2010 Vancouver Real Estate Forum

By Commercial Real Estate Group at Clark Wilson LLP

KEYNOTE ADDRESS – ECONOMIC OVERVIEW: DEMYSTIFYING THE FUTURE

Speaker:

Warren Jestin, Senior Vice President and Chief Economist, Scotiabank

Warren Jestin provided the Forum with his thoughts on the current economic situation and what lies ahead.

Among the emerging countries, China, India and Brazil, are growing at a faster rate than the established economies. This growth will benefit commodity-based economies, such as Canada, but will also provide competition and challenges throughout the economies of the developed countries.

Recovery in the United States and Europe will be slow and uneven. The domestic recession is not over in the United States. Foreclosure rates continue to rise and growth in many sectors, including the commercial real estate market, continues to be slow.

Western Canada will lead growth in Canada for the next 5 years. Growth will be slower than before the recession and the recovery will not bring back the pre-recession economy for some time.

According to Mr. Jestin, interest rates in Canada do not currently reflect "normal". It is anticipated that the Bank of Canada will raise interest rates in June or July, probably modestly, but by the end of 2011, interest rates could be up by as much as three (3%) percent.

The Canadian dollar has a close relationship with oil. Mr. Jestin predicts that the Canadian dollar, which is currently flirting with parity, will continue to remain highly volatile. We are, however, more likely to see the Canadian dollar remain flat or go up as opposed to down.

Three issues that Mr. Jestin sees emerging in the future are (1) the new economy driven by the emerging world, (2) aging population; and (3) environmental issues and greening policies. While we are on the road to economic recovery, it’s a long way back to the pre-recession economy.

INVESTMENT PANEL: A GLOBAL VIEW ON THE LOCAL MARKET

Moderator:

William Briscoe, Executive Vice President, Investments, GWL Realty Advisors Inc.

Panel:

Avtar Bains, Executive Vice President, Colliers International
Mark Hannah, Principal & Managing Director, Avison Young Canada Inc.
Jim Szabo, Executive Vice President, CB Richard Ellis Ltd.

The panel of real estate investment leaders discussed recent and current investment trends in the local market.

According to Jim Szabo, the first half of 2009 saw the emergence of off market commercial real estate transactions. It had been expected that, in the midst of the global economic upheaval, a vast number of listings would come into the market. Canadian investors proved to be resilient and a flood of listings did not happen. It was estimated by the panel that approximately fifty (50%) percent of the transactions over the last 9 months were off market.

While shopping centres are typically the dominant asset class in investment transactions, Class A office buildings in Vancouver were the dominant asset class in investment transactions in the last year. Over the last year, there were 9 transactions involving the purchase and sale of office buildings, representing more activity in this asset class in one year than in the previous 6 years combined.

According to Jim Szabo, the condominium market has been surprisingly resilient and has essentially recovered all losses since 2008. Trades on development lands may exceed 2008 pricing in the near future. Mark Hannah added that with construction costs down since 2008 and limited new inventory on the market, there is opportunity in the development and condominium market.

Avtar Bains observed that although Canada is appealing to investors from jurisdictions experiencing domestic turmoil, the typical investor in the local market is domestic rather than foreign. Jim Szabo concurred, noting that more than half of the nine (9) office building transactions over the last year involved domestic investors. While pension funds and public REITS are returning as key players to the market place, private investors continue to be the most active investment market buyers in Canada.

THE ISLAND THEORY: HOW SIGNIFICANT ARE THE GLOBAL CHALLENGES ON VANCOUVER REAL ESTATE?

Introductions:

Cameron Muir, Chief Economist, BC Real Estate Association

Speakers:

Gary Carpenter, Senior Vice President, Bentall US
Jon Love, Managing Partner, KingSett Capital

Andrew Bibby introduced this session by noting that Vancouver is seen by outsiders as an "island", with an economic law unto itself. He posed the question for the panel as to whether this is view true and, if so, whether it is sustainable.

Moderator Cameron Muir provided a brief summary of the economic dynamics affecting Canada and Vancouver over the past 12 months. He noted that "stodgy" Canadian lending practices have left Canadian borrowers relatively unscathed by the economic downturn. Low interest rates have provided stimulus, and with a commodity based economy and higher Canadian dollar, Canadian real estate is now viewed as a safe haven. He cautioned that external risks, such as sovereign debt default, increasing interest rates and the possibility of compression in the U.S. commercial real estate markets, could lead to a reduction in the flow of capital and impact the Canadian real estate market.

