Inflation, interest rate hikes, labour shortages, and a possible real estate downturn on the horizon — 2022 has not been an easy time for Canadian real estate. If you’re a property owner or decision-maker in commercial real estate, you’re likely coping with higher costs now while also staring down economic uncertainty in the future.
Some of the circumstances you’re facing are beyond your control or unavoidable; but there are some steps your business can take to weather the storm with resiliency, and possibly emerge ahead of your competitors on the other side.
The short game
Future-proofing your business is a long-term play, but some of the hurdles facing your business are already here. What can you do today and in the short term?
First, you can look at your cost structure. Re-visit and review your existing contracts and agreements in an effort to spot opportunities to reduce or delay costs. Here are some questions to ask yourself during this process:
- Vendor contracts: What’s in them, and what are the terms? Is there flexibility within the contracts to reduce your costs?
- Tenant and lease agreements: Which of your costs can be passed on to tenants, and which cannot? How many of your lease agreements are up for renewal, and what’s the likelihood of renewing at a different rate? Are you charging the market rate in your location for rent, and if not, do you have market rate adjustment clauses in your agreements?
- Creditor or lending agreements: Are you working with lenders who are giving you the best terms possible, or is there an immediate financial benefit to switching? In this era of rapid rate hikes, can you negotiate a lower rate with your lenders?
Next — and this principle applies to all companies, not just real estate — look internally to spot inefficiencies within your business model. Cutting costs and increasing revenue are not the only strategies for dealing with inflation, there are probably ways you can do more with what you already have. For example, are there opportunities to gain more productivity and reduce waste in your labour, or revisiting your capital and financing structure?
Doing an audit of your agreements and your company structure requires an immediate investment of time and resources, but those who make it come out better in the long run.
Finally, you can bridge the gap between long and short-term strategy by booking some time in the near future to do some scenario planning. The scenario planning itself will play out over multiple years, but there’s no time like the present to start.
The long game
The truth is that even with the best possible short-term strategy and execution, rising costs are unavoidable. Increasing labour costs, interest rate hikes totalling hundreds of basis points in a single year, and a six to seven percent inflation rate will erode earnings regardless of your previous performance or preparation.
But that shouldn’t stop you from planning or being proactive. In all likelihood, the events since 2020 have already prompted you, to some degree, to look ahead and assess what your greatest risks and sensitivities are.
A lot of the decisions you make, and the options available to you, will depend on the location of your properties. For example, those in areas with lower demand for commercial space and higher vacancy rates will have less leverage to pass increasing costs to customers.
The most successful property and commercial real estate groups have very detailed cash flow forecasts, where they map out the next five or ten years based on their current lease or tenancy agreements. They do a pro-forma cash flow analysis that factors in various possible scenarios. They undertake a lot of contingency planning and sensitivity analysis.
Cash flow will be the biggest difference maker in the uncertain times ahead. If you have access to significant credit facilities or shareholder capital, you won’t need to be as reactive to immediate change and crises.
Navigating the road ahead
As your biggest expenses go up, your attention to the details of your business should increase accordingly. The headlines will try to predict and project the future of Canadian real estate, but no matter what happens, your decisions will impact how you weather good and bad times.
You don’t have to navigate the road ahead alone. The top-tier advisors at MNP can help you look under the hood of your business, and assess the best way forward.
To learn more, contact:
Cary Frank | Partner, Real Estate & Construction | 604.637.1552 | firstname.lastname@example.org
Yohaan Thommy | National Leader, Performance Improvement | 905.247.3254 | Yohaan.Thommy@mnp.ca