An overheated real estate market in North America was one of the culprits of this financial crisis. Those looking for a quick recovery in the sector are going to be sorely disappointed according to some of the top property buyers on the continent.
Speaking at CIBC’s 14th annual North American Real Estate Conference, representatives of four of the top commercial property managers on the continent outlined how difficult the real market has become due to the global credit crisis.
More stringent lending conditions have drastically reduced the purchasing power of property buyers, particularly in the U.S. and UK, and as a result property prices have dropped. The good news is there have been very few instances of forced selling as yet, such as the recent sale of the John Hancock office tower in Boston which sold for $661 million this month — about half it’s purchase price of $1.3 billion in 2006.
None of the panelists have had to sell, meaning the losses of property value in the market are not being realized. Nonetheless, the devaluation taking hold of property prices is concerning, and they expect forced sales of property may play a larger role in the coming year.
“Our banking system continues to be in very bad shape. There is simply no money for anybody,” said David Henry, president and vice chairman of U.S.-based Kimco Realty Corporation. “What started as these small cracks in the ice about a year and half ago has spread into a major credit crisis for all types of assets.
“All of that bodes ill for real estate fundamentals. It bodes ill for all of us in the independent real estate industry. There is a growing acceptance by sellers that they really have to get on with it and sell at prices they don’t want too.”
There are attractive opportunities for buyers in this market. For the most part, leasing vacancies on commercial property remain low and tenants are creating an income stream that provides a nice capitalization rate (cap rate) against the lower price of properties.
“We have almost a 99% occupancy rate in Canada and in the U.S. it’s 96%,” said Tom Farley, president and CEO of Canadian property giant Brookfield Properties Corporation. “We have an average turnover of about seven years, so we can weather this storm. We’re focused on diverse capital. Anybody who has capital is going to come out a winner in this.”
Brookfield was the last company to purchase an AAA office tower in Toronto, the TD Canada Trust Tower, which it bought for $723/square foot, at cap rate of 7.5%.
When asked what he would sell the property for, Farley answered “$723 a foot.”
That price is a little too steep, said Andrea Stephen, executive vice-president, investments for Cadillac Fairview Corporation. “Last time we bought an office building in downtown Toronto was in 2001. At the time, we paid $300 a foot, and it seemed so expensive. In hindsight it wasn’t. In terms of cap rates and yields we’re probably back to those levels.”
The increase in cap rates is not something they are happy about, as in this case it is due to falling values, rather than rising revenues. Property managers are going do whatever they can to avoid selling, since many properties were purchased at higher valuations.
“Until the debt markets return to some level of normalcy, I think it’s going to be hard to see any return of the market. There are people who have capital who are waiting for distressed situation. If a seller is in distress, you see deals will get done,” Stephen said.
Property buyers will have to borrow at a much higher interest rate, since the pool of lenders has contracted. The lucrative mortgage backed security market (MBS) that fueled the run-up in prices in the earlier part of this decade is essentially dead.
“There is definitely a transfer of economics from the equity owner to the lender these days,” said Kimco’s Henry. “We’re a very active borrower from life insurance companies in the United States. We used to be able to borrow at 6%, now it’s 7.5% and climbing a bit. The life companies themselves, which were historically about 17% to 18% of the market, are now about the only aggressive commercial real estate lenders there are. The commercial banks are not lending any more and there is no longer a securitized lending environment.”
All of these factors are coming down hard on property owners.
“You’ve got three bad things happening if you’re an equity owner. You’ve got your net operating income eroding; you’ve got cap rates going up; and you’re dealing with higher debt rates and higher spreads from the lenders,” Henry said. “I think it’s going to be a lot worse in the coming year. You’ve got this massive wave of maturing loans, there will be a massive amount of workouts. There will be some extension, but there will be very high profile forced sales, more sales like the Hancock building and 1540 Broadway building — which sold for about a third of what they bought it for two years ago.”
Dori Segal, president and CEO of First Capital Realty said making money in real estate may return to its fundamentals, which is buying and developing property, as opposed to overpaying and hoping the market brings a better sale price.
“The business [we’re in] with shopping centres was to create sweat equity. That’s how many of us got started and how we made money. We told the vendor we could buy the property and we couldn’t. We found a lender and we asked to have a loan on the property with the equity we would have on closing — which of course we didn’t have. Then we found a tenant and told them we owned the building so they could do a list with us — of course we didn’t own the building,” he said. “That was the early 1990s. By the time 120 days went by, there was sweat equity we put into the property. You either expanded the property or you brought a supermarket to an empty space.”
He added, “I think what motivates us, is you want to buy properties where, in the next five to 10 years from its acquisition, you create enough sweat equity where you make some money. Hopefully there won’t be any refinancing issues during that period because the property is worth more than what you paid for, but not because the market went with us, but because we created that sweat equity.”
(04/13/09)
 | Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com |