Real Assets Market Report

June 30, 2019

TELUS GardenOffice | Vancouver, BC

Description Page No.

Investment and Economic Outlook 4Canadian Commercial Mortgage Market 7Canadian Commercial Real Estate Market 8

Office 8Retail 10Industrial 12Multi-Unit Residential 14

Global Infrastructure Market 16Conclusion 18

Table of Contents

Page 4

Investment and Economic OutlookThe primary question for our current outlook is whether upcoming interest rate cuts from the U.S. Federal Reserve are in response to a potential recession occurring or an attempt to prevent one. This is of great importance given divergence in financial asset outlooks. Sovereign rates are reflecting a significant slowdown, while risk premiums for credit remain low. Equities are close to all-time highs; however, defensive sectors are trading at a greater premium relative to their history. Inflation expectations are falling while gold appears to be breaking to the upside. Where we are in the economic cycle will inform which asset classes are more likely to be dislocated from underlying fundamentals.

When risk budgeting for asset allocation, our outlook relative to consensus, along with implied asset pricing, play an important role. Our global outlook is for a slowing expansion but not a recession. As yields have fallen, they provide natural stimulus and increasingly accommodative financial conditions. Equity earnings and margins, while slowing, remain at strong absolute levels. Labour markets remain extremely strong in the U.S. and Canada with positive real wage growth.

Consensus in the market appears to be reflecting a similar view for a late cycle slowdown with central banks easing as a precautionary measure. We have observed that U.S. employment figures, purchasing managers’ indices (PMIs), housing permits and credit spreads all reflect trends that preceded non-recessionary cuts (1987, 1995, 1998) versus recessionary ones (1989, 2001, 2007).

With strong equity and fixed income returns, balanced portfolio investors have witnessed close to double-digit returns, recovering losses from 2018. Real assets and private commercial mortgages have continued to demonstrate their diversifying return profile with lower but more stable returns through the first half of 2019.

Within infrastructure, we are seeing deal opportunities broaden outside of renewables. While valuations are rising, we still believe that premiums relative to equities and bonds remain strong.

After a slowdown in activity through the first quarter, real estate transaction volumes recovered in the second quarter. Fundamentals remain strong across Canadian commercial real estate sectors, as evidenced by relatively low vacancy rates. Real estate asset prices will likely benefit going forward as cap rates tend to follow sovereign yields with a lag. However, we anticipate income to be the driver of returns. Commercial mortgages should also perform well as spread premiums relative to corporate bonds are near five-year highs.

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Page 6Bay Adelaide CentreOffice | Toronto, ON

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Canadian Commercial Mortgage MarketThe Canadian commercial mortgage market continues to be active with both foreign and domestic lenders providing capital. The five-year and 10-year Government of Canada bond yields have compressed by 13 and 16 basis points over the last quarter (see Figure 1).

Figure 1: Government of Canada Yields

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0.5

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1.5

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Mar-19 Apr-19 May-19 Jun-19

%

5-Year 10-Year

Source: Bank of Canada. Jun 30, 2019.

Given the strong overall real estate fundamentals across Canada, the amount of capital available, and corporate spreads compressing, mortgage spreads have similarly declined by 10 basis points quarter over quarter. All in rate for five-year and 10-year mortgage rates are 2.95 – 3.15% and 3.10 – 3.30%, respectively (see Figure 2).

Figure 2: Commercial Mortgage Spreads

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Dec-18 Jan-19 Feb-19 Mar-19 Apr-19 May-19 Jun-19

Basi

s Po

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5-Year 10-Year

Source: CMLS Financial. June 2019.

While term mortgage (5 – 10 year) rates have declined compared to historical levels, shorter-term loans that are focused on land/land servicing, construction, and interim/bridge financing are providing accretive risk-adjusted opportunities for mortgage lenders. Given the relatively flat term structure of the yield curve, mortgage investors are challenged to take duration risk. However, having strong relationships, the ability to participate across the lending spectrum, and access to the entire mortgage market in terms of loan size ($20 - $400 million) can help mitigate these challenges.

Figure 3: Canada Yield Curve

0.0

0.5

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1Y 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10Y

%

Source: Bloomberg. As at Jun 30, 2019.

