Canada's Income Tax Act (ITA), acts as a flow-through vehicle for Canadian income tax purposes. The first Canadian public REITs emerged in the 1990s as a solution to the collapse of Canada's real estate market. In 1996, there were five publicly traded REITs on the Toronto Stock Exchange (TSX). As of 31 December 2019, there were 43 TSX-listed REITs with a total market capitalisation in excess of C$116 billion.16 Six of these REITs alone exceeded a C$5.0 billion market capitalisation as of 31 December 2019. While the Canadian REIT market remains small in comparison to its comparator market in the US, it is a continually evolving sector of the Canadian real estate landscape. In 2018, from January through to September, the S&P/TSX Capped REIT Index recorded a total return of approximately 13 per cent;17 however, amid interest rate concerns, corrections in global equities and a sharp decline in prices, the S&P/TSX Capped REIT Index fell to a total return of 6 per cent through the last quarter of 2018. For 2019, however, the S&P/TSX Capped REIT Index delivered an approximate 23 per cent total return in 2019, in line with the S&P/TSX Composite Index's approximate 23 per cent total return. There was very limited real estate IPO activity between 2017 and 2019; however, in that same period, equity and debt offerings made by existing REITs continued to increase. For example, 2018 saw approximately C$4.8 billion in equity offerings made by existing REITs, which was more than had been seen in the four years prior,18 and 2019 produced a record-breaking year for the Canadian REIT market from an equity issuance perspective, with C$7.5 billion in equity raised in total (a significant increase in the total seen in 2018).19
The majority of Canadian REITs are the product of smaller IPOs (typically under C$300 million) as compared to their US counterparts. Interestingly, this has had the effect of attracting a number of US-based cross-border REITs to the Canadian capital markets. Canadian REITs own a full range of asset classes, such as office, retail, industrial and multi-residential. However, among the office investments, relatively few REITs own Class A office towers (which, as discussed above, are typically held by large institutional investors). REIT activity in the retail class is largely concentrated within regional and local shopping centres. Recently, investment in multi-use developments has increased among the greater capitalised REITs.
The management of a REIT can be internally conducted through a trust's own executives and employees, or externally conducted, by way of a manager under contract. A number of Canadian REITs are externally managed and do not have their own employees. In these situations, the terms of the management agreement between a REIT and an external manager can be an important consideration in structuring an M&A transaction. Any acquirer of a REIT will have to be prepared to either assume those functions (if the management agreement is to be terminated) or make arrangements with the manager to continue in some capacity after a transaction closes. The Canadian real estate market tends to favour internalised arrangements, while sponsors typically prefer the fees flowing to them from an external management arrangement.
Whereas REITs make up a significant portion of public real estate entities, there are comparatively fewer public real estate companies in Canada. This is in part attributable to the fact that public real estate corporations, in order to compete with REITS in terms of cost of capital, require large-scale and sufficient tax attributes to defer taxes over an extended period of time. Consequently, real estate corporations tend to partake more actively in the development of real estate, particularly in the residential class.
Family-based private investors in real estate have significant industrial, retail and multi-residential holdings, but tend not to hold Class A offices or premium retail properties.
Canadian private equity funds (other than pension plans or life insurers) that partake in real estate investing tend to focus their investments solely on real estate, and generally do not invest across all economic sectors. Moreover, the equity raised by these private equity funds tends to be in the hundreds of millions, as opposed to the billions seen with public pension plans.
Large-scale Canadian private equity investors in real estate still remain fewer in number and tend to manage funds that have a significant pension plan backing. For example, in 2019 RBC Global Asset Management announced a partnership with pension fund manager British Columbia Investment Management Corp (BCI) and real estate developer QuadReal Property Group. The partnership has a portfolio of over 40 assets worth over C$7 billion. Historically, these pension-backed private equity investors invested in real estate that requires active management or repositioning, or that are in the office asset class (although it continues to be rare for them to hold Class A offices) or in the commercial asset class. However, the increased development of condominiums seen across Canada in the past decade has largely been driven by private equity capital and pension funds. In recent years, the Canadian real estate market has also seen an increased level of activity from foreign-based private equity investors as evidenced by Blackstone's privatisation of Dream Global REIT in 2019 for an implied value of C$6.2 billion, becoming the largest-ever Canadian REIT M&A transaction, and Deka Immobilien (Germany)'s acquisition of the Stantec Tower (office space) in Edmonton for C$518 million.
Recent market activity
Activity in the real estate market driven by REITs, private equity firms and foreign investors has continued to be a characteristic of the Canadian market for the past few years. Total transaction volume (for assets over C$40 million) remained strong in 2018 at C$16.3 billion (although showing a departure from the C$18.4 billion seen in 2017) 20 and flourished to record-breaking levels in 2019 at C$21.3 billion. Leading with the most activity for public real estate M&A transactions in 2019 were the office and multifamily sectors, with annual transaction values of C$5.8 billion and C$3.4 billion, respectively. 21 Transaction activity by public issuers accounted for C$7.5 billion in 2019 (an increase from C$3.6 billion-worth of transaction volume in 2018). However, 2019's purchasing activity was still dominated by private equity purchasers, which comprised approximately 49 per cent of the total acquisition volume for the year (or C$10.4 billion).22 In 2019, the S&P/TSX Capped REIT Index delivered a 23 per cent total return over the year,23 which fell in line with the S&P/TSX Composite Index's total return of 23 per cent, but was slightly below the S&P 500 Index and MSCI US REIT, which returned 31 per cent and 26 per cent, respectively.24 The industrial sector was the strongest-performing sub-sector in 2019, delivering an approximate 32 per cent average total return, followed by the office and hotels sectors, each with an average total return of about 26 per cent.25
In the past five years, Canadian real estate entities have increased their focus on real estate development opportunities, as opposed to solely being engaged on acquisitions of existing properties. In 2018 and 2019, several large public REITs and pension funds, indirectly through their corporate real estate arms, began or completed the building of office towers or mixed-use projects throughout the downtown Toronto core. Cadillac Fairview, which is controlled by the Ontario Teachers' Pension Plan, began construction of its expected C$1 billion downtown Toronto office tower in 2019. Allied Properties REIT and RioCan REIT continued to proceed with full development of The Well, a mixed-use residential, commercial and retail development located in Toronto. In the autumn of 2019, RioCan REIT also completed its acquisition of the remaining 50 per cent interest in ePlace™, a mixed-use development in midtown Toronto, for C$114.1 million, representing another step forward in RioCan's transformation to a major market, mixed-use focused REIT.
