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Tuesday, February 7, 2017

Houston Real Estate: A 2016 Review and Predictions for 2017

By Rand Stephens (Houston)

What a difference a year makes! As 2016 got started with $28 oil, there were a lot of glum faces around town and the mood in Houston took on a feeling of pessimism. Houston’s optimism grew over the year as oil prices increased steadily, but even at mid-year the general mood was still gloomy. Prognosticators were already predicting a dire 2017 with no real improvement in the Houston economy until 2018.
However, oil prices have done nothing but rise since that ominous low point and the year turned out much better economically than anyone predicted...


In 2016, the housing, industrial and retail real estate markets have all remained strong. However, multi-family is oversupplied and vacancy rates have increased. Fundamentals also declined in the office market; particularly in west Houston where the drop in the price of oil has had its most damaging effects. Transaction volumes were down across all real estate sectors, which is to be expected, as cautiousness and conservatism has been the prevailing sentiment for the Houston economy as a whole. However, there is not a trend of distress in the real estate markets as acquisition and development have been responsibly underwritten and financed since 2009.


Investment Sales
As a result of the “staying power” property owners have gained from responsible financing, investment sales activity will continue to be slow in 2017 until rental rates, particularly in the office and multi-family markets, recover to a point where buyers can rationalize asset values.

The industrial market has held up very well through this downturn with occupancy rates remaining well above 90% and industrial development will start up in 2017. Most of the big industrial developers in Houston are primed with sites and ready to start building; but even for the biggest and best, new development will likely require a lead tenant to kick things off.

The retail market is complicated because continued growth in online shopping has traditional retailers scratching their heads as to their “brick and mortar” needs. This industry trend that has generally put a damper on development while retailers continue to adapt to consumers use of technology to shop. Nonetheless, like the rest of the country, Houston has strong demand for dining, entertainment and lifestyle alternatives—despite the city’s economic downturn. Since these shopping needs generally can’t be satisfied online, 2017 will likely see growth in specialty retail (adaptive reuse, mixed-use), which thrives in and around Houston’s core. Traditional shopping center development will continue in the suburbs, but the days of vigorous big box retail expansion are over as traditional retailers adjust to the consumers new buying behaviors.

Houston will see improved job growth in 2017 as the upstream energy business has retrenched over the last two years and will slowly start growing again. This along with job growth in other sectors should mean the office market has bottomed-out and occupancy and rental rates will stabilize and possibly see improvement this year. So, with oil at $53 a barrel as we start 2017, and positive job growth since the beginning of the downturn in Q4 of 2014, Houston’s spirits are better, and the mood is now one of guarded optimism.

Tuesday, January 31, 2017

Retail disruption actually about innovation

By Marissa Rose (Chicago), Amit Parekh (Los Angeles),  Hilary Kellar-Parsons (Toronto) and Michael Ganz (Irvine, CA)

A current theme in retail real estate, as in many other industries, is disruption. Reoccurring throughout 2016, particularly at the 2016 ICSC NextGen Conference in Los Angeles, were key conversations on this trend. Some of Avison Young’s retail affinity group’s young professionals had the privilege of attending the conference and getting to hear speakers from several key companies driving the disruption of the retail industry.

Retail real estate is undergoing a transformative and dynamic shift, due in part to disruption from technology, integration with existing shopping centers and consumer experience. This disruption results in improved consumer shopping experiences, investors raising capital through crowdfunding in local communities and changes in the ways that retailers allocate product through seamless channels of distribution.

Attended by four Avison Young up-and-coming real estate professionals, the ICSC conference showcased various perspectives on how disruption is affecting the retail real estate industry across North America. Impressive panelists and presenters included senior members of the retail real estate community, including designers, in-house real estate executives, investors, and market experts who were able to give their opinions and thoughts about how disruption is affecting their businesses and the retail sector in general from a theoretical perspective. Next, bus tours allowed attendees to touch and feel the physical retail spaces discussed during the conference – one tour included various hot new Los Angeles retail destinations. This tour provided a great opportunity to see first-hand how new retail developments and retailers are adapting their retail platforms to embrace and capitalize on the disruption that the retail world is facing. A key lesson is that much of what is going on in the industry is driven by the desire of millennials to live-work-play in urban areas, and their concentration in city centres –  specifically locations where they are near their offices and surrounded by retail properties where they can shop, eat, and socialize.

