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2006: The Pace Continues

By Warren Brazier, Darren Donnelly,                                                 January 19, 2006
     Jane Glanville and James Speakman

The headline reads UDI Panel Glows: Commercial Real Estate Basking in Sunshine. While we saw plenty of similar headlines in 2005, that particular one came from a prescient September 2002 UDI panel (Kevin Meikle, Ron Bagan, David Goodman and Richard Wozny) that believed commercial real estate was at the beginning of a "golden era". Two years ago, industry experts Bagan, Scott Cressey, Gino Nonni and Ryan Beedie generated the story:  NAIOP Panel Bullish on BC in 2004.

Today both NAIOP and UDI presented their looks at what is in store for 2006.
 

NAIOP: Investment Markets 2006

NAIOPís breakfast featured a lively panel discussion among Cushman & Wakefield LePageís Kevin Meikle, Grosvenor President Andrew Bibby, and CBREís Tony Quattrin, moderated by Tonkoís Sandy Cruickshank.

Looking Back at 2005

According to Tony Quattrin, the biggest challenge for brokers in 2005 was simply handling the huge volume of activity. In Vancouver, from 2003 to 2005 investment sale transactions values increased annually from $800 million (2003) to $1.2 billion (2004) to $1.6 billion (2005).

Trying to find enough product to satisfy the huge appetite of purchasers was also a big issue. Not surprisingly, Andrew Bibby advised that Grosvenor was not a very active buyer in 2005, having difficulty finding high quality properties. Instead, they took the opportunity to sell some properties which were not an ideal fit within the companyís portfolio.

Quattrin and Meikle identified five active groups of buyers in 2005: (1) pension funds (including the Canada Pension Plan, whose purchases included 50% of the Oxford Portfolio), (2) REITS, (3) foreign investors, (4) private buyers, and (5) syndicates. Foreign interest seemed to be coming from all over the world and although not always successful, foreign interests were involved in many multiple bids. Private investors who are affected mostly by interest rates continued to take advantage of low interest rates. On the other hand, sellers were overwhelmingly private investors.

The panel was unanimous in noting that the rules of the marketplace Ė the way in which deals have been getting done -- changed dramatically in 2005. More buildings traded on an unsolicited basis, and quality properties were being listed without a price. 

The key to maximizing the vendorís (and brokerís) success in this new marketplace is to level the playing field in ways that enable purchasers to make unconditional bids. Quattrin suggested that the offering materials should contain all relevant information about the property, which would include professional environmental and building condition reports. He could also have noted that, increasingly, such materials contain a form of sale agreement prepared by the vendorsí lawyers specifically for the property, as was done in the high profile sale of the HSBC Building in downtown Vancouver.

Looking Ahead

Real estate is the Gold of the 21st Century. That was how Kevin Meikle summarized the thoughts of the panel on Vancouverís investment market in 2006 and beyond, suggesting that investors will continue to look for the security and predicable returns provided by real estate.

Both Meikle and Quattrin expect high levels of activity in the investment market in 2006, pointing to institutional capital still seeking "yield". Buyers are expected to continue to be predominantly pension funds and REITs.

Vendors are expected to include advisors for those same pension funds and REITs, to the extent that specific investment funds have reached their intended maturity dates; private syndicates; owners who have held Class A properties for more than two or three years and wish to take advantage of the decrease in cap rates; and owners of Class B and "hinterland" properties which will start to enjoy the cap rate compression experienced in Class A over the past several years. As well, both Quattrin and Meikle expect further pre-sales of investment properties by developers wishing to free up their capital for development-level returns by selling at investment return levels.

The panel agreed that the possible enactment by a new Conservative government of a capital gains rollover provision would have a "huge" impact on market activity, as it would alleviate the concerns of private ownership groups who may have held property portfolios for one or more generations and are facing tax problems in the event of a sale.

Generally, "cap rate compression is at an end" according to Tony Quattrin, with agreement from Andrew Bibby, both of them basing their view on input from colleagues in their US offices. Bibby noted that the risk premium attributed to real estate investment (as compared to investment in bonds or other secure financial instruments) is as low as he expects it to be, and suggested that this may be the end of the current real estate cycle. Kevin Meikle disagreed to an extent, arguing that cap rate compression will slow generally but there is still room for decline in some asset classes, such as hotel and congregate care facilities.

In the office market, the panel agreed that there should be upward pressure on downtown rents, as a result of demand driven by the 2010 Olympics and general economic growth, and a lack of new supply. They expect prices to reach or exceed replacement cost, in part due to location premiums and the lack of construction and development risk on existing product, and agreed that as a result the recently sold HSBC Building will "look like a steal" over the next few years.