Beyond the development of real estate, real estate entities continue to engage in meaningful acquisitions. In addition to the acquisitions by Starlight Investments, Summit Industrial and Minto Apartment REIT noted previously, other examples include Cadillac Fairview's acquisition of the East Harbour Lands in Toronto for C$690 million, KingSett Capital's acquisition of Dream Industrial REIT's eastern Canada portfolio for C$271 million, the sale of the HOOPP Montreal Portfolio for C$200 million, which was widely marketed and ultimately sold to PIRET/Blackstone, the acquisition by RioCan REIT of KingSett Capital's remaining 50 per cent interest in Yonge Sheppard Centre in Toronto for C$358 million, and Realstar Group's purchase of the Taunton Apartments in Toronto for C$164 million. The acquisition of real estate by pension plans and real estate companies is not, however, limited to within Canada's border. An increasing number of Canadian real estate entities are pursuing global opportunities in real estate. In January 2018, the joint venture between CPPIB, Singapore's GIC sovereign wealth fund, and student housing operator, The Scion Group, acquired a student housing portfolio comprising 24 assets across 20 university campus markets in the US. In May 2019, Invesque REIT announced it had entered into an acquisition to obtain a portfolio of 20 senior housing properties located in Virginia from Commonwealth Senior Living for C$340 million.
Foreign investment into Canadian real estate is not new. However, Asian-based, and in particular Chinese, investment into Canadian real estate surged from 2010 until 2017, when it began to experience a cooling off in response to, among other things, increased taxation. In 2018, increased regulation and taxation saw Asian investment in Vancouver fall from the C$1 billion-plus seen in 2016 and 2017 to around C$350 million. In contrast, Toronto, which lacked the regulations Vancouver had put in place, took in C$526 million in Asian investment in 2018, up slightly from 2017.26 The manner in which the current political climate involving Chinese and Canadian relations may impact on any foreign Asian-based investment in real estate has yet to be seen. An increased presence of US investors in Canadian real estate continued in 2018 with the C$3.8 billion acquisition of PIRET, a Canadian REIT, by Blackstone, one of the largest real estate private equity firms in the world based out of the US, the details of which are discussed further below, and the acquisition of Milestone Apartments REIT, a Canadian REIT with US assets, for C$1.7 billion by Starwood Capital, a US investment firm. In the first six months of 2019, foreign investment in the Canadian commercial real estate market was down approximately 70 per cent with transactions totalling C$1.5 billion, in contrast to the C$5 billion in 2018. However, the investment by US-based Ventas Inc of C$2.4 billion in senior housing in Quebec, the acquisition of Pure Multi-Family REIT LP, another Canadian REIT with US assets, by Cortland Partners LLC for about C$1.6 billion, the details of which are discussed further below, and the previously mentioned acquisition of Dream Global REIT by Blackstone for an implied value of C$6.2 billion (C$5.8 billion excluding the management agreement fee) in the second half of 2019 increased the amount of foreign investment total significantly in 2019.27
i M&A transactions
Canada's REIT market remains robust, with over 40 publicly traded REITs with an aggregate market capitalisation in excess of C$60 billion fuelling a significant portion of M&A activity in the Canadian real estate space. 2019 saw similar activity levels to 2018 in the real estate M&A market, with six transactions together totalling C$10.2 billion (as compared to three transactions totalling C$10.3 billion in 2018).28
As referred to above, early in 2018, an affiliate of Blackstone, together with Ivanhoé Cambridge as its acquisition consortium, acquired PIRET in an all-cash transaction. The transaction saw Blackstone acquire all outstanding units of PIRET for C$8.10 per unit, a 21 per cent premium over PIRET's 20-day volume-weighted average trading price (vwap). The total value of the transaction was C$3.6 billion and it had a capitalisation rate of 4.9 per cent. Also early in 2018, Choice Properties REIT (Choice) launched the acquisition, by way of a plan of arrangement, of Canadian Real Estate Investment Trust (CREIT) in a cash and stock transaction comprised of approximately C$1.65 billion in cash and the issuance of approximately 183 million units of Choice, representing a 21 per cent premium over CREIT's 20-day vwap, and implied a total value of C$6.0 billion and a cap rate of 5.5 per cent. The successful completion of the acquisition saw the enterprise value of Choice reach approximately C$16 billion. REIT-to-REIT mergers like this are relatively rare in the Canadian REIT market. In the autumn of 2018, Agellan Commercial Real Estate Investment Trust (Agellan) entered into an arrangement agreement with Elad Genesis Limited Partnership (El-Ad), an affiliate of El-Ad Group Ltd. The all-cash transaction saw El-Ad acquire all of Agellan's units for C$14.25 per unit, thus valuing Agellan at C$676 million. The transaction represented a 10 per cent premium over the 20-day vwap and a capitalisation rate of 7.4 per cent.
The real estate M&A market in 2019 started strong, with NWH Australia AssetCo Pty Ltd, as trustee for a controlled entity of NorthWest Healthcare Properties Real Estate Investment Trust, announcing the completion of an arrangement agreement to acquire 11 freehold hospital property assets from ASX-listed Healthscope Limited and its affiliates for approximately C$1.2 billion as part of a sale and leaseback transaction. In June 2019, Tricon Capital Group Inc (Tricon) closed an all-share transaction, with an implied total value of U.S.$1.4 billion, whereby Tricon acquired Starlight US Multi-Family (No. 5) Core Fund (Starlight US). The implied value per Class A unit and Class U unit of Starlight US represented premiums of 26.4 and 33.4 per cent respectively, to the 20-day vwap.
In the second half of the year, as referred to above, Cortland Partners, LLC launched a privatisation bid for Pure Multi-Family REIT LP in an all-cash transaction at a price of US$7.61 per unit for a total value of US$1.2 billion, representing an approximate 14 per cent premium over the 20-day vwap and a cap rate of 5 per cent. 2019 also witnessed the acquisition of Holloway Lodging Corporation by Clarke Inc at a value of C$265 million, Partners Real Estate Investment Trust by McCowan & Associates at a value of C$102 million and Temple Hotels Inc by Morguard Corporation at a value of C$514 million.
As discussed already, the year 2019 was capped with the completion of the privatisation of Dream Global REIT by Blackstone, the largest-ever REIT M&A deal in Canada, in an all-cash transaction for consideration of C$16.79 per unit and an implied total value of C$6.2 billion, representing an approximate 17 per cent premium over the 20-day vwap and a cap rate of 6.8 per cent.
2019 also saw ongoing disposition activity. In February, RioCan REIT disposed of a retail shopping centre in suburban Victoria, BC, which was purchased by Crestpoint Real Estate Investments and Anthem Properties in a deal worth C$110 million. A few months later, in May 2019, H&R REIT announced it had entered into an agreement to sell The Atrium, a 1.1 million square feet office and retail complex occupying a full city block in one of downtown Toronto's busiest intersections, for C$640 million. This represented a C$40 million gain relative to its fair value (as calculated using IFRS 13 standards). Also in May 2019, Plaza Retail REIT announced it had completed the sale of eight properties, totalling 19,309 square feet and located in Winnipeg, London, Ottawa and Halifax, for C$9.9 million. In September 2019, Choice Properties REIT completed its disposition of a 30 property portfolio, consisting of 27 standalone retail properties and three distribution centres with an average lease term of 12 years with Loblaw Companies Limited for an aggregate sale price of approximately C$426 million to an affiliate of Oak Street Real Estate Capital LLC.
ii Capital markets activity – public offerings
The Canadian REIT IPO market was relatively tame in 2018 and 2019. However, there were a few new REITs introduced to the space through initial listings on the TSX during this time.