Gary Carpenter, who is based in Seattle, provided an interesting perspective on the differences between the Canadian and US markets and Vancouver and Seattle markets. He referred to a recent article in the Economist magazine, which called Canada’s economy the "least bad rich country economy". He noted that Canada is currently everything that the U.S. is not. Canada enjoys strong job growth, strong corporate revenue growth, has a commodity based economy, an unbeatable corporate tax regime, productivity gains and, most particularly, a "best in class" banking system. Contrasted with this, the United States appears to be a "mess", with a real unemployment rate in the range of 17% and a massive and continuing real estate crisis. Stimulus effort, including changes in banking regulations, are only putting off an inevitable reckoning. Mr. Carpenter also noted that while activity in commercial property transactions has emerged in the past few calendar quarters and with U.S. based REITs expected to raise $100 billion in equity in 2010, the transactions are resulting in "fear based pricing" as these institutional investors strive to build their portfolios.

John Love, Managing Partner of Kingsett Capital, commented on the risk that while Vancouver and its real estate market have been an economic island throughout the economic downturn, this should not lead us to assume that global events will not affect us. He referred to global economic concerns, such as sovereign debt (not only in Greece, but also in Japan, the United Kingdom and United States), the risk of civil unrest and a global leadership vacuum. Canada is in materially better shape in terms of government, the banking sector and our "conservative, thoughtful attitude". With the strength of the "Canada story" behind it, a unique geography with a lack of developable land and the possibility of future gains in the Canadian dollar, Vancouver’s real estate market should outperform over the mid to longer term.

OFFICE LEASING IN METRO VANCOUVER: A TALE OF TWO MARKETS

Moderator:

Mark Renzoni, Executive Vice President & Managing Director, CB Richard Ellis Ltd.

Panel:

Tony Astles, Executive Vice President, Bentall LP
Sandy Cruickshank, Executive Vice President, Tonko Realty Advisors Ltd.
Tom Knoepfel, Senior Vice President & Portfolio Manager, Western Canada, Cadillac Fairview Corporation
Sandy McNair, President, Altus Insite

The tale is actually of three Metro Vancouver markets – Downtown, Richmond and Burnaby. The panelists agreed that Class 'AAA' and 'A' rentable space in Downtown Vancouver remains extremely tight, with no new supply coming on in the Downtown core in the foreseeable future. For 2011, Class 'A' rental rates in Downtown Vancouver are predicted to increase by anywhere from 10% – 15%. Tony Astles advised that with vacancy rates expected to go down and rental rates expected to rise, tenants should also expect inducements from landlords to decline and should consider doing deals now.

On the flip side, Metro Vancouver's two largest suburban markets have reached historically high vacancy levels. The question was posed whether we would accordingly see a flight of tenants to the suburbs. Tom Knoepfel and Tony Astles both observed that Vancouver's tenant make-up is comprised of smaller regional offices and not head offices, so there are few individual tenants that could shed large amounts of downtown space and relocate. Both panelists expect that tenants may start to trickle to Burnaby and Richmond as downtown core space remains tight. Sandy Cruickshank echoed these comments and noted that recent growth in Burnaby could be attributed to tenants that were already located in the suburbs. He noted that with Downtown rents starting to ratchet up again, tenants may start to look to Burnaby and Richmond. Rents, however, are not the only criteria in making decisions to move. Where executives reside, what amenities they enjoy Downtown, where their clients are located and where their employees live are also important considerations.

The panel discussed how old office stock is competing with the newer sustainable green buildings that are being completed in the suburbs. Clearly a "green strategy" has had an impact on existing stock. Building from the ground up for a tenant, gives the parties an opportunity to consider sustainability goals and it is much easier to accommodate such goals in new construction. On the other hand, it is very expensive and disruptive to convert existing structures and the standards are not as clear. Mr. Astles noted that most leases also allow landlords to charge back capital expenditures aimed at contributing to energy savings. Many tenants are reluctant to drive sustainability upgrades in existing buildings at the risk of incurring disproportionate rental increases. Today's tenants definitely express a desire for greener buildings, but the question remains about how much are they willing to pay to get it. Sandy McNair predicted that existing office stock will get converted faster than we think, with the driving force being the cost of electricity. Commercial properties may ultimately be forced to pay more for electricity than residential properties and the tenant community will therefore likely require landlords to go green and commit to keeping energy consumption low.

