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Pension plans must be wary of investing in ‘bubble’ real estate markets: expert

Real estate can be a wise investment for pension funds -- if the right market is chosen.
Real estate can be a wise investment for pension funds -- if the right market is chosen.

Recent data from Statistics Canada shows employer-sponsored pension plans have $150 billion invested in Canada’s real estate market.

But as warning bells continue to ring that Canada’s hot housing markets – namely Vancouver and Toronto – are ripe for a correction, are the pension plans putting their eggs in the wrong basket?

READ MORE: What a real estate crash could mean for Canadians

“Real estate offers diversification away from stocks and bonds,” said Andrey Pavlov, professor of finance at Simon Fraser University. “Overall, I’m in favour.”

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However, he said he’d be “nervous” about investing in overvalued markets. In addition, Pavlov said there is risk of double damage if workers own homes in a “bubble market” in which their fund is also investing.

“The situation that is bad is if most of your plan members are homeowners…and you invest in the same market, then you’re doubling down on the situation that can hurt in two different ways.”

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It’s not impossible for this to happen but it is unlikely.

The pension funds usually start with about a five per cent investment, said Pavlov; that number could increase after a year if it’s doing well.

“Outside of Toronto and Vancouver, I think the rest of Canada is fine for real estate investments. So it depends what they have chosen.”

WATCH: Real estate in Canada 

In the first quarter of 2016, 34.5 per cent of pension assets sat in bonds, 27.8 per cent in stocks, and 9.2 per cent in real estate. That’s up from 8.8 per cent a year earlier.

“The value of pension funds held in stocks fell 3.1 per cent in the first quarter, and that of bond holdings decreased 2.2 per cent,” the Stats Canada report states.

“Conversely, the value of investments in real estate rose 3.4 per cent, continuing a four-year upward trend.”

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The year-over-year increase in real estate assets, from the first quarter of 2015 to 2016, works out to just shy of $5 billion.

More than six million Canadians are members of employer-sponsored pension plans, Stats Canada states. In all, the funds are worth $1.6 trillion.

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Putting additional pressure on pension plans are Bank of Canada warnings that low interest rates are here to stay.

“I have heard from many Canadians who are rightly worried about their ability to live off their savings and who are seeking a return to higher interest rates,” Bank of Canada Governor Stephen Poloz said Tuesday.

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Canadians seeing smaller returns on their investments isn’t likely to change soon, Poloz said, and should consider adjusting their retirement plans.

READ MORE: Vancouver, Toronto markets push home prices up 11.4% across Canada

There is federal oversight for employer sponsored pension plans in Canada; the Office of the Superintendent of Financial Institutions (OSFI) supervises the plans, which are required to follow applicable tax and pension laws.

However, while OSFI keeps watch, Ottawa is not on the hook should funds be lost.

“OSFI supervises federally regulated private pension plans and intervenes in a timely manner to protect members and beneficiaries of pension plans from loss,” the OSFI website states.

“While recognizing that plan administrators are ultimately responsible and that funding difficulties can result in a loss of benefits.”

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The day-to-day management of the plans is carried out by the pension plan administrator; if a member has concerns, they should contact the plan administrator and copy the OSFI on all correspondence.

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READ MORE: Canada Pension Plan Changes will hurt economy in short term: officials

For pension funds a diverse investment portfolio is the safest bet, along with solid risk management.

“We’re not very good at predicting returns,” Pavlov mused.

While he agrees big risks can sometimes bring big gains, he said pension plans don’t need to “push their luck.”

“Risk-reward relationship works only if you’re a prudent and rational investor. It does not work if you’re doing reckless things,” said Pavlov.

With a file from the Canadian Press