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Canadian Commercial Real Estate MarketOfficeNational downtown office vacancy rates are 9.8% (see Figure 4). This was a 29 basis point decline from the prior quarter and 86 basis point decline from the prior 12 months.1 Overall, fundamentals are positive across Canada with the exception of Alberta.

Figure 4: Downtown Vacancy Rate

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5

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Vancouver Calgary Edmonton Winnipeg Toronto Ottawa Montreal Halifax

%

Q2-18 Q2-19

Source: CBRE Limited. Jun 30, 2019.

1 CBRE Limited. Jun 30, 2019.2 CBRE Limited.

Major construction projects are now occurring in Vancouver, Toronto and Montreal (see Figure 5). These are also the markets with the lowest vacancy rates. However, even with preleasing on new projects, we expect vacancy rates to rise slightly over the coming years as new supply comes online.

Figure 5: Downtown Construction

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Vancouver Calgary Edmonton Winnipeg Toronto Ottawa Montreal Halifax

%Sq.F

t. (M

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Construction (LH) % of Inventory (RH)

Source: CBRE Limited. Jun 30, 2019.

Alberta continues to be challenged by commodity price volatility and limited pipeline capacity. Office vacancy rates will likely be elevated for several years. However, the long-term outlook for demographics and capital investment is positive.

Figure 6: Average Annual GDP Growth Forecast (2019 – 23)

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Calgary Edmonton Vancouver Toronto Ottawa Montreal

%

Canada

Source: Oxford Economics. March 2019.

The Ottawa market has also been performing well. Demand is driven from both public and private sectors. The pending federal election has the potential to slowdown government activity. However, demand will likely increase for core properties along the transit corridor with the new LRT line nearing completion. There is also potential for the current level of inventory to become restrictive to tenants in the central business district (“CBD”) due to the declining vacancy and will likely force new tenancies outside of the Ottawa CBD.2

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TELUS GardenOffice | Vancouver, BC

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RetailThe Canadian retail market has been relatively stable compared to other global markets (see Figure 7). For example, the United States has much higher retail square feet per capita and the United Kingdom is experiencing higher e-commerce penetration.

Figure 7: Total Return

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Canada US UK

%

2016 2017 2018

Source: MSCI. 2018.

Canadian retail vacancy rates have risen because of the bankruptcy of Sears (see Figure 8). Due to the Sears closures, regional shopping centres had the largest impact as vacancy rates rose from 4.4% (Q2-2017) to 11.0% (Q4-2018). Aggregating all retail subsectors, vacancy is 6.3%.

Figure 8: Vacancy Rates

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2006 2008 2010 2012 2014 2016 2018

%

Regional Power Centre All Other Total

Source: CBRE Limited. 2018.

Older generation retail centres and those in tertiary markets have been most impacted by store closures, changing consumer behavior, and technological advances. Retail offerings that cater to experiential (e.g. theatres, restaurants, fitness) and necessity (e.g. grocery) based retail have typically withstood the volatility within the retail sector. As a result, retail construction has declined and current activity is primarily focused on mixed use retail (see Figure 9).

Figure 9: Construction by Retail Type

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100%

2013 2018

Mixed Use Regional CommunityNeighbourhood Power Centre Outlet

Source: CBRE Limited. 2018.

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UptownRetail | Victoria, BC

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Industrial The industrial market has been the strongest performing property type over the last year in Canada. Expectations are for continued positive momentum for this sector due to several factors, including low vacancy, income growth, positive net absorption, and the growth of e-commerce.

Figure 10: Annual Total Property Return

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2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

%

Office Retail Industrial Residential

Source: MSCI. 2001 - 18.

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Cold/freezer chain logistics is a subsector within the industrial property type. Cold chain logistics manages the distribution of temperature-sensitive products. The market is typically divided into food and grocery, and pharmaceutical products. This sector has also been performing well and tends to have inelastic demand.

Due to the substantial capital required to construct and equip these facilities, the overall supply of cold chain logistics is limited and account for 0.6% of total industrial inventory (see Figure 11).

Figure 11: Total Canadian Industrial Inventory

0.6

99.4

TemperatureControlled

All Other IndustrialFacilities

Source: Colliers International Research.