WHAT IS THE OUTLOOK FOR THE DEBT MARKET?

Moderator:

Ward McAllister, President & CEO, Ledingham McAllister Properties Ltd.

Panel:

Dean Atkins, Vice President, Mortgage Investments, B.C. Investment Management Corporation
Shirley Bennie, Vice President & Area Manager, Business Development Bank of Canada
Bruce Clarke, SVP & National Head, Commercial Real Estate, HSBC Bank Canada
James McPherson, President, Realtech Capital Group Inc.

Dean Atkins provided an overview of the mortgage market metrics over the past 12 months. He noted that mortgage interest rate spreads over five year Government of Canada (GOC) bonds rose to up to 400 basis points (bps) in the first quarter of 2009, and have since fallen back to the range of 180 bps. Given the relatively high mortgage rates, institutional lenders such as life insurance companies and pension funds added to the mortgage lending allocations throughout 2009, leading to further competition and lower rate spreads. Combined with a reduction through the year in GOC bond rates, the overall interest rates fell throughout 2009 to below 5%.

Mr. Atkins also described bcIMC's activity in the development loan sector, primarily in the residential sector, and stated their expectation that the Vancouver residential market and pricing should remain flat throughout the remainder of 2010 (with prices perhaps falling up to 10%), with concerns including the introduction of the HST, rising interest rates, affordability and tighter CMHC lending criteria. Lastly, he noted that there is more competition on the fixed term mortgage market than for development loans, particularly for large (over $50 million) development loans where most lenders continue to tread carefully.

Shirley Bennie discussed the push by the federal government to increase the activity of Business Development Bank of Canada (BDC) in the commercial real estate lending sector and the differences between BDC and traditional lenders. BDC purports to provide more flexible structures, higher loan to value ratios for commercial properties and up to 30 year terms.

Bruce Clarke, Senior Vice President and National Head, Commercial Real Estate, HSBC Bank Canada, advised that the lending sector is "back to normal", depending on what the definition of "normal" is. He noted that with the economy recovering and a reduction in "special credit loans", banks are looking to become more active, although access to capital is and will be different than in previous economic recoveries. At the same time, enhanced regulation and oversight by the Office of the Superintendent of Financial Institutions (OFSI) and the international Basel II Bank Regulation coming into effect, have had a significant impact on lending policies and activity. Among the impacts will be a "flight to quality" borrowers and an increased emphasis on overall credit limits for individual borrowers, which given the increasing scale of real estate development projects may affect a lender’s ability to make loans to existing clients with loans in place. He noted that banks have become less interested in increasing their balance sheets than in increasing the return on existing assets and from existing relationships, and are looking at what ancillary income can they earn from existing relationships.

Jim McPherson advised that lending is continuing to open up. More lenders have re-entered the market on the fixed term debt side and interest rate spreads have decreased to the range of 175 bps to 180 bps over GOC. Loan to value ratios are moving back into the 70% range and amortization periods are going back to 25 years. Mr. McPherson predicted continued downward pressure on rate spreads due to the number of lenders coming back into the market. He noted that construction loans are also getting back to the 75% to 80% loan to cost range, although not a lot of lenders are looking at larger development loans. There is once again an active market for mezzanine loans to provide developers with up to 50% of the equity required for construction projects, with pricing much more competitive than 18 months ago. Mezz loan interest rates having fallen from the "high teens" to the "low teens" or even lower. Areas which continue to have difficulty in obtaining loans include hotels, resorts and properties in smaller communities.

Some lenders have expressed that they are worried about being able to fill their allocation in 2010. This may be a result of diminished market activity, which is in the range of 15% below pre-recession levels.

In the question period, panelists noted that the bigger chartered banks are limiting loans to $50 million (as compared to up to $150 million prior to the economic downturn), resulting in the need for syndicating the loans. Panelists predicted that interest rate spreads will continue to decline.

