Winnipeg’s office and industrial share in relation to other Canadian commercial markets

At a recent WinnipegREALTORS® commercial division breakfast meeting, REALTORS® were told the background behind the blockbuster Sun X deal in 2007, which led to Winnipeg’s commercial real estate sector having its best year ever with more than $700 million in dollar volume sales. 

It was a record year in more ways than one as MLS® dollar volume activity, the majority of which is residential, broke the $2-billion level for the first time.

John McFadden, senior vice-president of Bentall Capital — the high-profile fully-integrated national real estate company that was the successful purchaser of Sun-X — explained Winnipeg’s office and industrial share in relation to other major markets across the country. 

He said direct real estate (not REITs) has provided a superior return and is still performing well over the long term. Based on the IPD (Canada) asset class returns to December 2007, real estate had a 16.5 per cent return over a one-year period, 17.8 per cent over three years, 14.9 per cent over five years and a 13.1 per cent return over a 10-year period. Capital appreciation has accounted for the majority of recent gains in Canada.

Note: IPD (Investment Property Databank) is a global information business, dedicated to the objective measurement of commercial real estate performance. In its 2007 results release, IPD indicated the West outperformed the East for the third year in a row. Edmonton had the highest return of 31.2 per cent with Vancouver at 20.7 per cent and Calgary at 20.4 per cent. It was based on exceptional capital value growth. Of the major sectors, offices had the highest return at 18.9 per cent.

Historically, cash flow has generated the bulk of real estate return, especially among “stabilized” properties — this is perhaps one of the strongest motivators to hold real estate.

Debt is less a factor in Canada compared to the U.S. as a deterrent to driving pricing. The reason is equity investors play a far more dominant role in providing capital for Canadian real estate.

While the cost and availability of accessing debt financing has gone up in Canada, the significant influence of institutional investors, such as Bentall Capital, offsets a severe adjustment in pricing here.

Mc Fadden’s perspective on the “sub-prime effect” is more favourable than that found in the media and its impact on the U.S. market. He said demand for better quality commercial real estate remains relatively strong in Canada. Banks and life insurance companies continue to lead the demand, but spreads have increased, making borrowing more expensive and restrictive, especially for “B” and “C” assets.

He still sees large pension funds being attracted to real estate, but believes the funds will be more strategic in investments. Some larger public pension funds have little exposure to real estate and the ones that do tend to concentrate on the four largest cities in Canada.

There are significant “portfolio premiums” being asked for large industrial portfolios, since they are difficult to build up and assemble.  

The Sun-X transaction

The transaction offered Bentall Capital 2.4 million square feet of superior flex industrial with another 325,000 square feet of expansion potential. Bentall also acquired 35 acres of vacant industrial land with 785,000 square feet of development potential.

The major acquisition gave Bentall significant market share with best in class and strategic locations within Winnipeg’s five major industrial areas. The existing portfolio was well managed by Sun-X and presents some good land development capability.

Bentall also likes the tenant diversity and lease expiries. The company now has an immediate presence in Winnipeg’s commercial marketplace. As is the case with other national companies, Bentall is well aware of the strength in Winnipeg’s diverse and stable economy.

In summary, Mc Fadden made the following points:

• Real estate has been a top performing major asset class over the past five years.

• ICREIM / IPD index: 14.9 per cent annualized return in the five years to the fourth quarter of 2007 

• Capital flows into real estate and low interest rates resulted in cap rate declines of between 75 and 100 bps (basis points) during 2007.

• Cap rates stabilized and were showing signs of increasing slightly in the first quarter of 2008.

• Expected returns on diversified core portfolios to be driven by income yields (unlevered) of between six to seven per cent in 2008.

U.S. sub-prime mortgage and liquidity concerns together with potential recession have increased uncertainty.

• Given the potential slowdown in the economy and its various sectoral impacts, any on-going improvements in Canada’s property markets are not likely to be evenly distributed across all markets and property types.

• The focus must be on the fundamentals — buy for income and not capital appreciation.