By Graeme Webster, Koble Commercial Real Estate & Brokerage.
Over the past 10 years, we have seen a transition in types of active buyers in the Ottawa commercial real estate market, most notably between $2 to $20 million. The most recent change has occurred over the past 36 months.
Up until 2007
It was only 10 years ago that we witnessed the subprime mortgage meltdown in the US and the ensuing financial crisis. Up until that time, we were in a seller’s market and most of the buyers in the $1 to $20 million range for commercial real estate were Real Estate Investment Trusts (REIT), institutions, developers and some professional syndicators, along with long-term real estate family investors.
Deals were plentiful and competition was everywhere. It didn’t matter if properties were fully leased, or had vacancy, there was always a buyer looking to place capital. During this time frame, the market relied on projected future growth, aggressive leasing assumptions and the competing low cost of capital. Today’s fundamentals seemed to be an afterthought for most deals. In August 2007, when the subprime crisis began to affect the lending market and Ottawa’s commercial real estate market, transactions in this size range essentially came to a standstill. Lenders weren’t lending and buyers paused, assuming that the prices of real estate would plummet.
2008 to 2012
Prices didn’t plummet, but the transactions seemed to be on hold. It felt like the market had changed to a buyer’s market overnight, but values didn’t drop and sellers didn’t suffer. Although many lenders became less active, buyers were still able to nance deals from traditional lenders who had tightened up their lending criteria.
During this time, there was an emergence of local professional real estate buyers and some institutional buyers with local representation. They often had in-house management and construction teams, sometimes their own leasing team. The active buyers during this period understood the fundamentals of the leasing market and the overall economy in the Ottawa area, and they were pricing any risk with respect to vacancy or any potential risk in the specific asset class, ending up with some excellent deals.
2013 to Present
Over the last 36 months, a new type of buyer has entered the market for high-quality commercial real estate with stable returns. These new buyers are people who are frustrated with their stock market returns, or are looking to diversify their portfolio. They include local private high net worth investors such as doctors, surgeons, accountants, lawyers, entrepreneurs, federal employees and local private families. Some of them are investing for the first time, while others are looking for additional commercial real estate investments.
So what has changed for these buyers?
Everyone knows that we are in an all-time low interest rate environment with today’s Government of Canada 5-year bond yield: 0.66%, compared with 4.572% 9 years ago. With the access to inexpensive debt, banks aggressively lending on longer amortizations, and higher loan-to-value ratios, the private investor has been enticed into the market.
These private individuals also look at lending differently. For example, physicians with professional holding companies have been able to leverage their holding company funds as security.
2. Asset Class
Private investors are investing in what they understand, not in speculative opportunities. Many possibilities exist for investors to purchase value-add opportunities or assets in poor-performing sectors with risk-adjusted discounted prices, but that is not what these investors want. We see our clients looking at well-located retail plazas, multi-tenanted showrooms and industrial warehouses with smaller leasable areas and good ceiling heights.
It’s all about leasing fundamentals and reducing risk. The buyers want to know that there will always be demand for their properties, regardless of what is happening in the economy. Interest rates will inevitably increase and when these new buyers renew their mortgages in 5 years, they don’t want to be renewing with vacancy.
Retail has been one of the most stable assets sold in the Ottawa region, with 10 years of consecutive growth in the number of transactions, with the exception of 2014. All other asset classes have had major drops.
Because of the low interest rates and demand on well-located quality assets, capitalization or cap rates (the ratio of net operating income (NOI) to property asset value) have been compressed. We don’t often have conversations with clients about cap rates, as these represent the return on an all-cash purchase—it’s more of an industry measuring stick than a valuable assessment tool. Because of the aggressive lending, the focus is on the opportunity cost of the investor’s savings. If the client is looking at commercial real estate, they are usually more interested in annual cash-on- cash returns and liquidity.
• Cash-on-cash – Cash flow after debt service / initial investment
• Liquidity – New buyers to commercial real estate want to know that if they need to exit for whatever reason, they won’t lose their money
Cap rates aren’t the focus, but they remain an important metric with appraisers and lenders to make sure that the buyer isn’t priced out of the market.
4. The Process
If you are surfing the Internet and browsing MLS or other commercial brokerage websites, you are likely not going to find what you are looking for. If you do, you will be waiting a long time and will probably be competing with a number of other investors, as anything that is reasonably priced sells almost immediately.
Today’s buyer is proactive, and they know what they want. When we first meet with investors, we go through a thorough review of their goals and objectives. We then design a customized plan to target buildings that will meet their criteria and help them attain their goals. Usually, these buildings aren’t for sale, so often we submit offers on multiple buildings before finding a willing seller.
The “off-market” deal’s biggest advantage is absolutely no pressure. Our client isn’t competing as the property is not “officially” for sale. They have selected the asset because they are comfortable with the tenant profiles, overall condition, asset type and, most importantly, location. No compromises!
We can often negotiate a price where the client gets all of the above and keeps the bank and its appraisers happy.
Are there still opportunities for all buyers?
For active buyers who have spent the past 10 years investing in the commercial real estate market, many value-add properties are still available—and most of these are still found “off market.” For owners who are suffering from vacancy, upcoming capital costs and other concerns, it could mean an opportunity for local professional buyers who are willing to roll up their sleeves and put sweat equity into the project.
For many of the previously active investors, a $2 to $4 million deal is too small. Their businesses have scaled up and they now have the resources and the platform to focus on the $10 to $15 million properties and up, out of the reach of most private investors and just below where the institutional investors begin to play.
There is room in the market for all types of buyers and, more importantly, many opportunities exist. You just need to have the right team in place and be ready to jump when the opportunity arises.
From: InvestCRE Magazine.