THE VICTORIA REAL ESTATE MARKET: A PERFORMANCE REVIEW

Moderator:

Andrew Turner, President, Invermay Real Estate Advisors

Panel:

David Ganong, President, Canada ICI Capital (Victoria) Corporation
Robert Jawl, Jawl Properties Ltd.
Andrew Tong, Senior VP Acquisitions and Dispositions, Concert Properties Ltd.
Ty Whittaker, Vice President, Colliers International

Members of the panel seem to agree that quality industrial space is the best place to invest your money these days in Victoria, but such space is difficult to come by. In the recent years, the industrial market has appreciated significantly. Ty Whittaker noted that space can now command $12 per square foot (or perhaps even $14 psf for build to suit), which is an increase of several dollars per square foot over the past few years.

The panel also agreed that the strength of the Victoria office market lies in the fact that it is "boring". Robert Jawl had the benefit of comparing it with his time spent looking at properties while working in New York. He noted that while Victoria is not a very exciting place to invest, it doesn’t experience the extremes other markets face. The office tenant base has the advantage of providing product for the provincial government, which lends long-term stability and support to the office market. Andrew Tong noted that while investors may want to avoid the large downtown Calgary and Toronto markets, Victoria offers an advantage of smaller scale. Supply, though, is a problem.

None of the panel members were keen on investing in the retail market in Victoria. Mr. Whittaker noted that Victoria just doesn't have the necessary population growth to make retail attractive for investment.

The panel was also tepid on the multi-unit residential market in Victoria. Mr. Tong noted that developing A grade sites for condos may work, but he would stay away from B sites. Victoria has more foreclosure opportunities than pretty much anywhere else in Canada right now, but it does not have the depth of market to support developing all the opportunities. Historical absorption has been low in Victoria, and there are accordingly few buyers for available mega-projects. Mr. Tong noted that the demand for luxurious product is limited, although there still seems to be a demand for entry level condo space. Calgary and Toronto buyers seem to have vanished from the Victoria market, and condos have to be built to the local market. Without a quality brand and location, condos are best priced in the $300,000 – $320,000 range.

RESIDENTIAL MARKET: READING THE CRYSTAL BALL

Moderator:

Jennifer Podmore Russell, Senior Manager, Financial Advisor, Deloitte

Panel:

Ben Taddei, Chief Operating Officer, Parklane Homes
Richard Weir, Vice President, Bosa Development Corporation
George Wong, Owner, Magnum Projects Ltd.

The panel was cautiously optimistic about the state of the residential market in Vancouver. Jennifer Podmore Russell noted that the Vancouver market continues to be driven by immigration growth, which continues to meet or exceed expectations. The residential market was very responsive to the recent contraction. CMHC forecasts indicate that home starts this year will meet growth within the market, but not exceed it. Current new product launches are up significantly from last year, with nearly 45 launches taking place this year to date.

Richard Weir noted that banks are still in charge of determining what gets built and by whom. George Wong believes that it is more important than ever to talk to the market you intend to develop in to find out what they want. Mr. Wong believes the market to be unforgiving unless you are building in a hot spot. The Fraser Valley market has not rebounded as strongly as the Vancouver market.

There is little doubt that the market today has changed from two years ago. Ben Taddei noted that today, it's all about affordability and inventory. Affordability is at an all time low. Inventory is constrained by land supply and the approval process. Mr. Weir noted that there is now a lot of activity in the lower end price range. Mr. Wong noted that investors are not trigger-happy to buy, but instead are sitting on their cash looking for value. The investors in the current market are different from those two years ago. Gone are the flippers and present are first-time home buyers and those waiting for the right offering. Mainland Chinese buyers are still active investors in the Vancouver market.

The panel acknowledged that land prices have remained high. Mr. Taddei noted that land prices are even higher than what they were during the peak of the market two years ago for smaller product, multi-family developments. Mr. Weir believes that the spaces he has been looking at have decreased a bit, but that unrealistic asking prices are still expected, meaning that land will sit in the interim. If good product can be achieved on a site, developers may be willing to pay a premium for it.

The panel acknowledged that there are ongoing difficulties in dealing with municipalities. The approval process often takes far longer than it should. Mr. Weir noted that cost control for developers is critical. A number of outlying municipalities seem to have adopted Vancouver's model of extracting a portion of the supposed lift in value for amenity delivery. In the Fraser Valley, an increase in density does not always equate to an increase in value.

TENANT PERSPECTIVE: WHAT DOES THE FUTURE HOLD FOR RETAIL?

Moderator:

Ian Thomas, Chairman, Thomas Consultants Inc.

