Lacklustre forecasts keeps buyers sidelined and prices in check for commercial real estate in 2011

BY PETER MITHAM/FRANK O'BRIEN

Recovery on the economic front will go hand in hand with retail and office investment in 2011, as developers cautiously brush off plans for towers downtown and improved housing starts boost demand in the suburbs for retail projects.

But this year will be characterized by hard bargaining on prices and incentives as doubts remain about the depth and speed of the economic recovery.

While Metro Vancouver retail remains "the most sought-after property type" in Canada, according to a third-quarter report by Avison Young, sales tallies are off across the board from the second quarter as activity slowed in the second half of 2010 to the lowest level since the first quarter of 2009.

Overall investment sales totalled $527.3 million in the third quarter of 2010, including $68.8 million worth of office deals and $143.7 million worth of retail sales.

Those deals include South Surrey's South Point Exchange, which sold to a private investor for $91 million, and Bosa Development Corp.'s sale of Semiahmoo Shopping Centre to First Capital Realty Inc. for $82.7 million - both driven by strong growth in surrounding residential communities.

But the deals also highlight the shift from the bargain-taking deal-making that characterized the first half of the year to a strategic rejigging of portfolios in the second half that heralds more stable conditions as owners prepare for the long term.

Based on interviews in the third quarter, Colliers International reported that 61 per cent of investors were looking to expand their portfolios, down slightly from six months earlier when 65 per cent were looking to expand. On the other hand, approximately 22 per cent were looking to rebalance.

Close to two-fifths of respondents attributed the shift in emphasis to a desire to shift asset classes, while other key factors were linked to advantages to be gained from location, liquidity and leverage. Approximately 17 per cent were looking to trade up or trade down and 6 per cent were looking to increase leverage.

A further 28 per cent refused to disclose the reasons for rebalancing their portfolios, but the several factors point to a hunkering down for the long term in the face of lacklustre growth for the year ahead.

Modest expectations

Central 1 Credit Union is calling for no more than 2.4 per cent growth in B.C.'s real GDP for 2011, while the Colliers survey notes that 83 per cent of investors are maintaining, minimizing or decreasing their exposure to risk. While investors want growth, they're not willing to take a hit in order to achieve it.

This has put safe locales such as Vancouver at centre stage.

Colliers notes that the proportion of investors keen to divest themselves of properties in Greater Toronto is more than double those keen to invest (53 per cent versus 26 per cent), while Vancouver was an appealing investment locale to 18 per cent of investors - with just 12 per cent considering selling their Vancouver-area holdings.

A panel discussion hosted by the commercial real estate association NAIOP in the last quarter of 2011 underscored the appeal Vancouver holds for buyers.

"Investors want to have hope, they want to believe in a future, and I just think Vancouver has this poster boy, poster girl perception that we have it all," said panellist Kevin Meikle, senior vice-president with Cushman & Wakefield Ltd. in Vancouver. "Just to have that underlying sentiment, I think, will bode well for our B.C. market."

Of course the sentiment may not be true - Meikle said the perception is based on the diverse economy of B.C. rather than its strength or vibrancy - but the limited supply of potential investment real estate keeps demand steady for the assets that do become available.

Meikle expects hotel properties to follow retail as the next popular asset category among investors as institutional owners continue to rebalance portfolios to keep pace with the slow but emerging recovery.

On the other hand, Colliers executive vice-president Avtar Bains expects office properties to see strong demand as the economy and tenants' requirements for space picks up and cash flows improve.

New space includes 71,500 square feet in the mixed-use tower adjacent to the Rosewood Hotel Georgia redevelopment and Jameson House on Hastings Street; the new office towers being discussed are primarily on sites owned by institutions that have desire to part with their assets.

"Owning a building in downtown Vancouver is almost like being a member of an exclusive club. And getting into that club is really difficult," Bains said, noting that 34 of the top 45 buildings downtown are owned by just five groups.

Still, the tight ownership circle and lack of new supply fuels demand for new assets to flesh out the class. While smaller investors are buying up lower-tier properties to the east of downtown to get a slice of the office market, the major owners are able to build top-tier product with the help of deep pockets and an attractive financing environment.

While banks are still demanding solid commitments before releasing financing for construction, institutional builders have the wherewithal to move forward with projects.

New office towers

This could spur development of two to three new towers in Vancouver, CB Richard Ellis executive vice-president Jim Szabo told NAIOP. While much of the rest of the continent grapples with negative absorption, a tight market in Vancouver is inviting new construction and investment.

"The market could probably withstand something in the neighbourhood of two, possibly three office towers downtown in that 700,000-to-a-million-square-feet [range] because they won't all be done at the same time," Szabo said.