Meikle noted that land prices, although having risen dramatically in the past several years, are currently constrained by very high construction costs, and should not be expected to increase in the next year. However, if and when construction costs ease, land prices should again start to rise.

All in all, other than a concern expressed about the possible effects of a potential US recession on the Canadian economy generally, the panel was very optimistic about Vancouverís investment market in 2006 and beyond.
 

UDI: Development Industry Forecast

UDI featured panellists Avtar Bains of Colliers, developer Rob MacDonald, Concertís David Podmore, Gino Nonni of WesGroup, and was moderated by Concordís David Negrin.

The Big Picture

Following up on his remarkably exuberant presentation at last yearís UDI Market Outlook luncheon, Rob MacDonald told the audience that the British Columbia economy and real estate market will exceed his earlier predictions.

According to MacDonald, staggering levels of economic growth in China and rising economic freedom and growth in India will lead to increasingly high demand for commodities and other products either produced or transshipped in British Columbia. Wealth created by the oil-based economy in Alberta will bring people to British Columbia seeking recreational, retirement and other housing, and long term economic prosperity in the United States will add to BCís economic prospects.

Jobs and economic growth will lead to demand for residential, recreational, commercial and industrial property. MacDonald said that he continues to invest in and develop major projects in British Columbia and, based on his expectation that "decades of prosperity are on our horizon" he will continue to do so.

Industrial Market

Gino Nonniís comments follow WesGroupís successful strategic shift a few years ago from buying value added properties to developing land, in a sector where the highly constrained supply of land requires creativity and patience from developers.

The industrial market has seen buying at a record pace, where the typical buyer is a local owner/user and larger, quality properties attract multiple offers from institutional buyers. The lease market is under-supplied with vacancy of less than one percent in WesGroupís properties and tenants on waiting lists for popular locations.

Nonni sees development opportunities in the industrial strata market as a way to meet the demand from small companies which want their own space. By 2020 he says that container traffic through our ports will triple, creating a need for an additional 19 million square feet of industrial space. But where is the land for such product?

In order to meet the demand for space, developers will need to be flexible and willing to take on risk. They will need to look for land which may currently be unattractive but is "in the path of progress". For example, to remediate brownfield sites and/or achieve creative mixed use zoning, developers need to work with municipalities and the public and a good team of consultants. Developers who do that will have purchasers and tenants lining up.

Residential Market

David Podmore continues to be bullish and optimistic in his forecast for the real estate market in British Columbia and Western Canada, generally. According to David, the province is experiencing an unprecedented alignment of factors favourable for continued economic growth. All industries are strong in British Columbia. This positive economic atmosphere is present in Alberta, Saskatchewan, Manitoba and the Northwest Territories as well.

However, unlike the forecasts for the commercial and industrial markets (with which he agrees), Podmore believes there is a need for caution in the residential sector. In particular, Podmore warns that discipline must be exercised in the high density multi family sector. While consumer demand remains strong, immigration continues to increase and foreign investment in residential markets continues to grow, Podmore cautions that developers in the multi family residential market need to be disciplined Ė especially with respect their costs.

Issues facing the residential market include affordability, increasing land costs and construction costs (due partly to an extreme skills shortage) and a sharp reduction in equity withdrawal by homeowners which had been fueling investment by individuals. These issues will weed out the inexperienced and undisciplined developers.

Concert is exercising caution by diversifying in both location and product type, targeting property with unique and distinguishable characteristics and focusing on higher end multi family residential product.

Podmore cautions that the increasing project costs due to skills shortage (in all areas of the industry and not just construction) is a major issue that has been underestimated to date. According to Podmore, industry must take an active role in supporting skills training and Concert is taking an active role in this.

His forecast is that the residential market will continue to be a good market but one in which developers must exercise caution and discipline to be successful.

Investment Market

Avtar Bains continued the bullish outlook by commenting on his area of specialty Ė office and shopping centre properties. In the past year, Bains has noticed a remarkable development in who is buying properties in BC. Formerly, significant Canadian properties were bought by Europeans, Americans and Asians. However, today the BC market is driven by Canadians. From pension funds to REITs, BC is increasingly being bought by Canadian players.

Investors see BC as a stable investment environment with increased liquidity and favourable economic platform. How far have we come? Look no further than a prediction from the recent Toronto Real Estate Forum (attended by over 2,000 industry types from around the world), where it was said, "the future of Canada is in the West".

Bains was even so bold to proclaim his own prediction for the future of BC: "Within the next decade, Vancouver will become a head office town".

Indeed, times have changed.

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