The current low cap rate, low-interest rate environment has been good news for acquisition-hungry REITS and REOCs, but acquirers do need to be picky, said Stephen Taylor, Morguard Investments Ltd.’s President and Chief Operating Officer.
“The low cap rates are bringing high-quality properties to market; Scotia (Plaza, Toronto) is a good example; Bentall Five (in Vancouver) another good example. Certainly some landmark buildings have been drawn out as people realize that premier pricing is available,” Taylor said at last week’s RealREIT Conference in Toronto.
It’s not only trophy properties going on the block however. “It is also drawing out a lot of lesser-quality buildings that are trying to present themselves as if they were higher-quality assets and certainly trying to achieve the kind of level of pricing that they are talking about for the prime assets,” Taylor said as part of a panel discussion on growth strategies for REITs and REOCs.
While the Morguard Investments CEO said strong fundamentals and low cost of capital make it a “great time to be in the real estate,” his company has taken what can be summed up as a high-low approach to growth: it will pay up for top-tier assets but is avoiding the middle of the market.
“The high-quality core properties we are still aggressively pursuing but our view is if you are going to pay for quality you better get quality… and then financing them for as long as we can with the attractive debt that is currently available,” Taylor said.
As for the “value add” properties beyond? those top assets, Morguard is typically avoiding those properties in its portfolio, having determined that they are not worth the risk. It is also looking more aggressively toward new development, seeing that many lower-quality properties are priced at or near replacement cost.
“If you are going to pay replacement costs, you might as well be getting a brand-new building as opposed to buying an older building at a high cost,” Taylor stressed. Morguard has also cast its gaze south as alternative to paying what it sees as “fully priced assets” in Canada.
Fellow panelist Armin Martens, President and Chief Executive of Artis REIT of Winnipeg, adopted a similar southern approach a few years ago with acquisitions in the markets of Minneapolis-St. Paul and Phoenix as befits its status as a more opportunistic investor. “We’re finding better value in the United States,” he said. “We started there a couple years ago, cap rates kind of continue to compress there but there are more opportunities, higher cap rates, lower price per square foot and even a conservative lease profile and financing available.”
Martens said about 15 per cent of Artis REIT’s portfolio in now in the U.S., a percentage that looks certain to grow considering that Canada is “priced to perfection” or as others might say, expensive.
For a company that started eight years ago as a micro-cap public company with just one building, and a $5-million market capitalization, it has grown in spectacular fashion to its current market cap of approximately $1.8 billion.
That’s been virtually all via acquisitions. Last year it made about $800-million in acquisitions and this year, it has made about $1.1 billion worth of acquisitions. In the second quarter alone, it spent nearly $479 million acquiring commercial properties, bumping its portfolio up to 175 income-producing properties with approximately 18.6 million square feet of leasable area.
Artis does not do a ton of development, Martens noted, with just four projects in its development pipeline representing about 4 per cent of its total book value.
RioCan REIT no slouch
Retail real estate specialist RioCan REIT similarly has been on an acquisition tear post the 2008-2009 recession. The REIT purchased about $2-billion worth of property in 2010 and 2011, said Jordan Robins, its Senior Vice-President of Planning & Development, and he expects it to rack up $750-million to $1-billion worth of acquisitions this year.
Robins, like Martens and Taylor, is optimistic, although he struck a more cautious note. “We also remain quite bullish and suggest that the historic pace over the last couple of years will likely continue from our perspective – again provided that the arbitrage between the cost of capital and the risk we are taking remains reasonable and the assets we are considering purchasing meet our corporate agenda.”
Robins noted that RioCan remains interested in purchasing “quality assets” in the six major markets in Canada, is scouring the U.S. for suitable acquisitions and has a robust development pipeline which is his main focus.
RioCan has developed about 900,000 square feet of space in the last two years and has another 9 million square feet of space in its development pipeline.
Foreign out, pensions in (sort of)
While foreign buyers are finding it hard to enter the Canadian commercial market in any major way, pension funds too are finding it tougher to buy into more traditional income-producing properties as they have often been outbid by REITs which have been pumped up by cheap debt and equity capital, noted Taylor. The one exception, he said, are the open-ended funds which are the target of increasing amounts of pension fund money. “There the weight of capital is really encouraging them to really be competitive” on bidding.
Pension funds have one advantage over REITS, Taylor added, namely plenty of patience, which can pay off in development of new property. “That’s where having access to capital, having very patient money and not needing an immediate yield are advantages to the pension funds.”