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CRE is a long-term investment, now more than ever

From a business standpoint, the pandemic is having a very real and often brutal impact. Let’s not...

From a business standpoint, the pandemic is having a very real and often brutal impact. Let’s not diminish the reality of this. Businesses are hurting, especially small/Main Street businesses.

We are constantly seeing news stories about tenants versus landlords, both residential and commercial. Ontario will impose an eviction ban (several other provinces already have them in place) that has some landlords crying foul.

Market watchers ponder the long twilight of the commercial office market, as working from home becomes the new normal.

And yet, this publication and others have picked up no shortage of stories in recent weeks about new development in core office markets:

* Dutch firms plan 87-storey mixed-use high-rise in downtown Toronto

* TOD Bois-Franc: Intermodal Hub and Living Environment in the Montreal area, which will include 426,000 square feet of office space and another 406,000 square feet of commercial space

* Ottawa firm floats 1M-square-foot business park in southeast Ottawa.

And so on. In addition to plans for new developments, big players continue to buy existing prime real estate on their belief that market fundamentals remain strong.

But why?

As I have discussed in recent articles, history shows us a pandemic is a short-term event.

Assuming government, health specialists and the public at large do the right things to keep the viral spread relatively slow, the impact on business’s ability to pay rent may be relatively short term. 

Also, regardless of whether a person’s job requires they work in an office, many of us are just not wired to work from home in isolation long term. We need the social interaction and the change of scenery.

In relation to the market value of real estate investments, you have to take the long view. Over the economic life cycle of an income-producing asset, all revenue is important in sustaining market value, and income you earn today is more valuable today than rents received 20 years down the road.

It may be that now we are at a point where the revenue problems have peaked and businesses may be turning the corner on their own revenues to allow them to return to being stable rent payers.

The economic life cycle of a real estate asset is not enormously long. All these assets periodically need major reinvestments to introduce those new features which the marketplace will demand.

Office buildings constructed before 1960 didn’t need much in the way of advanced wiring as for the most part the only electric gizmo on a person’s desk was a telephone. However, functionality is constantly changing.

The average period between a major reinvestment probably is about 30 years. If we accept this, then it’s important to understand that income earned in the first months and years of the cycle after reinvestment is more important as a value determinant than the last months or years.

Market value today will be much more a function of the stabilized income over the first five to eight years of a building’s life cycle.

Asset market values at present might be down, but there is scant evidence so far that is conclusive.

But, as with any event that changes a property’s circumstances, the degree of impact on its value will depend on when the value is measured and the length of the change event (e.g. a pandemic) relative to how long before the property’s age demands reinvestment. 

Adjust to the present, plan for the future

In the midst of this viral event, savvy investors are looking ahead, and not just in terms of months. New developments take a few years to go from announcement to move-in – a window of time more than great enough to accommodate even conservative estimates on when we may have a vaccine.

With any new development (versus a reinvestment), what is key in terms of the market value of this income-producing asset is long-term stabilized net income. In any new project, there is a period of negative cash flow as a project gets built, marketing of space takes place and lease-up occurs; after which a developer’s proforma would show positive cash flow.

At some point, income and expenses become generally stable. With a new project, the uncertainty of tenancies right now only would be a concern if there were long-term impacts on how tenants use rental space.

It seems that with the development accouchements that are taking place, some investors/developers have concluded there will be demand for their projects when they open for occupancy in 24 or 36 months.

There clearly has been an awful lot of hurt taking place, but in terms of real estate, the financial pain hopefully is short-term.

One thing a property owner may want to watch is their property tax assessment.

Assessed value can be affected by sudden changes, and we have certainly just seen a sudden change. It will be interesting to see how property owners respond to their next tax assessments in light of this big, but hopefully short-term, rental income problem. Will we see a spike in property tax assessment appeals?

CRE: the shape of things to come 

We must also consider what a new normal will look like in a practical sense.

A recent report by Cushman & Wakefield found 73 per cent of the 40,000 workers it surveyed  would like their employers to adopt “some level of working from home.” Also, 90 per cent believed their employers trusted them to work remotely.

If COVID-19 does lead to long-term changes in how our society functions, what will that really look like? This recent piece in the Financial Post explores how, if fewer people do work in the office, that surplus space will be eaten up to some degree by the need to provide more space for those who do come to the office.

Landlords aren’t likely to reduce lease rates for a tenant just because they have fewer people in the same amount of square footage.

Further to this, the C&W report forecasts:

* The purpose of the office will be to provide inspiring destinations that strengthen cultural connection, learning, bonding with customers and colleagues, and supports innovation. (As I said up top, most of us can only stand to be socially distant for so long.)

* Current footprint sizes will remain steady, balancing social distancing’s relaxing of space density with less office space headcount demand in the new total workplace strategy.

Only time will tell, but I’d say these are reasonable considerations for what certainly are interesting times.

To discuss this or any valuation topic in the context of your property, please contact me at I am always interested in your feedback and suggestions for future articles.


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