Minto Apartment REIT completed its initial public offering (IPO) in July 2018 raising gross proceeds of C$230 million (including the full exercise of the underwriters' over-allotment option), comprised of an issuance of 15.863 million trust units at a price of C$14.50 per unit. In connection with the offering, Minto Apartment REIT indirectly acquired a portfolio of 22 high-quality income-producing multi-residential rental properties in Canada, with 4,279 suites, from Minto Properties Inc, one of The Minto Group of companies. The net proceeds of the offering were used by the REIT to fund the indirect acquisition of the properties and reduce Minto Properties' retained interest. Following completion of the offering (including the exercise of the over-allotment), Minto Properties Inc indirectly held a retained interest of approximately 56 per cent of the REIT.
BSR REIT, a Canadian REIT with US assets, completed its IPO in May 2018, issuing an aggregate of 13.5 million trust units at a price of C$10 per unit, raising gross proceeds of C$135 million. In connection with the offering, the REIT indirectly acquired a 48 property portfolio held indirectly by BSR Trust, LLC. The portfolio consisted of multifamily residential properties located across five bordering states in the Sun Belt region of the US. The net proceeds of the offering were used by the REIT to repay approximately C$122.3 million of indebtedness owing by BSR.
In March of 2019, NexPoint Hospitality Trust announced it had completed its IPO of 917,700 trust units at a price of C$5 per unit. The offering raised gross proceeds of C$4,588,500. NexPoint was created to acquire an initial portfolio of 11 hospitality assets located in the US and to raise capital to acquire hospitality assets in the US.
In October 2019, Continuum REIT announced their intention to conduct an IPO, planning to offer 18.65 million units at between C$15.50 and C$16.50, with the goal of raising upwards of C$300 million. However, after receiving an offer of C$1.7 billion from Starlight Investments, Continuum REIT accepted the takeover offer and withdrew their IPO.
The start of 2020, prior to the market crash resulting from the covid-19 pandemic emergency orders, also gave witness to the completion by Subversive Real Estate Acquisition REIT LP, a limited partnership and a cannabis-focused special purpose acquisition corporation, of its IPO on the NEO exchange, which raised US$2 billion.
Despite limited IPO activity in 2019, there was a record-breaking amount of public offering activity for existing publicly traded REITs with an all-time high total equity issuance amount of C$7.5 billion. This included two of the largest Canadian real estate equity issuances ever, with First Capital Realty raising C$453 million in February (as a secondary offering) and CAP REIT raising C$489 million in November (used for acquisitions and to repay debt). Some other notable-sized deals included the equity offering by SmartCentres REIT in January of 7.36 million voting units at a price of C$31.25 per unit for gross proceeds of C$230 million (used to repay debt and fund development programmes), the equity offering by Granite REIT in April of 3.749 million units at a price of C$61.50 per unit, for total gross proceeds of approximately C$230 million (used to partially fund the potential acquisition of two properties, one industrial income-producing property in Ohio and one development property in Calgary, Alberta, as well as to fund development costs associated with future build-to-suit opportunities on a parcel of land in Indiana), the equity offering by Minto Apartment REIT of 9.85 million at a price of C$22.85 per unit for gross proceeds of C$225 million (used to finance a portion of the purchase price for two high-quality multiresidential properties in Montreal, Quebec), and the equity offering by Allied Properties REIT in November of 5.7 million units at a price of C$52.70 per unit for gross proceeds of C$300 million (used for acquisitions and value-add programmes).
iii Investor activism
As previously noted, most publicly listed real estate entities in Canada exist in the form of a REIT. Most REITs, because they are trusts, do not provide to their unitholders those same rights and remedies as would be typically available to a corporate shareholder. However, the inability of unitholders to access such things as the oppression remedy, dissent rights and rights to call meetings or make proposals have not gone unnoticed. Institutional governance groups have and continue to pressure REITs to adopt more uniform trust declarations with rights comparable to those of a corporate shareholder. In light of this mounting pressure, some REITs are adopting some of those rights; however, a majority of REITs still have not moved to do so.
Canadian corporate law allows shareholders with a 5 per cent stake in a company to call for a special meeting, compared to the 10 per cent required under US law. Furthermore, in Canada, a shareholder can solicit votes from 15 other investors without issuing a proxy circular under what is referred to as the quiet solicitation exemption under the applicable rules. This allows a relatively small shareholder to gather powerful allies behind closed doors. Taken together, these circumstances give activists a more accessible basis from which to launch their campaigns. Canada's friendliness to shareholder activism helps explain why activism within the real estate market has been undergoing a paradigm shift in recent years.
Historically, the REIT market has seen a limited amount of unitholder activism, and it is driven largely by private equity where it has occurred.
With activism continuing its ramping up in the Canadian marketplace in recent years, there continue to be a number of prominent public unitholder activist campaigns launched against REIT management. Activist investor Sandpiper Group, one of the most prominent activist investors in the Canadian real estate space, together with FrontFour Capital Group, owners of approximately 6.2 per cent of the outstanding units of Granite REIT, called for a meeting of unitholders to replace the board in 2017. Ultimately, through activist efforts, the investor activist groups were able to not only to place three representatives on the board of Granite REIT, but also to remove the chair and vice-chair of the board. Following significant public pressure from investors, and in an effort to avoid a costly proxy contest, Agellan reached a settlement agreement with Sandpiper Group and ELAD Canada Inc in 2017, which involved board membership changes and the internalisation of management functions. In 2018, Sandpiper Group was granted a seat on the board of Artis REIT pursuant to a voting support agreement entered into with the REIT.
Following these events, in January 2019, Sandpiper Group announced it had identified five publicly traded Canadian real estate entities it plans to actively pursue. While Sandpiper Group did not announce the names, or even identify the type of real estate entities it intends to pursue, it did make clear it was prepared to bridge the value gap created by underperforming REITs and further highlighted the expected level of activist activity REITs may face in the coming year. It followed up on this announcement by negotiating to have two of its nominees, including Sandpiper's CEO, appointed to the board of Extendicare Inc. It is also worth noting that in February 2020, Sandpiper Group acquired a 10 per cent position in Dream Office REIT, citing its belief that the units of Dream Office are undervalued and represent an attractive investment opportunity.