Panel:

Christine Day, CEO, Lululemon Athletica
Stephen Henderson, Co-CEO, Staburn Property Group
Tom Munro, Vice President, Real Estate & Store Development, Overwaitea Food Group

The number of LuLulemon Athletica stores has increased from 7 in 2004 to 98 in 2009. Sales generated in 2009 were $1,318 psf. LuLulemon's strategy is (i) differentiate itself in the market; (ii) build the brand in a way that the consumer sees; and (iii) develop a relationship with consumers based around trust. Ms. Day suggested that retailers not over expand their footprint in the market before they expand the footprint of their customers. It is important to understand how your brand is built and to identify what makes your store special. Ms. Day also added that consumers identify with your staff, want to know about local charities that you support, want to feel good about their neighbourhood and want their local community to be unique.

Tom Munro of Overwaitea Food Group talked about patterns to promote growth in the grocery industry, stressing the importance of providing quality service to customers that is true to the banner of the store. With Wal-Mart making steady inroads into the BC grocery market, grocery stores are having to do more to distance themselves from their competition. Mr. Munro advised that Overwaitea is accomplishing this through improved customer service, product offerings, in house brands and selling more prepared meals in certain locations. Mr. Munro also discussed "The Rise" at Cambie and 7th in Vancouver – a mixed-use, multi-level, high density site with Save-On-Foods, Home Depot, Winners and residential units. Using such terms as "urban chic" and "urban hip", this new location is working extremely well for Overwaitea, providing a shopping focus that Vancouver did not previously have.

From a developer's perspective, Stephen Henderson observed that retail tenants are seeking higher density. Today's retail economics are being driven by urban customers. Greenfield sites are no longer doable as tenants and landlords alike are looking for mixed-use developments with underground parking and high density. Smaller retailers have also recently come back to landlords asking about "Promotion Funds" and landlords are being asked to work with these tenants and arrange meetings with anchor tenants in order to help with promotions. Finally, Mr. Henderson noted the role of public authorities in the development process – with the City of Vancouver requiring parking ratios of 2.5/1000 s.f. and a requirement for 25% "alternative transportation" options, more and more creativity is being required from developers to solve issues such as parking.

MARKETING VANCOUVER: POST OLYMPIC EXPECTATIONS OR QUESTIONS?

Moderator:

John Tylee, Director of Research and Chief Economist, Vancouver Economic Development

Panel:

C. Tsuriel (Tsur) Somerville, Director, UBC Centre for Urban Economics and Real Estate, Sauder School of Business
Brent Toderian, Director of Planning, City of Vancouver

Dr. Tsur Somerville and Brent Toderian debated whether the 2010 Winter Olympics will result in economic benefit to Vancouver and the metropolitan region. Dr. Somerville took the position that there is no objective evidence that any city has received an economic benefit from hosting the Olympics, that there may have been better uses for the government funds used to host the Games and that the City’s focus on the Green economy and sustainability must be analyzed with an "at what cost" viewpoint. Mr. Toderian stated that the benefits of hosting the Games cannot be measured solely in economic terms and that the City not only will benefit in the future from having hosted the Games, but has done so already. Intangible benefits such as the development of facilities that will be converted to community infrastructure, the change in how residents use and view the use of our streets, the elimination of the "No Fun City" attitude and a change in the manner in which the City will welcome business to the downtown core are all positives.

IS THE PUBLIC-PRIVATE-PARTNERSHIP (PPP) MARKET WORTH PLAYING IN? THE EVOLUTION OF PPP'S IN THE BC REAL ESTATE MARKET, ITS PLAYERS, AND ITS COMMERCIAL TERMS

Moderator:

Winnie Shi, Director, KPMG

Panel:

Duncan Ball, Senior Vice President, Project Finance, Bilfinger Berger Project Investments Inc.
Larry Blain, CEO, Partnerships BC
Greg Lewis, Partner, Bull, Housser & Tupper LLP

While the other panellists spoke informatively and generally about Public Private Partnerships in BC (noting among other things that Canada is one of the three or four leaders globally, and BC is a leader within Canada) Duncan Ball connected with the audience by talking about the similarities and differences between P3's and commercial real estate projects. Two of his more interesting tables are set out below.

