Canadian pension funds have been among the world’s most prolific buyers of real estate, starting a revolution that inspired retirement plans around the globe to emulate them. Now the largest of them is taking steps to limit its exposure to the most-beleaguered property type — office buildings.

Canada Pension Plan Investment Board has done three deals at discounted prices, selling its interests in a pair of Vancouver towers, a business park in Southern California and a redevelopment project in Manhattan, with the New York stake offloaded for the eyebrow-raising price of just $1. The worry is those deals may set an example for other major investors seeking a way out of the turmoil too.

“It’s the opposite of a vote of confidence for office,” said John Kim, an analyst tracking real estate companies for BMO Capital Markets. “My question is, who could be next?” 

Anxiety over office buildings has swept the financial world as the persistence of both remote work and higher borrowing costs undercuts the economic fundamentals that made the properties good investments in the first place. A wave of banks from New York to Tokyo recently conceded that loans they made against offices may never be fully repaid, sending their share prices plunging and prompting fears of a broader credit crunch. 

But the real test will be what price office buildings actually trade for, and there have been precious few examples since interest rates started rising. That’s why industry-watchers see discounted deals like CPPIB’s as an ominous sign for the market. 

Redeploying Cash

The pension fund isn’t actively backing away from offices, but it’s not looking to increase its office holdings either, according to a person with knowledge of its strategy. And where a property requires additional investment, CPPIB might simply look to sell so it can put that cash somewhere it can get higher returns instead, said the person, who asked not to be identified discussing a private matter.

Peter Ballon, CPPIB’s global head of real estate, declined to comment on the recent deals, but said the fund has continued to invest in office buildings, including a recently completed, 37-story tower in Vancouver.

“Selling is an integral part of our investment process,” Ballon said in an emailed statement. “We exit when the asset has maximized its value and we are able to redeploy proceeds into higher and better returns in other assets, sectors and markets, including office buildings.”

CPPIB’s C$590.8 billion ($436.9 billion) fund is one of the world’s largest pools of capital, and its C$41.4 billion portfolio of real estate — stretching from Stockholm to Bengaluru — includes almost every property type, from warehouses, to life sciences complexes, to apartment blocks. While that scale would mitigate any potential losses from individual transactions, it also means even a small shift in CPPIB’s office appetite has the power to cause ripple effects in the market.

Manhattan Tower

At the end of last year, the fund sold its 29% stake in Manhattan’s 360 Park Avenue South for $1 to one of its partners, Boston Properties Inc., which also agreed to assume CPPIB’s share of the project’s debt. The investors, along with Singapore sovereign wealth fund GIC Pte., bought the 20-story building in 2021 with plans to redevelop it into a modern workspace.

Boston Properties said last month that the selling partner — which the company didn’t name — had already spent $71 million on the project, but severing its ties released it from an obligation to commit an additional $46 million to the effort.

Around the same time, CPPIB sold its 45% stake in Santa Monica Business Park, which the fund also owned with Boston Properties, for $38 million. That’s a discount of almost 75% to what CPPIB paid for its share of the property in 2018. The deal came just after the landlords signed a lease with social media company Snap Inc. that required they spend additional capital to improve the campus, Boston Properties Chief Executive Officer Owen Thomas said on a conference call.

The two Vancouver towers, co-owned with another Canadian pension fund, were different in that they didn’t need substantial new investment and had Amazon.com Inc. already in place as the major tenant. But last month’s sale price of about C$300 million was down more than 20% from where the property’s value was assessed at in 2023, data from Altus Group shows.

That sale coincided with the completion last year of a new office tower in Vancouver that CPPIB developed with the same pension fund, and the partners wanted to keep their overall exposure to the city’s office market from increasing, a person familiar with their thinking said. 

With hybrid work schedules set to depress demand for office space in the long term, and higher interest rates increasing the cost of the constant upgrades needed to attract and keep tenants, even the best office buildings may not be able to compete with investment opportunities elsewhere.

“To get even better returns in your office investment you’re going to have to modernize, you’re going to have to put a lot more money into that office,” said Matt Hershey, a partner at real estate capital advisory firm Hodes Weill & Associates. “Sometimes it’s better to just take your losses and reinvest in something that’s going to perform much better.”

©Fortune