Another form of activism that has been utilised in Canada involved institutional investors joining forces to demand higher prices in takeover bid transactions. This is what transpired when unitholders of Milestone Apartments REIT demanded an increased premium from Starwood Capital Group in the context of the takeover bid launched by Starwood, and was eventually given an attractive 16 per cent premium over market. In 2019, a proposal by the executive chair of Hudson's Bay Company (which owns Saks Fifth Avenue and other department stores) to take the company private came under heavy criticism by activist investors (including Land & Buildings Investment Management) who believed that the offer price of C$9.45 per share was inadequate and did not properly recognise the value of the company's significant real estate holdings. Hedge fund Catalyst Capital mounted a public challenge opposing the transaction. Catalyst's tactics involved amassing shares, complaining to the Ontario Securities Commission about the process, and ultimately launching its own bid at C$11 per share. Ultimately, Catalyst's efforts paid off, resulting in a privatisation of the company in March 2020 by a consortium of certain continuing shareholders at C$11 per share.
REITs are vulnerable to activists in part because they are not governed by corporate statutes, but rather by their own declaration of trusts. Consequently, in response to increased shareholder activism in recent years, a large number of REITs have adopted an array of important corporate governance enhancements.29 In the wake of the current coronavirus market uncertainty, REITs need to take particular proactive measures to ensure they are prepared to deal with activist investors that could emerge once the dust settles.
i Legal framework and deal structures
There are numerous methods by which a public Canadian company can be acquired. With respect to M&A transactions in the real estate market, the two most commonly seen are structured either as a plan of arrangement or a takeover bid. An overview of these transaction structures, which are not unique to the public real estate M&A, is provided below.
Plans of arrangement
A statutory plan of arrangement is a voting transaction that can be effected by a Canadian corporation according to the laws of the jurisdiction in which the company was incorporated. A plan of arrangement is unique in that it can permit a buyer to acquire 100 per cent of the shares of a target company without having to require a buyer to make an offer, or enter into a share purchase agreement, with each and every shareholder of the target company. Instead, the purchaser is required to enter into an arrangement agreement with the target company, and when the plan of arrangement is completed, the purchaser acquires all of the outstanding securities of the target company in a single step. As such, it is unsurprising that a plan of arrangement is frequently utilised in friendly, non-hostile acquisitions.
The arrangement agreement is first negotiated with a target company's board of directors. Once the board of directors approves it, the target will apply to a court to begin the process of approving and effecting the arrangement. The initial appearance before a court will be to secure an interim order, which sets the procedural rules for the arrangement, including the manner in which the meeting of securityholders will be called and held, setting out those classes of securityholders that are entitled to vote and the requisite levels required to approve the arrangement. The interim order is usually uncontested.
Once an interim order is provided, the plan of arrangement is presented to the target company's shareholders for their approval. The details of the transaction, including the specific steps contemplated by the plan of arrangement, are set forth for shareholders in an information circular, the content and form of which is governed by applicable securities laws. Although the requisite shareholder approval threshold is determinable by a court under an interim order, acquirers typically propose that they be obliged to 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 transaction were effected outside the arrangement process. In most Canadian jurisdictions, the relevant corporate law statutes set out a threshold of two-thirds of the votes cast at the meeting of the target company's security holders. Convertible securities, such as warrants and convertible debentures, are typically not given the right to vote in a plan of arrangement, unless the rights of these securities holders are being altered by the arrangement in a manner that is unfair or is unreasonable.
If the requisite majority of shareholder approval is obtained, then the arrangement is presented to the court for its final approval. Disaffected stakeholders can, at this time, appear before the court to challenge the arrangement, although practically speaking, the vast majority of arrangements are presented to a court without opposition. The court, in reviewing the plan of arrangement, is guided by considerations of fairness and reasonableness, with respect to the effect of the transaction on shareholders. If the plan of arrangement is approved by the court, it then becomes binding on all shareholders of the target company.
Given that plans of arrangement are voting transactions effecting corporations, the REIT-to-REIT M&A context necessitates the presence of a corporation somewhere in the REIT structure. To date, courts have been accommodating in the flexible use of the plan-of-arrangement structure, even where a transaction is primarily a REIT-to-REIT M&A transaction. Moreover, a unique feature of REIT-to-REIT mergers is that to achieve a tax deferral, if offering REIT units for consideration, the steps outlined in Section 132.2 of the ITA must be adhered to, and within those steps is the requirement for a plan of arrangement.
A takeover bid, the substantive equivalent of a tender offer under US securities laws, is a transaction in which a purchaser makes an offer for the securities of a target company directly to the target company's securities 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.
Each Canadian province and territory has adopted a uniform regime under which takeover bids are regulated. The relevant legislation requires that a takeover bid be made to all registered holders of the class of voting or equity securities being purchased, and that the offer be sent to all registered holders of securities convertible into or exercisable for such voting or equity securities. Additionally, the offeror must make the same purchase offer to each securities holder in the class.
A takeover bid circular, delivered to all requisite securityholders, must contain prescribed information about the offer, the offeror and the target company. Where the consideration offered in exchange for the solicited securities consists, in whole or in part, of the securities of the offeror, the disclosure document must also include prospectus-level disclosure about the offeror. While the uniform regime adopted by the securities regulators in Canada sets out the minimum standards relating to the conduct of the bid, including disclosure requirements, it is generally unnecessary for an offeror to present the contents of its disclosure documents to securities regulators; nor is it likely that the takeover bid circular, unless a complaint is made, will be reviewed by the regulators once filed.
Once a takeover commences, the board of directors of the target company, or the trustees of the target REIT, have a duty to consider the offer and an obligation to make a recommendation to security holders regarding the adequacy of the offer. However, the ultimate determination as to whether to accept or reject a takeover bid is made by the securities holders.
The determination as to whether a triggering event for a takeover bid has occurred is based on objective factors. The most important factors, however, are the percentage of voting or equity securities beneficially owned or controlled by the offeror (and any of its joint actors) and the number of additional securities subject to the takeover bid. The threshold for triggering a takeover bid is 20 per cent of any class of voting or equity securities. When determining whether the threshold for triggering a takeover bid will be met, the number of securities beneficially owned by the offeror is interpreted to include both those securities that the offeror has a right or obligation, through options, warrants or convertible securities, to acquire within 60 days, as well as any securities held by affiliates or joint actors in the takeover bid.
Effective 9 May 2016, changes were made to the Canadian takeover bid regime. Under this new regime, all non-exempt takeover bids (including partial bids) are subject to the following requirements:
- 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 that are beneficially owned, or over which control or direction is exercised by the bidder and its joint actors (the minimum tender requirement);
- following the satisfaction of the minimum tender requirement and the satisfaction or waiver of all other terms and conditions, takeover bids will be extended for at least an additional 10-day period (the 10-day extension requirement); and
- takeover bids must remain open for a minimum of 105 days, unless the target agrees to a lesser period for the bid or another transaction.
These updated provisions, by increasing the amount of time afforded to a target company to respond to a takeover bid, has important implications for strategic shareholder rights plans and will likely continue to influence how M&A activity is structured.