3 Colliers International Research.

There has been a limited amount of newly constructed cold chain logistic facilities in Canada over the past 10 years. Supply is anticipated to remain low and developers typically do not construct these facilities on a speculative bases given the construction risk, leasing risk and government regulation associated with this type of product.

Net rental rates for newly constructed temperature controlled properties can range from $15 to $20 per square foot. For comparative purposes, dry warehouse rental rates are on average $7 to $13 per square foot. The higher rental rates are required for the substantially higher construction costs associated with cold storage facilities.

Due to the low supply and high demand for cold storage facilities, vacancy rates are approxmilty 0% in Canada.3

4 & 6 Manchester CtIndustrial | Bolton, ON

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Multi-unit Residential The multi-unit residential sector is one of the most stable property types in Canada. From a property fundamental and overall risk-adjusted return perspective, the purpose built rental market continues to add value to a balanced real estate portfolio.

Figure 12: Vacancy

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1990 1994 1998 2002 2006 2010 2014 2018

%

Source: CMHC. October 2018.

Figure 13: Standard Deviation of Returns

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Office Retail Industrial Multi-unit Residential

%

Source: MSCI. 2000 - 18.

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The demand drivers of the purpose built rental market are positive. There is strong population growth due to immigration, and demographic shifts are supportive of the rental sector (see Figure 14).

Figure 14: Average Annual Population Growth (2019 – 23)

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Calgary Edmonton Toronto Vancouver Ottawa Winnipeg Halifax Montreal

%

Source: Oxford Economics. March 2019.

4 Assumptions: Size: 800 SF, down payment: 5%, interest rate: 2.9%, amortization: 25 years, fixed term: 5 years, realty taxes: $233 monthly, utilities: $75 monthly, maintenance fee: $400 monthly, home insurance: $50 monthly.

Home ownership has become difficult due to high prices and mortgage regulations. The spread between condominium carrying costs and average apartment rents range from $521 in Calgary to $1,566 in Toronto.4

Figure 15: Gap between Owning a Condo and Renting an Apartment

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$500

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$2,000

$2,500

$3,000

Toronto CMA Ottawa CMA Montreal CMA Calgary CMA

Condo Carrying Cost Avg. Condo Rents (2bdrm) Avg. Apt Rents (2bdrm)

Source: Timbercreek Asset Management.

Condo affordability should further decrease if interest rates rise. A 1% increase in interest rates could add a further $129 on average to the carrying costs.

We believe that the purpose built rental sector continues to offer a viable solution to the housing affordability issues faced by many Canadians as it provides a lower cost option to homeownership and flexibility to the tenant.

Tennis & Broadview Multi-unit Residential | Toronto, ON

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Global InfrastructureInterest in infrastructure continues to be robust from institutional investors as over US$43 billion was raised in the first half of 2019, according to Preqin. 2019 is expected to be the largest year on record for fundraising at over US$100 billion.5

With 582 infrastructure transactions closing globally, the number of transactions continue to decrease since a record Q4-2017 (see Figure 16). However, the total value of deals has continued to increase, rising from US$63 billion in Q1-2019 to US$155 billion in Q2-2019.6 The average deal value has continued to climb as managers raise ever increasing amounts of capital.

Figure 16: Quarterly Infrastructure Deals (Q1-2014 to Q2-2019)

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No. of Deals Aggregate Deal Value ($bn)

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eals

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eal Value ($bn)

Source: Preqin.

Seeking Core InfrastructureIn addition to seeking larger assets, returns are being compressed for core assets. Institutional Investor reported that the average yield for core infrastructure investments tumbled 300 to 350 basis points from 2010 to 2015, driving prices up as much as 40%.

5 Preqin.6 Ibid.

We have seen an increased interest in core assets with the number of energy, utilities and telecoms deals rising in Q2, while renewable energy deals fell from 337 to 308, as reported by Preqin.

Figure 17: Infrastructure Deals by Sector (Q1-2014 to Q2-2019

0100200300400500600700800900

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2014 2015 2016 2017 2018 2019

Renewable Energy Conventional EnergyTransport UtilitiesTelecoms SocialOther

Source: Preqin.

