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Canada is stepping out of the shadow of its larger neighbor to the south. Although the Canadian market is a fraction the size of the U.S. market—about 10 percent—the country is increasingly popping up on the radar screen for international investors.

That interest is being fuelled in part by asset diversification strategies and views that Canada is a relatively stable investment market. Although there are some concerns about weakening in the housing market, Canada typically avoids extreme highs and lows in its economic and real estate cycles. In addition, core properties in major cities such as Vancouver, Toronto and Calgary offer similar institutional quality assets and comparable pricing to other major metros such as New York, San Francisco and London.

All of those factors are strong selling points for international investors. Yet Canada is a tough nut to crack with significant barriers to entry. According to JLL, Canada has one of the lowest proportions of foreign investment in commercial real estate in the world. One of the big hurdles for foreign investors is the highly competitive domestic buyer market and a smaller inventory of properties. Canada’s investment sales transaction volume is about 10 percent that of the U.S.

“We have a very strong and very dominant, pension fund-led institutional investment market here,” says Lucy Fletcher, vice president and head of the International Capital Group in Canada for JLL in Vancouver. Canada’s mandatory pension scheme gives Canadian pension funds significant investible capital, and those funds tend to invest in their own market.

“The situation in Canada is that it is an extremely well-funded market,” agrees Amy Erixon, a principal and managing director of investments at Avison Young in Toronto. “So there is a lot of domestic competition for property in Canada, much more so than you have in the United States, and that makes it very difficult for foreign investors.”

In Canada, the 10 largest pension funds own 65 percent of the class-A market, according to Avison Young. Canadian pension funds also tend to have higher allocations to real estate. Western pension funds typically allocate 8 percent to 10 percent to real estate. Canadian pension funds typically allocate 12 percent to 15 percent to real estate and are allowed to have allocations as high as 30 percent.

Despite that stiff competition, Canada is attracting interest from international buyers. “We are definitely seeing increased demand, but whether that is translating into deals is really dependent on the market and the opportunities that they are seeking,” says Fletcher.

For the most part, Toronto and Vancouver have been the biggest recipients of that international interest. Toronto is the largest city in Canada with a population of over 2.6 million. On the West Coast, Vancouver has benefited from its strong trade relationships with Pacific Rim countries such as Japan and China.

To a lesser degree, there also has been some foreign investment in markets such as Calgary and Montreal. For example, the Government of Singapore Investment Corp. partnered with Ivanhoe Cambridge last fall to purchase 1250 Rene Levesque, a 47-story office tower in Montreal.

Competition and limited supply is putting pressure on cap rates, particularly in the high-demand market of Vancouver. Cap rates in this West Coast city are usually about 100 basis points lower than other major metros in Canada. Even those cap rates—4.5 on a trophy office tower—look attractive to Asian investors, who have seen trophy properties in Japan and Hong Kong sell for cap rates of 2.5 to 3 percent. So from a global perspective, the low cap rates in Vancouver are still attractive, notes Erixon.

Certainly on the office side, the pricing for top assets puts Vancouver on par with premier cities such as London and New York. “Some might see that as a little bit unusual given the dynamics of our market and the depth of tenant base in Vancouver,” adds Fletcher. However, she adds, that is a reflection of limited availability, the strengths of the capital markets in Canada and the overall conservative banking and lending environment.

This article was republished with permission from National Real Estate Investor.