Takeover bids are infrequently utilised for friendly transactions in Canada. Among REIT-to-REIT transactions, they are even rarer. This is because most REIT-to-REIT transactions involve equity considerations, and cannot be tax-deferred consolidation transactions unless they conform to Section 132.2 of the ITA, which requires a transaction to occur by way of a plan of arrangement. As a result, nearly all REIT-to-REIT transactions occur by way of a plan of arrangement. Even the rare M&A deal that starts out being hostile generally ends up becoming a negotiated plan of arrangement transaction, albeit for an increased price.
ii Acquisition agreement terms
The overwhelming majority of real estate transactions and deals take place by way of a plan of arrangement. The significant difference observed in the context of real estate mergers is that the specific mechanics of the plan of arrangement must conform with the directions of Section 132.2 of the ITA to ensure a tax-deferred rollover for a trust unit offered in consideration by an acquirer REIT. Conditions in public real estate mergers are typically similar to any public merger transaction.
One common deal protection, typical to most public merger transactions, is a non-solicitation (no shop) provision. By adopting this provision, a target company not only is obliged to recommend a transaction to its securities holders, but also agrees not to solicit or negotiate other acquisition offers and to pay a break fee if the agreement is terminated in certain circumstances. In accordance with the exercise of its fiduciary duties, however, a board of directors is permitted, despite the existence of a non-solicitation provision, to change its recommendation, engage with a rival bidder that makes an unsolicited acquisition proposal that is likely to result in a superior offering, or enter into an agreement that supports a superior offering. The determination as to what constitutes a superior offering is a matter of negotiation; although it is almost invariably defined according, at least in part, to whether the proposal is more favourable from a financial perspective to securities holders than is the existing transaction. Break fees are permissible in Canada, provided that they permit a reasonable balance between their negative effect as an auction inhibitor and their potential positive effect as an auction stimulator (including if the fee was necessary to induce a bid). Reasonable break fees are typically understood to range from 1 to 5 per cent of deal equity value.
When a target board of directors seeks to defend a company from a takeover bid, a number of defensive tactics are available. The most common is the use of a poison pill or shareholders' rights plan. However, as discussed above, under the new legislation these types of plans will be void after 105 days. Additional defensive tactics include issuances of securities to dilute the bidder or potential bidder (often by placing the securities in friendly hands), a sale of assets, recapitalisations, the acquisition of a white knight and asset lock-ups.
iii Financing considerations
Considerations and conditions in public real estate transactions are typically similar to other public merger transactions. One distinct difference often found in real estate transactions, which would not be found in non-real estate transactions, is the potential presence of a condition addressing the necessary percentage level of mortgagee consents to the assumption of mortgages.
To finance their real estate merger transactions, private equity acquirers will often draw from the equity commitments of their limited partnerships. Pension funds, on the other hand, often finance the equity portion of their real estate transactions by drawing on their vast reserves of liquid securities and assuming underlying mortgages. For the most part, mortgagers tend to consent to the assumption of their mortgages, particularly where the acquirer is well-regarded as a significant player in the real estate market. Where mortgages have a provision requiring repurchase upon a change of control, which is common, credit lines or fresh mortgage alternatives must be available to the acquirers.
The nature of the Canadian bought deal underwriting structure, in which underwriters agree to purchase all of the offered securities under a prospectus, offers certainty of funding to a public REIT acquirer. As a result, a publicly traded REIT acquirer will often arrange a bought deal financing concurrently with the announcement of their acquisition transactions. Because bought deals can be through a subscription receipt structure, the acquirer's financing becomes contingent on the closing of the corresponding acquisition.
Public REIT-to-REIT merger transactions are typically in the form of unit-for-unit deals, with an assumption of the underlying mortgages of the target REIT. The equity portion of such a transaction can be sourced by way of available liquid funds, or can be financed through a bank facility, which would be subsequently repaid through a public debenture or the issuance of equity.
iv Directors' duties
Canadian corporate statutes impose two duties on directors: a duty of care and a duty of loyalty.
The Canada Business Corporations Act (CBCA) requires every director of a corporation, in exercising his or her powers and discharging his or her duties, to exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. The applicable standard utilised by courts to determine whether a director has satisfied his or her duty of care is both objective and subjective in nature. Objectivity is used to determine how a reasonably prudent person ought to have acted; however, the circumstances surrounding the exercise of a director's duties modify the objectively reasonable person standard to account for the specific facts of a situation, as well as the subjective knowledge and experience of the particular director.
The duty of care imposed upon directors does not rise to the level of perfection. Rather, courts have generally deferred to the business decisions of directors where they have been satisfied that the directors exercised an appropriate degree of prudence and diligence. This deferential approach to directors' decisions has become known as the business judgement rule (BJR). The BJR is a legal presumption that insulates directors from legal liability, so long as they act in an informed, prudent and diligent matter. In instances where the BJR is challenged, the onus is on the claimant to show that a director's decision is fraudulent or illegal, or represented a conflict of interest. Some of the factors courts have considered to determine whether a director's decision should be reviewed are whether:
- an independent committee was used;
- an outside valuation was obtained;
- professional advice was sought;
- the decision was made over a sufficient amount of time;
- alternatives were considered;
- the transaction was negotiated; and
- proper documentation was prepared.
The theme behind these factors is that they reflect the court's tendency to focus on the processes behind, rather than the outcome of, directors' decisions. The courts have maintained that the judiciary should not seek to substitute its judgment for that of a board of directors, unless the circumstances surrounding a decision are so unusual and extreme as to warrant such intervention. Consequently, if a director can demonstrate that his or her business decision was reasonable, in light of all the circumstances about which he or she knew or ought to have known, it is unlikely a court will have found him or her to have breached his or her duty of care. In fact, a director's failure to meet his or her duty of care often arises in situations where the director shows passivity to, and inattention towards, the business' activities.
The statutory duty of loyalty requires directors to 'act honestly, in good faith, and with a view to the best interests of the corporation'. A director's duty of loyalty is owed exclusively to the corporation, as a whole, rather than any individual group of stakeholders. In fact, the Supreme Court of Canada has held that directors, in determining what is in the best interests of a corporation, may look to the interests of, among others, shareholders, employees, creditors, consumers and governments. While this approach encourages directors to consider the effect of their decisions on different groups of stakeholders within a corporation, it continues to remain the case that the interests of equity security holders are given significant weight. Accordingly, the determination of whether an acquisition proposal delivers the best value reasonably available to equity security holders remains a central focus in director deliberations.