Metric Real Estate PPP
Debt to Equity 50–70% Debt / 50–30%Equity 90% Debt / 10% Equity
Coverage ratio 1.35x + 1.20x
Lease term Usually in 5yr increments Usually 25 to 35 yrs
Financing term Usually 5 to 10 yrs 25 to 35 yrs
Debt Providers Banks, lifecos, pension funds Project Finance banks, Lifecos, Capital markets
Debt Pricing Goc + 150 bps (5– 10 yrs) Goc + 250 bps (25+ yrs)
Equity IRR Cap rates of 7%–8.5%
9%-10.5% IRRs
12%– 14% IRRs
Key differences
  • Rents adjust over time
  • Residual value
  • Typically involves construction risk
  • Return on capital and return of capital
Tenure Freehold interest License
Lender's security Direct mortgage charge on asset Rights and entitlements are contained in the Project Agreement
Lender's remedy Right to foreclose Essential Assets. No rights to foreclose
Income source Triple net rent Availability payments
Residual Value Residual Value Risk No Residual value risk
Cash flow Cash flows adjust over time Cash flows are generally fixed for the life of the concession

UPDATE ON THE INDUSTRIAL REAL ESTATE MARKET

Moderator:

Robert Stokes, Senior Vice President, Cushman & Wakefield Ltd.

Panel:

John Conicella, Vice President, Managing Director of Development, WesGroup Properties LP
Tom Corsie, Vice President, Real Estate, Port Metro Vancouver
Maury Dubuque, Vice President Leasing, Bentall LP
Lawrence Green, President, Spire Developments

Robert Stokes provided an introduction to the panel and commented that although vacancy rates in our region have spiked since their highs of spring 2008, our region still has some of the lowest vacancy rates in Canada. Tom Corsie commented that the economic downturn and reduced consumption in the US has been severe for Vancouver Port business. He predicted that the US economy will eventually recover but expects that other international economies, especially in Europe and Asia, will recover at a significantly faster pace than the US.

Robert Stokes asked the panel to comment on the impacts of infrastructure development. In terms of growth, Tom Corsie advised that the Port is very bullish on long term container forecasting and is developing projects to increase capacity for container growth and the movement of goods. John Conicella commented that infrastructure was both our region's greatest opportunity and challenge in the future. $4.4 billion has been committed towards to infrastructure by the Provincial Government since 2008. In terms of infrastructure projects, the panel commented on the importance of the South Fraser Perimeter Road. 80% of the vacant industrial land in our region is located in the lands south of the Fraser River and, once complete, the South Fraser Perimeter Road will significantly increase access to Deltaport which is Vancouver's largest container terminal.

Lawrence Green commented that his company hasn't experienced major issues in respect to the leasing market. The focus has been more on keeping industrial buildings full rather than on lease rates. He commented that landlords have been willing to work with tenants by offering incentives and other potential advantages for staying, like rights of first refusal and options to purchase the premises. Muary Dubuque commented that although his company manages 39 million square feet of industrial space across the country, there have been relatively few defaults (17 in Canada, including 11 in Western Canada). Having spoken with a variety of brokers leading up today's discussion, Maury predicts that lease rates will be stable and will continue to hover around current lease rates for the next 12 months as landlords prefer to maintain current lease rates by providing tenant inducements and property improvements.

The panel observed that construction costs are down as much as 20-25% from the peak of spring 2008. There is continued downward pressure on construction costs as the trades are facing increased competition for limited work available for industrial sites. Panel members commented that they receive calls daily from various trades and architects soliciting work and expect that will continue in the short term. The panel was also requested to comment briefly on the movement towards green and noted that the demand for green or LEED standard industrial buildings are largely tenant driven and in our region, such demand, apart from large US companies with environmental stability mandates is not a primary focus for regional tenants in the current market economy.

WHAT ARE SOME OF THE KEY ISSUES FACING RENTAL APARTMENT INVESTORS AND WHAT STEPS SHOULD BE TAKEN TO PROTECT THEIR INVESTMENT?

Moderator:

Mark Goodman, The Goodman Report, Macdonald Commercial

Panel:

Michael Geller, B.Arch, MAIBC, FCIP, The Geller Group
Marg Gordon, Chief Executive Officer, BC Apartment Owners and Managers Association
Paul Richter, National Research Manager, RealNet Canada Inc.
Michael D. Oord, B.A., AACI, P. App., Senior Appraiser, Grover, Elliott & Co. Ltd.

