Real estate valuations have been difficult to control since the onset of the pandemic, and a February 23 online panel at the annual RealCapital conference focused on these challenges.
Aaron Cameron, assistant vice president of business arrangement at First National Financial LP, said Canada Mortgage and Housing Corporation (CMHC) will continue its stable underwriting approach for insured products, which is good for lenders and apartment owners.
In other sectors, lenders trust their internal valuation approaches as much as their expertise. While the cost of reviews has come down, Cameron believes it could impact quality as well, noting that some companies may be rushing through the process.
“It is difficult to know where the rents are going in each asset class at this time, perhaps with the exception and with the exception of industry,” he said, noting that industrial rents continued to increase.
âTransactional accounts often come from jurisdictions and places that are not necessarily really comparable. They can be 18-24 months old, so you can’t put much weight on them.
More equity, less leverage
Scott MacPherson, Vancouver-based managing director of Cushman & Wakefield’s Equity, Debt and Structured Finance group, said lenders are looking for a lot more equity in development deals. Thus, some companies may need to call on financial partners to finance projects.
MacPherson said his company doesn’t look too closely at cap rates when underwriting for clients, but focuses more on the weighted average cost of capital and makes sure there is a positive return above this cost.
Pre-pandemic deals for commercial properties would often have 70% leverage, but that figure drops to 55-65% in most cases, according to Cameron.
He said no one is going above 50 or 55 percent leverage for office and retail assets in Alberta if any offers are made because they aren’t comfortable with valuations. and the difficult economic conditions in the province.
âLand is what people will flock to in a crisis because it is what you can hold onto and overcome short-term impacts,â said Jaime McKenna, Managing Director and Head of Real Estate Group at Fengate Asset Management. .
MacPherson said peak prices for land licensed for condominium development in Vancouver have fallen from over $ 500 per square foot to around $ 300.
âWith declining revenues for absorption and fixed costs remaining essentially at the same level as in 2019, it is difficult to make up that difference. The residual value of the land must change. It is the only way the economy works.
The value of multi-family lots in Toronto has not been as badly affected as Vancouver, but it is likely close behind for the same reasons, according to MacPherson.
In Montreal, condominium land prices weren’t as affected because the city didn’t have as many existing products, MacPherson said. He expects more multi-family development there and in other large cities in Quebec.
MacPherson said industrial land across the country, particularly in Vancouver, has become more expensive.
McKenna said Fengate was considering apartments, condos and industrial development land. He explores more outside of urban cores, where prices have generally held up but where there are more favorable conditions and longer shutdowns.
Fengate is also considering acquiring land to change its use, McKenna said, and will sue the untitled land if it has a good idea of ââwhere the property could be in five years.
Development, retail concerns
While 2020 has definitely been a sluggish year for brick-and-mortar retailers and much of the real estate they occupy, MacPherson said grocery store-anchored sites and well-located ones with stable national tenants are still expected to. be fine during the pandemic.
The challenges will remain with retail and big box stores, and MacPherson said a lot of creativity and fairness will be needed to reallocate locations that continue to struggle or fail to survive.
Fengate’s portfolio of small businesses has held up well thanks to good credit tenants. He examines commercial intensification projects where properties are complementary to residential games.
Retail space represents around five percent of Killam Apartment REIT’s (KMP-UN-T) portfolio and it has acquired assets with potential redevelopment opportunities, according to CFO Dale Noseworthy.
âThe biggest challenge right now is the exit strategies and what you need to underwrite,â Cameron said of the development proformas.
Rising costs are always a risk, which is why Cameron said you need to make sure you partner with developers who have the cash and the means to manage that risk.
MacPherson said he’s having difficult and sometimes pessimistic discussions with developers as his company looks at things more difficult and more realistically. It seeks to protect the investors it involves, as well as the flagship projects of the sponsors.
Fengate asset management
McKenna said the apartments in which Fengate currently owns an interest are under development. Rents held up outside the GTA, which has been under downward pressure, but she believes they will recover before her apartments are ready to rent.
Industrial properties have been a hot acquisition target and the growth in rents has pushed up values. McKenna is “a little concerned about the Amazon effect” and the potential contraction of the millions of square feet of industrial space he occupies and has built.
âWe’re paying more attention to 100,000 to 200,000 square foot floorboards compared to mega-bombers,â McKenna said. She believes there is a solid future in the industrial asset class as long as expectations remain realistic.
Suburban Fengate offices have experienced some compression in rent and value due to longer periods between lease expiration and relocation, according to McKenna.
Student housing ratings have been hit hard as buildings are 20-50% occupied due to school closures and COVID-19 precautions. The senior sector is also affected.
âOur senior portfolio has definitely contracted in value this year because we’ve seen a significant increase in the number of vacancies,â McKenna said. “We are currently in the low to mid 80s and we know it will take well over a year for this to burn off.”
McKenna said all of Fengate’s acquisitions in 2020 were off-market and had a different structure, with deals often focusing less on price and more on terms.
Killam Apartment REIT
Killam enjoyed its second year of acquisitions in 2020, although Noseworthy said much of its activity took place before March. The majority of its transactions were off-market.
She hasn’t seen much change in apartment buying over the past year and rents have generally held up well across Canada.
Killam primarily uses CMHC-assured financing and has good covenants and long-term relationships with other supporting lenders. Its projects are 60 to 65 percent in debt and don’t maximize loan availability, according to Noseworthy.
âThere are a lot of buyers and deals are going on,â Noseworthy said.
Killam expanded its multi-family repositioning program and was able to increase rents by 25% by investing an average of about $ 25,000 per unit. Noseworthy said he is also seeing “really healthy” valuation differentials on multi-family unit sales in almost every city.
Killam has six ongoing projects and 10 years of development in its pipeline.
âWe’re aiming for a return of around five percent, but we want to see a 100 to 150 basis point spread in terms of the value we’re creating,â Noseworthy said.
Killam is based in Halifax, which is also its biggest market and enjoys a great appetite for housing. Noseworthy said the trend towards remote working is leading more and more people to relocate to Nova Scotia’s capital, whose apartment sector also benefits from universities’ proximity to the city center.
Killam has only one multi-family apartment building in downtown Toronto, and Noseworthy said he’s doing well. The company is also optimistic and is increasing its presence in the southwestern Ontario cities of Cambridge, Kitchener and Waterloo.
âSuburban Alberta, for our assets, is doing pretty well,â Noseworthy said. âThe city center is where the challenge lies.
âThere are a lot of moving parts and each market and submarket evolves differently. “