Directors cannot contract out of their duties and can be held personally liable for a breach of their duties. Although REITs are trusts, and therefore not governed by the CBCA or its provincial equivalents, it is the case that common law applies a similar, if not higher, standard of care and loyalty to a REIT's trustees than it does to corporate directors. Moreover, REITs, in their trust instruments, have generally adopted similar standards of care and loyalty to those in Canada's corporate legislation. Furthermore, although no definitive decision on the matter has been made, Canadian courts have typically held trustees of public REITs to the standards expected of the directors of public companies.
v Income tax considerations
Carrying on business in Canada
Income taxation in Canada is governed primarily by the ITA, a federal statute, as well as by sales tax, and provincial and territorial tax laws. The ITA imposes an annual income tax on the taxable worldwide income of every person resident in Canada (including corporations). Non-residents of Canada are also subject to income tax under the ITA if they are carrying on business in Canada. The determination as to whether an activity constitutes carrying on a business in Canada is a question of fact, generally determined by the types and the amount of activity carried on in Canada by the non-resident.
As of January 2020, the basic Canadian combined federal and provincial tax rate for income earned by a corporation ranged from 25 per cent (Alberta) and 26.5 per cent (Northwest Territories, Ontario and Quebec) to 31 per cent (Prince Edward Island (PEI) and Nova Scotia).
Disposing of taxable Canadian property
Non-residents of Canada are also subject to tax under the ITA if they dispose of 'taxable Canadian property'. Taxable Canadian property generally includes (1) Canadian real property; (2) shares of corporations that are not listed on a designated stock exchange that derive (or derived at any time in the previous 60 months) more than 50 per cent of their value, directly or indirectly, from Canadian real property; and (3) shares of corporations listed on a designed stock exchange or units of a mutual fund trust (including REITs) if at any time in the previous 60 months a non-resident (together with persons with whom it does not deal at arm's length and partnerships of which the non-resident or a non-arm's length person are a member) owned 25 per cent or more of the issued shares of any class of the corporation or units in the trust and more than 50 per cent of the value of the corporation or the trust was derived from Canadian real property.
Non-business rental income
Under the ITA, certain payments by Canadian residents to non-residents are subject to withholding tax at a rate of 25 per cent (subject to applicable treaty relief). In particular, payments received by a non-resident from renting real property in Canada are subject to 25 per cent withholding tax on the gross rent received. There is no reduction to this rate under Canada's treaties. In certain circumstances, it is possible for a non-resident who is earning income from renting real property in Canada to elect to be taxed as if it were carrying on business in Canada in lieu of being subject to withholding tax. This allows the non-resident to pay tax on net income rather than being subject to withholding tax on the gross rental revenue. Other payments to non-residents that are subject to withholding tax include interest paid to non-arm's length parties, participating interest, interest subject to the 'thin-capitalisation' rules in the ITA, certain administration/management fees, royalties and dividends.
The applicable rate of withholding is often reduced under a treaty. Many treaties reduce the withholding tax rate on dividends to 15 per cent or 5 per cent in situations where a non-resident recipient that is a corporation holds at least 10 per cent of the voting shares of the dividend-paying corporation. Most interest payments payable under a traditional loan held by a non-resident arm's-length lender are exempt from withholding tax under the ITA. However, loans between non-arm's length parties are subject to withholding tax under the ITA. The rate of withholding tax on non-arm's length interest is reduced to 10 per cent or 15 per cent under many of Canada's tax treaties, and withholding tax on non-arm's length interest is eliminated under the Canada–US Tax Treaty. Interest that is subject to Canada's thin-capitalisation rules may also be deemed to be a dividend and subject to withholding tax as described above.
REITs are designed to act as flow-through entities. Generally, a REIT will not be liable for Canadian income tax as long as it distributes its income to its unitholders. Distributions of REIT income to non-residents are subject to withholding tax at a rate of 25 per cent (subject to applicable treaty relief). Distributions by a REIT that are returns of capital may also be subject to withholding tax at a rate of 15 per cent. Generally, the gain realised upon the disposition of REIT units is not subject to Canadian tax so long as the unitholder and non-arm's length persons hold less than 25 per cent of the units of the REIT (see 'Disposing of Taxable Canadian Property', above).
Value added taxes
The federal government imposes a value-added tax, known as the Goods and Services Tax (GST), at a rate of 5 per cent, on goods and services purchased in Canada. GST generally applies to the sale and rental of non-residential real estate. Sales of never-before-occupied residential real property are also subject to GST. Special rules require owners of residential real property held for rent to pay GST on the fair market value of the property when it is first occupied by an individual as a place of residence. Sales of previously occupied residential real property are not subject to GST. If GST is levied on a sale or rental of real estate, the buyer or tenant may be able to recover the GST through input tax credits if the real estate was acquired in connection with a commercial activity (generally, a business) and the buyer is registered for GST.
Several provinces, including Ontario, have harmonised their provincial sales tax with the GST. The combined tax is called the harmonised sales tax (HST). In 2020, the rate of HST in Ontario is 13 per cent (which includes the 5 per cent GST). Generally, the application of HST mirrors that of GST. In those provinces and territories where HST is not applied, provincial sales tax is not applied to the purchase of real estate.
A non-resident of Canada who carries on business in Canada, and who makes taxable supplies in the course of that business, is required to register under Canadian GST legislation and to collect and remit GST. Moreover, if the non-resident does not have a permanent establishment in Canada, it must post security with the Canada Revenue Agency, in respect of its collection and remittance obligations.
Other transfer taxes
Land transfer tax is a form of provincial (and in some cases municipal) tax payable by the purchaser of real property. The purchase of real estate in Ontario is generally subject to land
transfer taxes of various forms. Subject to certain exemptions, land transfer tax in Ontario is payable on every conveyance of land tendered for registration in the provincial land registry systems and every unregistered disposition of a beneficial interest in land. The rate of land transfer tax is determined according to the type of property being transferred and the total value of consideration paid. Generally, the maximum rate of tax is 2 per cent on the value of the consideration in excess of C$400,000. However, in certain circumstances, including transactions involving leases with an unexpired term of 50 years, land transfer tax is payable on the fair market value of the real property, rather than on the total value of the consideration paid. Purchases of land in the city of Toronto are generally subject to an additional land transfer tax. The maximum rate of the Toronto tax is generally also 2 per cent on the value of the consideration in excess of C$400,000. Exemptions from Ontario land transfer tax include, but are not limited to, certain transfers: between spouses, between an individual and his or her family business corporation, between family members whose farmed land is being conveyed, and between affiliated corporations.
Ontario and British Columbia have introduced a foreign buyer land transfer tax. Generally, this surtax is paid by non-Canadian purchasers of Canadian residential property. British Columbia's 20 per cent foreign buyer land transfer tax applies to properties purchased in the Metro-Vancouver area, and certain other regions of British Columbia. In Ontario, the 15 per cent non-resident speculation tax applies to certain residential property purchased by non-Canadians in the Greater Golden Horseshoe Area, which includes the City of Toronto and its surrounding areas. British Columbia has also instituted a speculation and vacancy tax that applies to certain owners of residential property in certain regions of British Columbia, including Metro Vancouver. This tax generally applies at an annual rate of 0.5 per cent of the value of the property for Canadians, and 2.0 per cent for non-residents. Vancouver has also instituted an empty homes tax of 1 per cent annually, which was introduced to return empty or under-used properties to the rental market in Vancouver.