Paul Richter indicated the 2-3% differential in cap rates that has been measured over the last 10 years is unlikely to change and that history will continue to repeat itself. He predicted that Vancouver's market will continue to trend upwards slightly before levelling off. The moderator asked Mr. Richter why, when looking at sales and value on price, cap rates continue to go up but overall values are staying about the same? Mr. Richter responded that this trend is mostly a result of specific locations where the deals are happening. For example, Burnaby and Coquitlam tend to post higher values for rental properties. In response to a question from the moderator as to why an investor would accept cap rates of 3 ½ to 5 ½ in the apartment market when there are other options, Mr. Richter suggested that investors see value in the "potential" of these buildings and find the long history of low vacancy rates attractive. Apartment buildings are less of a challenge to maintain as an asset than a strip mall/industrial complex where sometimes very high vacancies are experienced. The approach of these investors is to renew the building and increase rents in order to increase their return.

Michael Oord discussed how investors look at "highest and best use" of apartment buildings, and said that investors consider "the optimum use of the property that is legally possible and financially feasible". He noted that whereas investors used to look at apartment buildings as investments in land as redevelopment sites, the moratorium on the demolition of rental housing and the requirement to replace 100% of any demolished rental suites in the City of Vancouver has meant that repositioning seriously aging rental buildings has become the choice for achieving the "highest and best use" of these properties. "Repositioning" typically includes vacating and renovating, adding units, adding buildings and reducing expenses through fixing aging heating systems, etc. Mr. Oord noted that all of these factors come in to play in the Vancouver market, which has likely contributed to lower cap rates for apartment building investments. Achieving the "highest and best use" is the #1 determinant in establishing value, and rental buildings showing a 2-3% cap rate have undoubtedly been repositioned. Mr. Oord said that he’s seen investors obtain considerable upside with rents 50% higher than the CMHC average simply by removing tenants, renovating and repositioning.

Michael Geller was asked by the moderator why developers are having such great difficulty in building the desperately needed rental units to solve the rental housing crisis when they are so proficient at building condominiums. He answered that the cost of creating rental housing is simply not offset by the rents that a developer/investor can charge. The disparity between economic rent (the revenues needed to cover costs) and market rent is too great. He suggested that programs such as the Short Term Incentives for Rental Housing (STIR) program in the City of Vancouver, which offers incentives to encourage the creation of new market rental housing, provide the best solution to encourage developers to create new rental housing. However, he noted that three of the most high profile projects under the STIR program were set to take place in the West End of Vancouver and that each project has unfortunately faced major opposition from existing residents of the West End. Mr. Geller said that the STIR program is not dead and that the concept of offering density bonuses and other similar credits to developers is a good one and he predicted that developers will continue to come forward. Mr. Oord did not necessarily agree. In his experience since the STIR program was created, he’s only seen one project where STIR was successfully applied, leading him to conclude that maybe the economics just aren’t there. He also noted that any buildings created under STIR are covenanted as rental buildings for the life of the building.

Marg Gordon noted that the main membership base of the BC Apartment Owners and Managers Association is now made up of investment owners. Most new units coming onto the rental market are condo units. No new purpose built apartment buildings are being developed. She said that the market is simply not meeting Vancouver’s housing needs. Most rental buildings in the City are 50-60 years old and are at the end of their life cycle. She noted that there are so many interventions by all levels of government that the hodge podge of policies and solutions is basically a disincentive to doing business in the rental market, and that this threatens rental housing viability in the City. She said that rent control is another issue that is suppressing the industry. Rent control ignores the out of control costs faced by many apartment investors, particularly in respect of the older rental buildings. Ms. Gordon explained that there simply are not the capital dollars in the hands of apartment investors to undertake the required capital improvements to keep their buildings viable. Eviction, renovation and subsequent building repopulation is currently the only process available to investors to resuscitate buildings and maintain rental units, thereby ensuring a reasonable return on the investment. Michael Oord also noted that the gap between wages and land values/rents is an issue in the City and that the market needs smaller units and a more affordable inventory. HST is expected to have a disadvantageous effect on investors in apartment buildings, whether it be with respect to renovating and resuscitating these buildings or just operating them on a daily basis. She also said that her association continues to lobby the provincial government for changes to the Residential Tenancy Act that balance out landlords’ and tenants’ rights.

