By RUSSELL CAMPBELL

Investment in real estate by Canadian pension funds has grown at the prodigious rate of more than 40 per cent a year in the 1980s and all indications are that pension funds will become increasingly involved in property investment.

Some of the major life insurance and trust companies have been able to capitalize on this interest by offering real estate funds. However, within the past year, several financial institutions have decided to wind down their real estate funds because of difficulties they experienced trying to attract pension fund investors. It seems likely that other such real estate funds will fall by the wayside as this market grows increasingly competitive.

The growth of pension fund interest in property investment has been partly a result of the increasing awareness of the benefits of real estate ownership in relation to more traditional pension investments in stocks and bonds.

At least as important, though, are the aggressive efforts of some financial institutions in marketing their real estate funds. As a result of these efforts, pension fund investment in real estate has grown exponentially.

Pension funds are relatively new participants in the real estate game. For example, in 1974, pension funds owned about $53-million in real estate. This represented about 0.5 per cent of total pension assets in Canada. But according to the most recent Statistics Canada figures, real estate investment had increased to $1.38-billion in 1982, or 1.8 per cent of all pension fund assets. Currently, it is estimated that real estate investments worth more than $2-billion are owned by pension funds.

Of this amount, about $1.3-billion is invested in one or more of the three real estate funds operated by Morguard Investment Ltd. of Toronto, the first major packager of properties for pension investors in Canada.

In 1975, Morguard realized that pension funds wanted to participate in the potential appreciation of real estate and formed Pensionfund Realty Ltd., the first of its real estate funds. It offered pension funds the benefit of Morguard's real estate expertise and enabled pension investors to learn more about the investment characteristics of real estate while earning high rates of return on their investment.

This potential for high returns is a major reason for pension fund investment in real estate. However, there are also other important benefits.

For example, a fundamental requirement of pension funds is that the investment returns must keep up with inflation because of the increases in pension benefits that occur over time. Based on its historical performance record, real estate offers a good hedge against inflation.

Another significant benefit of property investment is that, in general, real estate prices are not vulnerable to rapid declines.

Thus, the combination of a high return in excess of inflation and low risk makes real estate eminently suitable for pension funds.

However, pension funds have identifiable likes and dislikes when it comes to particular types of property investment. This favoritism arises from their desire to ensure that the benefits of real estate ownership are not outweighed by unexpected losses on individual properties.

Pension funds' interests lie most prominently in properties such as office buildings, warehouses and shopping centres. What these property types have in common is a steady income flow and some opportunity for capital gains without undue risk.

While funds occasionally invest in other types of real estate, they are typically reluctant to get involved in what they perceive to be more risky forms of real estate, such as undeveloped land. Land investment is generally considered to be more speculative than pension funds care to consider because of the lack of a steady income.

There are essentially two ways for pension funds to invest in real estate properties.

The direct investment route is most often appropriate only for the largest pension funds, which have the financial capacity to support individual projects and the expertise available, either internally or externally, to undertake these projects. The Ontario Municipal Employees Retirement System, with more than $3-billion in assets, is an example of a pension fund that has undertaken direct real estate investments.

The more common method is through a joint-venture arrangement with a financial institution. Life insurance companies such as Great-West Life Assurance Co., Sun Life Assurance Co. of Canada and Canada Life Assurance Co., as well as trust companies such as Royal Trustco Ltd., have all established successful real estate funds.

Apart from Morguard, a number of other real estate organizations such as Lehndorff Canadian Properties and A. E. LePage Ltd. have also created real estate funds and have achieved a measure of success. However, the preponderance of non-Morguard real estate ownership by pension funds is through the real estate funds of life insurance and trust companies.

These real estate funds can be separated into two types - closed-end and open-end funds. Closed-end funds typically require the locking-in of money until the properties are sold. Open-end funds are more like mutual funds in that they offer a somewhat greater measure of liquidity. A pension fund's investment in an open-end fund is usually redeemable within a short period of time.

Each of the sponsors of real estate funds of both the closed-end and the open-end variety have particular areas of expertise and interest when it comes to property selection.

Some real estate fund sponsors place a greater emphasis on owning specific types of property in their funds. For example, Canada Life has a decided emphasis on shopping centre investments. Others emphasize certain geographic regions.

Another point of difference is often in the degree of diversification of the particular fund. Some believe in having all of the money invested in a few properties while other real estate funds have sought greater diversification.

Apart from the obvious differences between the various real estate funds available, an important element in determining the success of these funds has been the ability of the real estate fund sponsors to communicate their expertise to pension funds.

A concerted effort in all aspects of marketing, such as personal selling, advertising, promotional literature and publicity, has served to encourage some of the growth in real estate funds.

However, institutions have had the benefit of introducing their own clients in other investment areas, such as stocks and bonds, to the real estate funds. With this captive audience and the institution's credibility as an investment manager, these real estate funds have enjoyed rapid growth.

However, this initial advantage of the major financial institutions, with their large rosters of pension fund clients, has begun to fade with the proliferation of real estate funds.

With this increasingly competitive environment, all real estate fund sponsors will have to better understand the needs and desires of pension funds.

From a pension fund perspective, the wide variety of real estate funds available offer many opportunities for high returns at low risk.

Russell Campbell is assistant vice-president with James P. Marshall Inc., a Toronto-based pension investment counselling firm.