For those who lived
through BC’s lost decade, the views expressed at
yesterday’s Urban Development Institute
seminar were strikingly upbeat.
As moderator of the event,
I enjoyed a front row seat as four industry experts
entertained and informed the crowd with information gleaned from
their personal involvement in dozens of recent transactions, backed up
by research-heavy charts and graphs.
According to Kevin Meikle of
Royal LePage Commercial, there is a new paradigm in the investment world in which real estate,
generally, is very attractive. Richard Wozny of
Royal LePage Advisors explained
the factors behind Lower Mainland retail’s emergence as a hot
market. Colliers International's
Ron Bagan spoke on what he
referred to as the bond of Vancouver commercial real
, industrial properties. Lastly, David Goodman of
Macdonald Commercial and author
of The Goodman Report rounded out the
presentations with the reasons why he calls 2002 a
magical time in the rental apartment market.
increases despite rising vacancy
Following meetings last week as part of his firm’s
National Investment Team, Kevin Meikle argued that
the apparent "disconnect" in the marketplace of
increased real estate investment activity and firm
prices while vacancy rates (especially in Toronto office
product) have risen sharply, is simply a
reflection of "an evolution in the global investment
stage, generally. Real estate has just changed its
position in the marketplace.…If anything, it is
connected to the marketplace much more so than we have
ever had before because of changes which have occurred
in the real estate market."
He points to new, conservative asset management and
development strategies and believes that, nationally,
real estate looks very strong as an investment vehicle.
Since 1999, the spread between relatively stable
cap rates --
around 8.5% for Toronto Class A office - and 10-year bond yields - now
under 5% - has nearly doubled. During the
same period, the TSE 300 Index has taken equity
investors on a roller coaster ride from 7,000 to 11,000
and back down to 6,000. Real estate just looks good. The
result has been increased activity across all
According to Meikle, obtaining financing for
investment-grade product is easier than ever as
"securitised" or "conduit" lenders have finally arrived
in Canada in a significant way. He points to about ten
players offering mortgage-backed security financing now,
compared to just two a couple of years ago.
The market is attracting more foreign investors,
REITs (Real Estate Investment Trusts) which are becoming more specialized in specific
asset classes and private buyers getting involved in
real estate in $25,000 or $50,000 investments through
retail limited partnership syndicates
being marketed by investment houses.
Often they are buying from some of the larger pension
funds and life companies which have had to sell real
estate to maintain their asset allocation ratios in the
face of plummeting equities.
In the national office investment market,
Royal LePage believes that the market is bottoming out in
terms of the negative absorption and that vacancy rates
are stabilizing. Demand for quality downtown space
exceeds supply and cap rates for prime properties are
being pushed below 8%.
Meikle observed that "the big story is retail", where
transaction volume has increased by up to 300% from
2000/2001. The pool of buyers is diverse. Israeli and
German buyers have been very active in the East but have
shied away from BC as this province continues to be more
expensive than the rest of the country by as much as a
full cap rate point. "So," he says, "it’s easier for us
to take investors from Vancouver to the East than to
bring Easterners here." Having said that, cap rates are
now being pushed down to 9%, after a number of high
quality Lower Mainland shopping centre sales were
completed in 2001 and earlier this year at or above
In terms of clouds on the horizon, the economy is
unpredictable, "Kyoto is a concern" and
sees current REIT payout ratios as being unsustainable.
The biggest concern, however, is that investment demand
has shifted so dramatically to real estate that "prices
are going to be pushed up to levels where maybe people
start feeling uncomfortable."
Meikle stated "It is my belief that people that don’t
play now are going to be left behind."
Retail: Strip Malls, Big Box and Street
Richard Wozny recalled that "in the late 1980’s
shopping centre conventions were massive and extravagant
affairs occupying the entire Toronto Convention
Centre.…. By 1994, the convention could be held in a
hotel room. Today once again things look great for most
forms of retail real estate." His presentation focussed
on the reasons retail real estate is attractive.
Wozny believes that difficult times in the 90’s
"cleared out a lot of poor real estate and marginal
retail tenants." The result is that the strong have
survived and even what was once viewed as marginal
street front retail is now healthy.
Among the many virtues of real
estate hi-lighted by Wozny, he mentioned:
excellent risk/return ratios,
outperforming stocks and other investment instruments
by a wide margin over the last five years, and
averaging an annual "and relatively reliable" return
of about 8%.
it yields real cash income.
a real estate investment is
relatively transparent and easy to understand.
Meaningful due diligence can be carried out.
it involves a high degree of
leverage, which is very good in the low interest rate
times we are enjoying – although obviously risk will
rise as interest rates do.
most new developments now
have Wal-Mart or a major supermarket anchor, providing
REITs and other syndication vehicles are making
real estate investment more liquid. Wozny noted that
"The REITs are unlocking value in literally everything
that is nailed down. For example, there is a new REIT
in the US which invests in bank branches allowing the
banks to become tenants, redeploy their capital and if
necessary vacate. The new landlords have limited risk
as most locations are suitable for another use, such
as a coffee shop. It is reasonable to speculate that
large retail firms with a lot of real estate will spin
that real estate off in the form of a REIT."
