Property Biz Canada

Real estate trades then and now … negative leverage then and positive leverage now


Why do we all hear grievances that prices in commercial real estate are too high when Marshnet reports sales/purchases of $14.4 billion or 2,045 trades of real estate in 2015 (more than $1 million in all trades not part of owned homes)? These trades cannot all be grounded on wrong valuation parameters. Surely our check and balance systems driven in large parts by our financial institutions prejudiced by the early 90’s melt down have kept buyers in check.

Petrus Report TableThat 2015 trade level is a 276% increase or 3.8 times the 1995 total trades. Pick any frame of reference, or for example, the five year average total sales of $5.0 billion (1995-99); $8.0 billion (2000-04); $10.1 billion (2005-09); and $13.0 billion and the respective increases in the number of trades: 834; 1,122; 1,389; 1,513 and the growth pattern is clear except perhaps for the 2008-2009 transitory downturn.

The 1990-94 was the real melt down period in real estate and 1995 is recognized as the start of the correction. While the GTA is our frame of reference, pretty much of all the western world and certainly Canada and the US faced the same conditions of restrained financing conditions, high vacancy, and low fundamentals whereby for example, class “B “office buildings in downtown Toronto were financeable mainly with vendor financing regardless of the $50 per square foot price range. Understandably, these low prices relative to the $400 price range of the late 80’s price levels were a reflection of the negative property income due to low net effective rates and high vacancy factors.

The stakeholders of late 80’s observed negative leverage conditions whereby cap rates were actually lower than the cost of mortgages as a modus operandi. The table/chart sourced from captured the posted rate for a five year fixed rate mortgage as the proxy for the direction of the interest rates. Understandably, lower rates are and were available for 5yr Fixed - Sales in Billionsdifferent quality loans and our competent lenders and mortgage brokers will be first to identify the wide range of rates available for different loan risks and the fact that rates fluctuate throughout the year as influenced by various economic conditions. Nonetheless, the chart below drives the point of generally declining mortgage rates in the 1995-2016 period.

That late 80’s period is the precursor of the 1990-94 period that witnessed the collapse of most of the Trust industry as well as a serious tightening of mortgage financing. The fundamentals of a real estate investment contended negative cash flow over the first two or three years of acquisition in anticipation of capital gains. As interest rates have continued to decrease since that period, trades today are accretive and they are based on positive leverage conditions across all assets classes.

Real estate is not for the faint of hearts. Either fundamentals are shaky and financing conditions are tight or prices are perceived to be too high. Either way, today’s existing markets with positive leverage have much momentum and risk is more with the renewal rates then today’s level of real estate prices. Most of our institutions and large private fund managers have reportedly a laddered renewal mortgage strategy over-layered the portfolio lease renewal schedule to balance the risk of such renewal rate risk.

This article is an excerpt from Petrus Commercial Realty Corp. Real Estate Report (GTA) Vol 23.04 – Storefront Retail, May 6, 2016.


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Pierre Gagne

About the Author ()

Pierre Gagne, Broker of Record is the driving force behind the firm. He is a prominent and reputable industry veteran whose career started in 1980 with one of Canada's largest real estate institutions. Pierre subsequently had a successful eighteen year career with a national commercial real estate brokerage firm prior to setting up PETRUS Commercial Realty Corp. His academic achievements include: McGill University, Bachelor of Commerce: Real Estate Analysis and Urban Planning (B.Comm., 1980); University of Western Ontario, Master of Business Administration (MBA, 1985). He is as well a retired Accredited Appraiser of the Canadian Institute (AACI).

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