A primary characteristic of core infrastructure is the predictability of cash flow, which is driven by the revenue model of the asset. The risk for managers is mispricing an asset when competing for core infrastructure that may not have the same level of certainty of cash flow. For example, if similar returns are expected for an asset with availability-based revenue, as an asset with usage-based revenue it is likely that the portfolio is not being compensated for the risk taken with the latter (see Figure 18).

Social Circle Solar FarmRenewable Energy | USA

Page 17

Ultimately, the risk of mispricing an asset is present with the strong demand for core infrastructure assets, especially if there is pressure to deploy capital. It is important to understand the contractual framework of an asset during due diligence to ensure the expected return is justified and that the asset fits within the context of the overall infrastructure portfolio.

Figure 18: Revenue Models of Infrastructure

Source: TD Greystone, Callan.

Availability Based Regulated Contracted Usage MerchantConstant revenue, provided asset is maintained and operational.

Economic return of the asset set by government regulation regarding consumer pricing and level of service.

Contracted pricing and volume off-take with specific counterparty.

Wide variety of usage models where revenue based on use.

Market pricing dependent on supply/demand dynamics

Typical AssetsSocial Infrastructure Water or Electrical Utilities Power Generation, Energy

Storage, CommunicationsToll Roads, Other Transportation

Power Generation

Lower Risk Higher Risk

Higher Predictability Lower Predictability

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ConclusionThere is favourable supply and demand dynamics within the Canadian commercial real estate market. We anticipate strong net operating income growth in the residential and industrial property types. Retail will likely have stable performance but focus should shift towards higher-quality, urban, transit-linked locations.

The Canadian mortgage market is active and some lenders are offering very compelling quotes to borrowers. We believe that having strong relationships in the market, being able to participate across the lending spectrum (land, construction, term) and loan size ($20 – $400 million) will provide additional accretive opportunities to deploy capital.

Infrastructure continues to raise significant capital with over US$40 billion raised in the first half of 2019. We believe that the recent increased transactions in assets provide an opportunity to add core, stable assets, but should be done prudently in an increasingly competitive market.

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The Hub @ KGSOffice | Surrey, BC

Rabbalshede Kraft AB Renewable Energy | Sweden

Andrew Croll, CFA, CAIAVice President and Director,Alternative Investments 416.309.2587andrew.croll@greystone.ca

Sean Collins, CFA Vice President and Director, Institutional Relationships 416.309.2183sean.collins@greystone.ca

Growth.It’s what we do.Broader offerings. More opportunities.

(07/2019)

Opinions reflect those of TD Greystone Asset Management as of the date hereof. The information contained herein has been provided by TD Greystone Asset Management and is for information purposes only. The information has been drawn from sources believed to be reliable. Graphs and charts are used for illustrative purposes only and do not reflect future values or future performance of any investment. The information does not provide financial, legal, tax or investment advice. Particular investment, tax, or trading strategies should be evaluated relative to each individual’s objectives and risk tolerance. TD Greystone Asset Management claims compliance with the Global Investment Performance Standards (GIPS). A GIPS compliant presentation is available upon request. TD Greystone Asset Management has been independently verified for the period from January 1, 2000 to December 31, 2018. The verification report(s) is/are available upon request. Verification assess whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm’s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. Verification does not ensure the accuracy of any specific composite presentation. TD Greystone Asset Management (“TD Greystone”) represents Greystone Managed Investments Inc., a wholly-owned subsidiary of Greystone Capital Management Inc. (“GCMI”). GCMI is a wholly-owned subsidiary of The Toronto-Dominion Bank.In Canada, TD Greystone Asset Management is a registered portfolio manager, exempt market dealer and investment fund manager. TD Greystone Asset Management is registered as an investment adviser with the Securities and Exchange Commission in the United States. Products and strategies shown are currently only offered through TD Greystone Asset Management. For more information on the strategies and products shown please visit https://greystone.td.com.® The TD logo and other trade-marks are the property of The Toronto-Dominion Bank.

Andrew Croll, CFA, CAIAVice President and Director, Alternative Investments 416.309.2587 | andrew.croll@greystone.ca

Sean Collins, CFA Vice President and Director, Institutional Relationships 416.309.2183 | sean.collins@greystone.ca

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