In Ontario, municipalities are entitled to levy annual property taxes under the Municipality Act. In exchange for these taxes, municipal governments provide many city-based services. The calculation of municipal tax is dependent on the value of the property compounded by the 'mill rate', which is determined annually and based on the financial needs of the municipality. In the past decade, some municipalities such as Toronto and Montreal have introduced a municipal land transfer surtax. This municipal land transfer tax is paid, by the purchaser of real property, in addition to provincial land transfer taxes.
Investment in real estate in Canada (whether directly or indirectly, by a Canadian resident or non-resident) will have significant tax implications that vary depending on the individual or specific circumstances relevant to the particular situation. Investors (and real estate entities) are advised to seek independent tax advice in connection with any potential investments or dispositions.
vi Regulatory considerations
Property ownership falls under provincial, rather than federal, jurisdiction in Canada. Newfoundland, Nova Scotia and New Brunswick are the only remaining provinces in which there are no restrictions on foreign ownership of land.
Manitoba, Saskatchewan, Alberta and Quebec have legislation restricting foreign ownership of parcels of farm land. Manitoba restricts foreign ownership of farmland to 40 acres. Saskatchewan restricts the purchase of farmland by non-residents to 10 acres. Alberta legislation caps foreign ownership of agricultural land at two parcels containing 20 acres: however, the legislation does not apply to certain commercial uses of land. Quebec's legislation, the most restrictive of the bunch, prohibits non-Quebec residents from acquiring more than four adjacent hectares of farmland (roughly 10 acres). PEI restricts non-PEI residents (defined as persons who have not lived in PEI for at least 365 days over 24 months) from purchasing more than five acres of land, or 165 feet of shoreline. In 2016, British Columbia implemented an additional property transfer tax of 15 per cent on Metro Vancouver homes purchased by foreign buyers. When this foreign buyers' tax was initially introduced, however, there were concerns that it was too sweeping, penalising those recruited to Vancouver on work permits. As a result, the tax was amended in 2017. Since then, it has also been raised to 20 per cent. In 2017, Ontario, following in the footsteps of British Columbia, introduced a 15 per cent non-resident speculation tax on residential property purchased in the Greater Golden Horseshoe Area by anyone who is neither a citizen nor permanent resident of Canada.
Under Canada's Competition Act, mergers and acquisitions of all sizes and in all sectors of the economy are subject to review by the Commissioner of Competition. The Competition Act requires companies to notify the Commissioner of Competition, by way of a pre-acquisition filing, if a proposed transaction meets, or exceeds, certain asset size or revenue criteria. Generally, a pre-acquisition filing must be submitted if:
- either the value of the assets to be acquired, or the value of the assets owned by the corporation being acquired, or the annual gross revenue of the business being acquired, exceeds C$96 million (in 2020); and
- the parties to the transaction, together with their affiliates, have either assets in Canada, or annual gross revenues from sales in, from or into Canada, exceeding C$400 million (in 2020).
Upon receipt of the filing, the Commissioner of Competition has 30 days, although extensions are common, to review the filing so as to narrow and refine issues and to determine what, if any, additional information is required from the parties to assess anti-competition concerns. In particular, the Commissioner will consider what additional information is required to determine whether the proposed transaction is likely to lessen or prevent competition substantially. Real estate, historically, has not been a sector in which the Commissioner has given refusals or divestiture orders.
Investment Canada Act
Under Canada's Investment Canada Act (ICA), certain acquisitions by non-Canadians of Canadian businesses are subject to pre-closing review. The application of the ICA is limited to those investments made by non-Canadians that involve an acquisition of control over a Canadian business. Whether a pre-closing filing for a control transaction will need to be submitted to the Minister of Industry will depend on:
- the enterprise value of the Canadian business (if the acquirer is not a state-owned entity);
- the book value of the Canadian business (if the acquirer is a state-owned enterprise, or is not a World Trade Organization (WTO) Member State); and
- whether the business is in a sensitive sector.30
For acquirers who are not a state-owned entity, the financial threshold that triggers the requirement for a pre-closing review under the ICA depends on the nationality of the investor. Nationals of a specified free trade party31 that directly acquire control of a Canadian business are only subject to a pre-closing review under the ICA if the enterprise value32 of the Canadian business exceeds C$1.613 billion (in 2020). Investors who hail from WTO Member States are subject to a pre-closing review under the ICA if the enterprise value of the Canadian business exceeds C$1.075 billion (in 2020).
For acquirers who are state-owned entities, the book value threshold required to trigger a pre-closing review will depend on the nationality of the state-owned entity. State-owned entities from WTO nations are only required to file a pre-closing review under the ITA if the book value of the Canadian business they are acquiring meets or exceeds C$428 million (in 2020). Non-WTO Member States directly purchasing Canadian businesses are required to submit a pre-closing review if the book value of the Canadian business exceeds 5 million dollars. An indirect control transaction by a non-WTO Member State for a Canadian business will require a pre-closing review only if the book value of the business exceeds C$50 million (in 2020).
In those transactions where a non-Canadian investor gains control of a Canadian business that does not meet nor exceed the financial threshold required to trigger the submission of a pre-closing filing, a notice of investment must be filed within 30 days of closing.
The ICA reserves a residual right to review any non-resident acquisition of a Canadian business on nation security grounds. This right of review is unique in that it is not conditional on value or quality thresholds being met. As such, even investments that do not involve high asset values, or an acquisition of control over a business, may be subject to review on national security grounds.
The ICA defines a Canadian business to mean:
- a business carried on in Canada that has a place of business in Canada;
- an individual, or individuals, in Canada who are employed, or self-employed in connection with the business; and
- assets in Canada used in carrying on the business.
Whether Canadian real estate assets can be considered a Canadian business for this purpose is a question of fact, determined primarily by the second criterion – specifically, whether there are individuals employed in connection with the real estate. Consequently, a hotel that has employed staff in Canada to render their services would be considered to be carrying on a business, whereas an office tower that has outsourced all of its services would not.
2019 was marked by a deceleration in the global economy, stemming in part from disruptions to trade and weaknesses in foreign economies. Despite this global deceleration, the Canadian real estate sector had a strong year, with record levels of equity issuances and supply of senior unsecured debt for existing real estate public entities, an active M&A landscape and record transaction volumes in the underlying property markets. One real estate trend that emerged in 2018 and into 2019 was the increased diversification of assets. For example, developers and investors are entering partnerships and joint ventures to reduce risk by making the most of a partner's skills and resources.33 Moreover, it seems that real estate entities are starting to redirect additional development funds to the US, where taxes are lower, regulations are fewer and markets are larger.34
Looking ahead to 2020, both in the immediate future and to the longer-lasting implications, it is impossible to ignore the role that covid-19 will have on the global economy and the domestic real estate market. The pandemic has already caused notable disruptions across virtually every industry, and the Canadian real estate market will not be exempt. Increased global and Canadian unemployment and social distancing measures have at least temporarily caused uncertainty regarding which commercial real estate sectors will be hit hardest, and which sectors could potentially come out on top.
