Canadian REITs are looking at ways to capitalize on the significant development potential of their building portfolios. While federal government “specified investment flow-through” (SIFT) tax rules for REITs limit direct involvement in property development, urban intensification is driving up land values and making new construction an increasingly attractive option.
Allied Properties REIT
Allied Properties REIT has 60 buildings in Toronto located on 24 acres of land that is ‘significantly underutilized’ said CEO Michael Emory at the RealREIT conference in Toronto held September 13th. “There is the opportunity to grow up, or up and out, or on adjacent property,” he said.
“The rate of intensification in Toronto East and West Toronto is tremendous and it is going to accelerate” Emory explained. In Toronto the market is seeking a balance between retail and residential unlike Vancouver where condo development has driven out retail uses.
“In addition to the SIFT rules, operational prudence restricts the amount of gross book value that can be spent on development” said Emory, in Allied Properties case to about 15%. The REIT is currently invested at the 3% to 4% level in development activity.
Pre-leasing is considered the riskiest part of new development because it involves getting a sophisticated tenant to commit to space three years in the future according to Emory. A 30% to 50% level of tenant take-up would be a requirement for Allied Properties REIT to proceed with a construction project.
RioCan REIT owns 4,500 acres of land across Canada that is only 25% covered by buildings, according to Jordan Robins, Senior Vice President of Planning and Development. Riocan has been reviewing its portfolio to determine how to best extract value from it properties primarily with increased retail density. Other times, when retail is not the highest and best use, Riocan looks to something else either new format retail, residential or mixed use.
Places to Grow legislation in Ontario has limited urban sprawl and compelled developers to shift from sticks and bricks to hi rise in the core. “It started with residential and now the retailers are following,” said Robins. Retailers had to change their traditional format to operate in the core, take on less space, operate on multiple levels, adopt to underground parking and, in addition, rents in the core are different than in the country.
The value of downtown locations to retailers became evident to Riocan when Home Depot pulled out of a deal to locate at Portland Street and Queen Street in Toronto. Robins described how all the major retailers approached Riocan when Home Depot left, many willing to take the newly constructed building with absolutely no changes to the structure. “It was ground breaking to have retailers interested in locating in the core,” he said.
First Capital Realty
Major shopping center owner FirstCapital Realty has about 2,000 acres of land which is also being reviewed for its development potential according to its CEO, Dori Segal.
Morguard Investments Inc.
In the east end of Ottawa, Morguard Investments is undertaking a major expansion of the St. Laurent Shopping Centre. Margaret Knowles, Senior Vice President of Development for Morguard, described it as a slow process that has already taken three years and involved the acquisition of adjacent employment lands.
One of the first steps to redeveloping malls is to talk to the anchor tenants who Knowles said control the major shopping centres. She described shopping centres as ‘living things that are changing all the time’ consequently the tenants eventually need to reconsider their space to compete against other centres.
A fundamental impediment for all property developers is interest rates, said Knowles. “We have had a good run but if they were to change it would ripple through everything.” The cost of money is outside of our control and construction financing has a huge impact on a development. Knowles described it as ‘a huge risk’.
Morguard is also considering construction of a third tower of 390,000 square feet adjacent to two buildings it acquired from the federal government at Bank St. and Slater St. in downtown Ottawa. It would be built to a LEED Gold standard which is a requirement of federal government tenancy.
LEED Gold is becoming a new requirement for office buildings, said Michael Emory. You would be ‘out of your mind’ not to build at that standard today.
Canadian REIT (CREIT) has a mezzanine loan program where it works with a network of property developers who have local knowledge and acquires assets upon the completion of the projects, said Vice President, Adam Paul. CREIT has 12 development properties including small-scale retail, industrial and greenfield development.
The biggest risk is the larger economy, said Paul Adams. If we are on the edge of a major economic downturn, then that is a huge impediment to development. He added that ‘time lines will be significantly delayed’.