Wozny made a number of other
observations regarding Lower Mainland retail properties.
He sees highways as increasingly attractive sites for
retail as they offer good access over the long term in
an increasingly congested city. He points to upside in
street retail properties where an anchor might be
attracted, citing East Hastings and Victoria Drive as
examples where "rents are twice as high near London
Drugs….as they are a few blocks away." He also notes
that commercial street fronts are often immune from the
impact of Wal-Mart and big boxes as they have a
different food and service oriented role within the
community. Regarding big box, generally, Wozny sees their expansion as nearing
Wozny closed by commenting that while retail "remains
the most complex form of real estate, it has become
easier to understand and a more stable asset if only
because there are fewer players."
Syndicators, Stability Seekers and Owner-users eat up
In contrast to retail,
Ron Bagan was able to point to the relative simplicity of
industrial product from an investor’s point of
view. He first looked at the important variables of vacancy,
rents, cap rates and liquidity.
Over the last several years Lower Mainland industrial
property has shown very little fluctuation in vacancy
rates. Rents have been steady. The cap rate has "been
plodding along at 8.75%". With the price of most
properties below $5 million and owner-users making up
about about one-quarter of the buyers, liquidity is
typically very good. The significance of a large number
of owner-occupiers is that - unlike retail, office and appartment properties
- there is a market for untenanted buildings. In addition, owners need not
maintain large capital reserves for tenant improvements
and other major re-tenanting expenses.
Other factors favouring industrial investment include
limited supply in the Lower Mainland, ease of
construction phasing (as opposed to, say, a phased
downtown office tower…) and a low entry level, making
small syndications easy.
As a result,
Bagan sees demand in high-quality areas
like Richmond and Annacis Island now creating
opportunities for owners to sell below 8% cap rates. It
also means that "lenders have a huge appetite for it.
They are able to make nice bite-sized loans under $5
million that are easy to move." He noted that 70% to 75%
financing is not unusual.
Rental Apartment sales: A Magical Period
In the August, 2002 issue of The Goodman Report
David Goodman reported on "A SURGING MARKET"
and, apparently, it shows no signs of slowing.
Goodman reviewed the "gloomy" conditions existing in
1999. Investors had a poor view of BC under the NDP
government, our high federal and provincial taxes were
disincentives to sell, there existed intrusive
provincial rent review legislation, investors were
unfairly "spooked by leaky condos", and net
out-migration and flat rents added to a bleak picture.
The contrast with today’s conditions could not be
He also pointed out contrasts with the post-Expo boom
which lasted until 1992 showing that today’s market is
much more fundamentally sound. "The late 80’s was a
period of wild exuberance, tantamount to a feeding
frenzy," according to Goodman. "Offshore investors were
gobbling up properties." Average price per suite over
that five-year period rose between 62% and 103%,
depending on municipality. Not surprisingly, there was a
lot of flipping. But with mortgage rates at 10% and cap
rates of around 5% to 7%, investors were buying on the
assumption that inflation was a given "and capital
appreciation would win over negative cash flow", making
a crash inevitable.
From a high of 353 apartment properties trading in
1989, the level of activity dropped to a range of 50 to
70 over the last seven years of the 90’s. During that
decade average price per suite changed, depending on
area by somewhere between minus 18% and plus 8%.
Today, Goodman points to a "positive convergence"
which is extremely conducive to activity in this sector.
He called it "a magical period where the sun, moon and
stars have aligned" to create positive conditions for
owners and investors alike. He pointed to a number of
new provincial government has
dropped personal taxes significantly
federal government has
reduced capital gains inclusion by 50%
rents for new product over
$2.00 per square foot are now common, encouraging new
construction and renovation
low vacancy rates
historically low mortgage rates – "CMHC offering five-year money at 5% and
10-year money at 6%"
a great deal of institutional investment money
As a result, there has been a dramatic increase in
activity in the last 12 months. Goodman predicts total
apartment transactions in the Lower Mainland will reach
160 this year, with a 100% increase in dollar volume
from last year.
Goodman caught the attention of
the 100 seminar attendees with a table showing the
dramatic difference in the tax treatment for an
individual selling a property in 1997 compared to 2002.
The differences (see table) show the results of the top
marginal tax rate reduction from 54% to 43% and the
change in the capital gains rules. Looking ahead, Goodman sees increasing sales
activity based on strong fundamentals and "low interest
rates will enable new investors to benefit as they
upgrade their buildings and correspondingly increase
rents, which I consider undervalued." Also, he sees a
continuing increase in supply
of new rental units with rents, primarily in Vancouver with rents
firmly in the $1.80 to $2.30 range.
Goodman concluded with a
sentiment shared by the entire panel, "BC is again open