The panellists all noted that there are many factors affecting the rental housing investment sector, ranging from political issues and deteriorating rental stock to the demolition moratorium and the opposition of existing residents in certain areas. They agreed that for investment in the rental housing market to make sense, investors must be able to increase rents or decrease expenses, or achieve a combination of both. Michael Geller noted that the challenge of increasing rental housing and providing investors with a viable investment could potentially be met by the regeneration of older buildings with a mix of rental and market units. The panellists also discussed parking requirements, and Michael Geller suggested that the City should turn its minimum parking standards into maximums and allow investor landlords to make better use of extra underground stalls and surface lots.

FINAL COMMENTS ON THE RISKS, TRENDS, CHALLENGES, AND OPPORTUNITIES FOR THE NEXT 12-24 MONTHS

Moderator:

Andrew Bibby, President and Chief Executive Officer, Grosvenor Americas

Panel:

Eric Carlson, President & CEO, Anthem Properties
Remco Daal, President and Chief Operating Officer Canada, Bentall LP
Scott Hutcheson, Chairman & CEO, Aspen Properties Ltd.
Michael Kitt, Executive Vice President, Oxford Properties Group

Andrew Bibby posed a number of interesting questions to the panel.

What will drive the Vancouver real estate market as the world economy recovers?

Eric Carlson's view is that, while the US and Europe struggle to recover in the face of massive debt problems, demand for commodities by developing countries will continue to positively influence the economy of BC and Vancouver. Steady immigration of 22,000 to 35,000 people a year to Vancouver will continue, ensuring a steady demand for real estate of all kinds. Compared to his home base of Alberta, where energy dominates, Scott Hutcheson likes the diversity of the BC economy. Meanwhile, Michael Kitt and Remco Daal agreed that fear amongst institutional money managers – of both stock markets calamity and government defaults – is a positive for the real estate industry, and Vancouver in particular as a relatively stable market.

Will rising interest rates have a big effect on residential development?

Interest rates will obviously affect affordability and pricing, but Eric Carlson believes that as long as people keeping moving to the Lower Mainland demand will be steady. Developers will meet steady demand by building the right product.

With $1.5 trillion in debt maturing in the next 4 years south of the border, are we immune to a potential US property collapse?

Remco Daal sees Vancouver’s strong fundamentals of high quality and reliable income streams as insulating us from serious risk. Michael Kitt has a slightly different view, arguing that we are competing in a global marketplace and we cannot expect to trade at a premium to the US forever. He says that Oxford Properties sees the US debt crisis as a unique opportunity to buy, which means diverting their investment capital from Canada to the US.

If retail cap rates cannot fall any further, how can pension funds achieve the benchmark returns they need?

The panellists who invest for pension funds agreed with the premise that they cannot expect capital gains and therefore must drive income, and there is more opportunity to do that in retail than office. Having said that, Remco Daal opined that until cap rates get back over 7% he does not expect to see pension funds as retail buyers.

In Vancouver, we have seen a pattern over the last several decades where no one builds office towers for years and years and then there is a flurry of activity. Are we overbuilding now?

Remco Daal noted that Vancouver’s development process is lengthy, tenants are smaller and it is difficult to pre-lease, but once you have built your tower, you have a great asset. Michael Kitt agreed that it is precisely the barriers to entry in Vancouver that make it an attractive and stable market. The small building sizes relative to other downtown markets reduce risk to a comfortable level and low volatility in rents work together to make office developers comfortable here. Scott Hutcheson, speaking from a Calgary perspective, agrees that there is much lower risk of oversupply in Vancouver.

Some of the speakers today suggested that the market is willing to pay a premium for sustainability, for green product. Is that really the case?

The panellists disagreed to some extent on this question. On the institutional side, Michael Kitt and Remco Daal talked about a commitment to sustainability within their own organizations as the right thing to so and a reality that major government and large corporate tenants are demanding it. On the other hand, Scott Hutcheson noted that during the economic crisis, tenants were in survival mode and no one was asking for LEED. Eric Carlson agreed, offering the opinion that is only the politics that drive public sector and institutional tenants to require it. On the private side, it is like selling condos – there are some extra features that buyers will only want if they do not have to pay extra. That does not mean that it is not worthwhile using sustainable design, but it is a value proposition. If, for example, sustainable design means energy costs will be lower, there is value.

Didn't they say the same thing last year? Links to Feature Articles from past Vancouver Real Estate Forums:

2009 Vancouver Real Estate Forum

2008 Vancouver Real Estate Forum

2007 Vancouver Real Estate Forum

2006 Vancouver Real Estate Forum