Unlike Calgary, where speculative construction surged on the back of an oil and gas boom, a more conservative character in Vancouver's diverse, small-tenant market means solid pre-leasing is needed for at least half the potential development sites even as downtown vacancies in triple-A space remain a low 4.4 per cent.

Vancouver is now entertaining or anticipating proposals for six sites around the downtown core, including:

-- 520 West Georgia Street (500,000 square feet) by Westbank Projects Corp.;

-- 745 Thurlow Street (380,000 square feet) by Bentall Capital;

-- 800 Griffiths Way (240,000 square feet) by Aquilini Investment Group;

-- 400-block West Georgia Street (480,000 square feet) by Austeville Properties Ltd.;

-- 1000-block West Hastings (260,000 square feet) by Oxford Properties Group; and

-- 1200-block Burrard Street (190,000 square feet) by Reliance Holdings and the Pattison Group.

"About half of them are pension fund-owned sites and the other half are privately owned sites," Szabo said of the possible construction sites. But he cautioned, "Privately owned sites are going to need construction financing to get off the ground, and they're going to need preleasing. And preleasing in this city is difficult."

Several large tenants requiring in the vicinity of 100,000 square feet of space will be reviewing lease arrangements in 2011 in anticipation of a 2014-15 renewal date, meaning new projects have a pool of potential tenants. The current market constraints stand to keep supply limited, support rising rents and ensure a secure market for investors.

"I don't see any possibility whatsoever that downtown Vancouver will match the graph of downtown Calgary," Bains observed during the NAIOP discussion. "That's one of the innate protections we have in our marketplace - that we are so diversified that no one's going to come into the marketplace and want 400,000 or 500,000 or 600,000 square feet all at once."

Industrial

Metro Vancouver's industrial vacancy rate increased to near 5 per cent in the final months of 2010 and, unless there is a sudden uptick in demand, will likely remain close to that level for 2011.

In some key markets the stubbornly high land prices have convinced owner-operators to look at retrofitting older buildings, while speculators are turning to strata units because it has become "economically unfeasible" to build for lease, according to Avison Young.

Industrial lease rates across the region are down from 10 per cent to 15 per cent, and some landlords - especially those holding big-bay space - are providing generous incentives to draw tenants in, said DTZ Barnicke.

Not that strata space is proving a boon for spec builders, either. Sales of new buildings above 40,000 square feet have seen prices drop as low as $100 per square foot, lower than the cost of replacement.

Yet land values are still in the $900,000-per-acre range in the Fraser Valley and easily top $1 million in Burnaby, Richmond or Vancouver.

So, with eight million square feet of industrial space sitting vacant and land prices holding steady as the new year dawns, most expect little speculative construction this year.

"New construction has led to an oversupply," noted agent Steve Caldwell of DTZ Barnicke, who forecasts this will lead to lower lease rates, particularly in larger industrial properties.

A bright spot, he notes, is in new small strata space of between 2,000 to 4,000 square feet, "which will likely hold steady."

An overview of the challenges facing the Metro industrial market is in Delta, which has 21 million square feet of space, 9.2 per cent of it vacant. But this is one market that could prove the first to pick up if economic conditions improve.

The $658 million South Fraser Perimeter Road - running from Deltaport to Highway 1 - starts this year and is expected to spur speculative construction.

Also, the Tsawwassen First Nation is expected to finalize a deal soon to develop 335 acres of land adjacent to Deltaport.

All this is in the future, however, and will not lead to a big improvement in Delta's industrial market this year. Like the rest of Metro Vancouver, 2011 will be characterized by tenants and owner-occupiers "remaining on the sidelines until they witness sustained improvement in their business and the economy", notes Avison Young.

Multi-family

Despite stratospheric prices and the lowest capitalization rates in the country, sales of apartment buildings is expected to be one of the stars in the 2011 real estate environment. This is one market where big investors seem willing to open their wallets in a search for security and cash flow.

"There is no question that the multi-family market will remain strong this year," said Bains, noting that pension funds and other institutional investors have created a new diversity of buyers.

Bains, who one year ago quarterbacked the sale of two of the largest apartment portfolios in the city- Beach Towers and Langara Gardens that sold for a total of $280 million - said only reluctant vendors are keeping the market reined in.

Bains noted the low rental vacancy rate - around 1.5 per cent - little increase in new product and an expected 40,000 newcomers will keep apartment values rising.

This would mean another increase in prices that soared 16 per cent in 2010 from a year earlier to a new average high of $218,266 per apartment in the last six months of 2010. Most sales action is coming in expensive areas, including Vancouver's West End and South Granville. In the West End - the hottest market last year with 11 buildings selling - the average price "per door" was $243,943, according to a survey by David Goodman of Macdonald Commercial.

from Western Investor, January 2011