Many factors can affect whether a real estate firm should put their money into a property or not. Downturns in the economy, population growth and long-term return on investment all usually play an important role.
Over the years, these priorities have shifted, and so have investor strategies for managing risk and generating ROI. In PwC Canada’s 2020 report on the Canadian real estate investment landscape, major closures of retailers are creating a subdued sentiment, and the single-family housing market has come under pressure as affordability becomes an issue.
“With high asset prices and rising costs for land and labor, our survey reveals declining business prospects overall,” the report reads. “As increases in foreign direct investment and the large amount of domestic capital crowd out smaller players, it is no surprise that our 2020 emerging trends barometer shows many in the industry are in a holding pattern.”
Real estate investors must take market trends into account and do what they’ve always done: adapt strategies accordingly.
But how have these strategies changed? We spoke with Canadian real estate experts who have insight on more recent developments in the last five years, in contrast to the overall evolution in the last decade. Scott Figler, national manager at real estate services firm, JLL Canada, took on the role in Canada last year. Meanwhile, Chris Langstaff, senior vice-president of research and strategy at LaSalle Investment Management, has worked in his role since 2006.
Investing in guarantees vs. potential
For Figler, the most important factor is in the build potential of the property; for outdated or operational industrial or office buildings, investors would consider when the current lease expires so they can renovate and charge higher rent.
“If it is a high quality industrial or office building, an investor would want to know who the tenants are, how solid their cash flow is and how easy it might be for them to break their lease,” said Figler.
In 2017, LaSalle launched a core investment fund in Canada targeting properties in major markets, with a goal of generating predictable income on high-quality properties. Langstaff noted that, in recent years, there has been an industry shift to upgrading buildings and signing long-term leases, as investors anticipate a potential recession. When the 2009 recession happened, larger, long-term investors with stable, core assets did not panic and understood they might have to take a hit on some properties.
“It’s more of a cyclical thing. Generally speaking, there’s still an appetite for core and there’s still an appetite for value-add,” Langstaff said. “When things do start to go south a little bit… people will retreat to the safety of more income-oriented real estate like say apartments or perhaps even long-term leased industrial.”
Retail properties generally follow the same rules, but Figler said that densification trends are driving what investors look for in urban areas. In Toronto and Vancouver, the vacancy rate has fallen below one percent. “An investor would want to know what potential exists on the parking lot so they could construct an office building, residential units, or additional retail to support the existing building,” Figler said.
This is having a big impact on how investors perform due diligence. Access to transit is a major factor, and properties within walking distance of major areas command a premium, he said. “Investors are looking for any opportunity to build more housing. Building housing on retail parking lots is a logical win-win since there is great need for housing, and additional housing next to a retail centre will boost sales,” Figler said.
“These markets also have good exposure to the Canadian tech market, where large investors see long-term growth,” said Langstaff. However, they are also careful to avoid jumping on trends right away. An example is WeWork, which had to pull out of an upcoming IPO after revealing significant revenue losses. While properties like co-working spaces can be risky, properties such as apartments can weather downturns well and guarantee stable long-term income.
As investors anticipate future risk and uncertainty, there can be different strategy by size.
Figler said that large funds and REITs are focusing on high-density areas, though some investors might see a higher return on investment if they make the right moves. “RioCan is selling off anything that is not in Toronto, Vancouver, Montreal, Ottawa, Calgary or Edmonton,” he said. “This trend is providing significant opportunity for smaller, usually privately owned investment funds, to acquire properties in Canada that these funds are divesting.”
Recovering from losses
Of course, poor returns on investments do happen. For Figler and Langstaff, there are several ways to approach this.
“One is to bundle several underperforming properties into a portfolio sale that includes a few strong properties,” Figler said. For example, Choice Properties recently sold off an entire portfolio of underperforming Canadian properties, mostly in small towns, for $426 million.
Langstaff goes back to the 2009 recession to explain one strategy of recovering from losses. Canada did not suffer as much as other markets as larger firms didn’t leverage mortgage debt in their properties. With stable core assets, these investors played the long game.
“Our strategy at the time was to shore up those assets that have some leasing deficiencies. A lot of investors had to drop their rents that they underwrote at a much higher level and then lease up space at a lower rent,” he said. “It’s better to have this lease at least paying some rent and paying the recoveries, than having nothing there.”
Note: This is intended to be used as general information only and does not constitute investment advice. Please conduct your own research before making any investment decisions.
Jessica Galang is a tech journalist who has been tracking the Canadian tech ecosystem for the last several years. In the past, she was news editor at BetaKit and a reporter at The Logic, interviewing hundreds of entrepreneurs in emerging industries.