Continuing high demand for developable land and a rapidly changing financial landscape are already being felt, according to commercial real estate experts who gathered at the June 7 Land & Development conference at the Metro Toronto Convention Centre.
MSCI head of real estate economics and chief economist Jim Costello, who lives in New York City, moderated the panel and led things off by saying debt costs are rising for land acquisitions and developments.
Colliers partner and head of capital markets Emeka Mayes said most development is occurring in the industrial and multiresidential asset classes due to the rent growth in those sectors, but lenders have less conviction in future multiresidential rent growth, so they won’t underwrite based on those potential future rates.
Toronto-based Casey Gallagher, executive vice-president of the CBRE Capital Markets national investment team, said the pandemic had a more immediate impact on the low-rise housing market than on high-rise buildings, where construction timelines are longer.
Caution with transactions and developments
“I certainly think that there’s a greater sense of caution in the approach to land transactions right now,” said Gallagher, adding there’s high sensitivity in Toronto, Montreal and Vancouver because pricing is aggressive and construction costs are high.
“I think we’re going to see some softness on land transactions as people take a sober second thought and factor in construction cost increases, development charge increases, parkland and all of the other soft costs that matter as much as hard cost increases matter to a pro forma.”
The number of transactions has slowed and the size of deals has become smaller, according to Mayes, who is based in Montreal.
Mayes said developers are being more selective about which projects to move forward with in a period of rising inflation and interest rates. They are only acting on those that appear to be the most attractive financially.
Vancouver-based Concert Properties chief investment officer Andrew Tong agreed with Mayes that some developers are temporarily shelving projects to mitigate risks.
However, he thinks there will still be chances to buy and take advantage of opportunities, particularly involving small developers that are highly leveraged.
“Residential developers are actually pushing out of the core and looking to find cheaper, larger pieces of land,” Mayes said.
Gallagher said he’s seeing land price premiums being paid for quality downtown Toronto sites and “there’s a lot of competition for a non-infinite amount of capital for a lot of sites that are core-plus.”
Zoning and approvals issues
Tong said whether land is zoned versus unzoned impacts the number of bids and price paid for it. Zoned land in extremely good transit nodes will definitely receive a premium price, while there will be more uncertainty and a thinner bidder pool for other properties.
Mayes is seeing the construction of multiresidential developments move further out from downtown Montreal to areas where there’s access to public transit, but where development charges can be avoided.
She’s also seeing projects originally intended as purpose-built rental apartments being switched to condominiums.
Tong said the rezoning approval process is lengthy and uncertain in Vancouver, which can also have a bearing on developer costs. As a result, he’s seeing more activity in areas where there’s more certainty and a clear path to development that can be underwritten and priced more easily.
Tong said different levels of government need to become better aligned with their requirements to create more efficiencies or they won’t achieve the increased affordable housing supply they’re attempting to attain.
Mayes said most developers want to build social housing and create affordability, but solutions are needed to make it faster and cheaper to build.
“It’s a simple solution, but right now all of the solutions that are being implemented are in the form of an indirect tax that’s just having the reverse effect.”
Office and industrial sectors
Tong said the flight to quality in office assets doesn’t just apply to buildings; lenders are asking for more covenant and security from even their best clients owing to the uncertainty within that sector.
Gallagher said there’s been rapid escalation in industrial land and construction costs and there’s a scarcity of quality, well-located and easily accessible industrial land in Canada.
Tong thinks there’s “more juice” in industrial rental rates. He doesn’t think the market will slow down because vacancies are so low and demand is so high in core cities.
Concert just completed a lease renewal with a 120,000-square-foot industrial tenant that saw its rent increase from $7 to $18 per square foot, with escalations built in, so Tong believes the asset class “still has a lot of legs.”
Gallagher said large industrial developers operating in multiple Canadian markets will search out less expensive opportunities. He cited how much cheaper it is in Calgary than Vancouver as an example.
“I can get a great facility, great labour and all the land that I need, so I think Calgary is going to continue to be the Western Canadian hub for industrial,” he explained. “I think Vancouver will be a great location, but because there’s such a little supply of land it’s not going to attract the large logistics facilities.”
Such buildings, however, are difficult to do on a large scale so he doesn’t expect to see many of them in the 500,000- to one-million-square-foot range.
Mayes cited an industrial vacancy rate of less than one per cent and rental rates that have doubled in parts of the Montreal market. Large tracts of brownfield land around the downtown core that were previously unattractive to develop are now being opened up, she added.
Alberta office space comprises about 0.8 per cent of Concert’s portfolio and the firm was considering converting an office building to multiresidential because the city is incentivizing such moves. It was decided, however, that such a transition wouldn’t work financially in this instance.
Concert converted a well-located Victoria hotel into an apartment building, but Tong said costs escalated due to the condition of the building’s superstructure.
Gallagher said it’s usually not worth the cost and effort needed to convert older office buildings to other uses.
Environmental, social and governance factors
Costello noted increasing environmental regulations are forcing, or will force, owners of older buildings to make significant performance and carbon reduction improvements. New buildings will also have to meet new high environmental standards.
Costello asked how that’s impacting building owners and developers.
Tong said investors, particularly institutional investors, are demanding developers and building owners have strong environmental, social and governance plans for their portfolios.
Gallagher said a major challenge is that regulations are often evolving faster than large buildings can be constructed, so developers are forced to adapt and respond on the fly.