The multifamily sector is likely to remain a leader throughout the remainder of 2020 and beyond. In the fourth quarter of 2019, it was the most active sector, recording investment volumes that totalled C$4.1 billion.35 Notable transactions in this space in 2019 included Starlight's acquisition of Continuum REIT, the acquisitions completed by Minto Apartment REIT and Realstar Group's acquisition of the Taunton Apartments in Toronto as previously mentioned. With extremely low vacancies and the price of rent consistently rising, the multifamily sector remains stable and is likely to continue thriving when a new normal begins to establish itself.
With an increasing demand for online shopping, and following a strong year in 2019 where the industrial sector was the strongest performing sub-sector with average total returns of approximately 32 per cent,36 that sector also stands out as a contender for a relatively strong year going forward. While it is still early in the coronavirus outbreak timeline, the distinction between essential and non-essential goods, and differing rates of consumption between the two, may further impact warehouse and storage spaces. As of the fourth quarter of 2019, the top 10 tightest industrial markets in North America were in Canada, with the top three being Toronto, Victoria, and Waterloo, all with availability rates below 2 per cent.37 The race for space is only likely to continue as e-commerce and giant delivery corporations continue to benefit from increased service use during the pandemic and the limited in-person retail opportunities that come hand in hand.
As mentioned previously, with the exception of Ventas REIT's acquisition of a seniors housing portfolio in Quebec for C$2.4 billion, the senior housing space was relatively quiet in 2019. Reduced deal volume has continued so far in 2020 and, in light of the covid-19 global pandemic, this is generally expected to continue for the remainder of 2020 (particularly in respect of long-term care residences). Nonetheless, in the long term, seniors housing industry professionals are maintaining a positive outlook and expect this sector to account for a growing share of the capital allocated to real estate in the coming years as the demand from the baby boomer cohort continues to takes effect.
The office sector will also be one to watch. After a strong year in 2019, with an average total return of approximately 26 per cent38 and continued low vacancy space in most major cities, this sector was poised to have a strong 2020. However, following government guidelines and restrictions on entering office workspaces as a result of the pandemic, many offices have moved to virtual workplaces. This change may be temporary, but some employers are starting to question mandatory in-office policies, and particularly those in tech spaces. Shopify's CEO, Tobi Lutke, is one such employer. In May 2020, he announced that the company will keep their offices closed until 2021, and that the majority of workers will continue to work remotely indefinitely.39 It is likely too soon to make sweeping claims based on a few actions, especially given the strength of the office sector going into 2020 and the continued leasing of significant space by large companies, as evidenced by Google's February 2020 agreement to a major long-term lease at 65 King Street East in downtown Toronto under which Google will occupy 400,000 square feet of office space across 18 floors in Toronto's newest, next-generation office development. However, a decrease in demand for significant office space by some employers could be a new reality where office-centricity has become less of a priority, and the realisation, in light of covid-19, that such employers can still run their operations effectively out of office. What the new normal looks like following the pandemic and a return to the workplace, including whether physical distancing becomes a general requirement or a new cultural phenomenon, will play a role in how well the old office model withstands this test and what changes are made in the way employers utilise office space in a post-covid environment, and how the office real estate subsector adjusts accordingly.
Uncertainty seems to be an ongoing reality for Canadian markets, and 2020 is no exception to this. While it could be a short period of time before the strong upward trends of late 2019 resume, there is the possibility that covid-19's effects could be more profound, and said trends may not be seen again for some time to come.
1 Brenda Gosselin and Stephen Pincus are partners at Goodmans LLP. They wish to thank Emily Windrim, legal summer student, for her assistance in the preparation of this chapter.
2 Jones Lang LaSalle (JLL) 'Canada Investment Outlook – Q1 2019 Report' (JLL 2019 Report).
3 CIBC 'Canadian Real Estate Investment Banking – 2019 Year in Review' (CIBC 2019 Report).
4 CIBC 2019 Report.
5 CIBC '2018 Canadian Real Estate Year in Review'.
6 CBRE Group Inc 'Q1 2019, Industrial Market Report'.
7 PIRET was acquired and privatised by Blackstone and Ivanhoé Cambridge in 2018.
8 Clayton, Frank and Hong Yun (Eva), Shi. 'WOW! Toronto Was the Second Fastest Growing Metropolitan Area and the Top Growing City in All of the United States and Canada'. (31 May 2019) Ryerson Centre for Urban Research and Land Development.
9 Sharma, Neil. 'Canadian City Sees 183 per cent Surge in Foreign Buyer Investment'. Mortgage Broker News (5 May 2019).
10 Canadian Real Estate Association, 'Quarterly Forecast- Q1 2019' (14 June 2019).
11 Huebl, Steve. 'Record Decline in Home Sales and Listings in April: CREA'. Canadian Mortgage Trends (17 May 2020).
12 JLL, 'Canadian pension funds eye further real estate allocations' (29 January 2018).
13 Marr, Garry. 'Canadian Pension Funds Have Amassed C$188B in Real Estate Assets. And They Are Hungry for More'. Financial Post (5 October 2017).
15 Specific examples include the privatisation of Oxford by OMERS; and Cadillac Fairview by Ontario Teachers' Pension Plan.
17 JLL 2019 Report.
18 Chris Murray and Jack Silverson, The Real Estate M&A and Private Equity Review, Canada chapter, third edition (The Law Reviews, 2018) at 72.
19 CIBC 2019 Report.
20 JLL 2019 Report.
21 CIBC 2019 Report.
22 CIBC 2019 Report.
23 JLL 2019 Report.
24 CIBC 2019 Report.
25 CIBC 2019 Report.
26 Wong, Natalie, et al. 'Chinese Real-Estate Investors Wary of Vancouver Head to Toronto' (12 April 2019) Financial Post.
27 Dream Global Real Estate Investment Trust Announces Closing of Blackstone Acquisition' (10 December 2019) Bloomberg Business.
28 CIBC 2019 Report.
29 Wes Hall et al, '2018 Proxy Season Review: Encountering the Changing Expectations of Investors', Kingsdale Advisors, 2018.
30 Real estate is not a sensitive sector under the Investment Canada Act.
31 The European Union, the United States, Mexico, Chile, Colombia, Honduras, Panama, Peru, South Korea, Japan, Vietnam, Singapore, Australia or New Zealand.
32 The enterprise value of a business is calculated differently.
33 PricewaterhouseCoopers, 'Emerging Trends in Real Estate 2019' (2019).
36 CIBC 2019 Report.
37 2020 Canada Market Outlook, CBRE.
38 CIBC 2019 Report.
39 Cheng, Candy. 'Shopify is joining Twitter in permanent work-from-home shift'. BNN Bloomberg (21 May 2020).