The biggest take-away that was evident at the conference was that disruption was never really about disruption, but instead about finding the gaps in customer offerings and filling those gaps through innovative and creative approaches to retailing. Many retailers embracing this trend have been dubbed as “disruptors” as a happy accident. When many of these retailers set out, their goal was to explore the gap, listen to what people wanted, and then create a retail experience curated specifically with customer desires in mind. In an industry where you must “adapt or die,” these companies found a way to take innovation a step further, and many are experiencing sizable growth as a result. A common trend is that these retailers have really embraced consumer preferences, which have shifted; consumers now desire value, authenticity, and/or meaning in their retail experiences. Companies like SoulCycle and ShakeShack have been able to fulfill these wishes. Because of this shift, the darlings of the retail industry, like Macy’s and Gap, have really struggled to withstand change. Macy’s and Gap have struggled to instill the brand loyalty seen in so many of today’s successful retailers.  

Lion Capital’s Sherif Guirgis shared with the attendees an investor’s perspective on the changing retail landscape and about the changing ways in which retailers are valued in the current economy. He echoed many of the above sentiments about current retail trends and about the importance of customers’ experience to not only the brand as a whole, but the brand’s value in the financial world.

(Marissa Rose, Amit Parekh, Hilary Kellar-Parsons and Michael Ganz are up-and-coming Avison Young Associates who specialize in retail sales and leasing services. Rose is based in the firm’s downtown Chicago office while Parekh works out of downtown Los Angeles; Kellar-Parsons advises Toronto-area retailers and Ganz assists clients in Irvine, CA. Services that the four brokers provide include landlord and tenant representation, sale and lease negotiations, and market analysis.) 

Tuesday, January 24, 2017

Is commercial real estate healthy for startups?

By Jesse Fragale (Toronto)

A few months ago, the Rotman School of Business in Toronto, in partnership with the Urban Land Institute, hosted an event entitled Is Toronto’s Real Estate Environment Healthy For Entrepreneurs? On the panel was an array of experienced individuals, including the CEO of a growing fin-tech company, the director of operations of a popular incubator and the head of a major office REIT. The event was packed – an indication of how relevant the question has become.

As a commercial real estate (CRE) broker in Toronto who specializes in office leasing, I am well aware of the challenges that startups have in acquiring the right office space in their early years. Conversely, from working with clients on the landlord side, I can appreciate the hesitation to lease space to these types of companies.

The Challenges

1.    1.  Uncertain growth trajectory

Companies that are at the first few rounds of financing in their new venture, or at earlier stages, have an incredibly difficult time estimating a growth pattern with any sort of precision. Their growth is certainly not perfectly linear, and this factor poses a challenge for brokers in finding not only the right space, but the right space for now. Companies at this point in their evolution are just not in a position to make commitments of five years or more without being exposed to some significant financial risk. Abstractly, we can think of these companies’ growth as a curved or exponential line on a graph, and office needs as a line that looks like a staircase – once the company is too big for the space, the firm hits a wall and needs to expand (a new step). We need to place this set of stairs over top of this growth line as precisely as possible.

2   2.  Covenant

When tasked with making a commitment to office space, landlords expect that they will be able to hedge their risk with a solid covenant from the tenant. When market conditions dictate that landlords have more bargaining power, they will be less likely to gamble on new ventures that have more potential to “go sideways.” As a result, startups can find it difficult to secure an office location without having a track record. This track record will typically mean a minimum of a few years of profitable operating history.

     3.  Disconnect from the commercial real estate community 

I believe that this point is the most controversial of the three challenges, but I believe it is real and should not be overlooked. The majority of these companies are being run by millennials and hiring millennials. Although the CRE industry is becoming more and more innovative, we are still behind in our engagement with millennials today – there is a lack of presence and engagement on social media platforms that they use every day (Snapchat, Instagram, YouTube, etc.)

What’s a startup to do?

Subleases, shared office, collaboration, oh my

Five- and 10-year deals are just not going to be an option for many startup companies. Potentially discounted subleases can lower upfront capital expenditures and shorten time commitments to make these companies more nimble. Shared offices and collaborative work environments are other good options, provided the clients are amenable to these arrangements and do not require exclusivity/use clauses (i.e. a clause whereby the landlord agrees not to rent space to another tenant that directly competes with the company that has said exclusivity.)  Shared space has become an attractive option over the past few years as we see more co-working groups on the scene in major cities.

No easy way out

Creativity might not cut it here as landlords – in lieu of an operating history – may ask for letters of credit, personal indemnification or upfront rent to compensate their risk. As a broker, the worst thing you can do in this regard is not have an upfront discussion of these potential requirements right out of the gate. The last thing you want to do after negotiating an offer or letter of intent is not be able to waive financing conditions at the 11th hour because you were ill prepared.

Engage, engage, engage!

Furthermore, startup clients should focus on retaining representation from brokerages that make an effort to communicate and engage with them – brokerages that understand their challenges and offer solutions. Staying relevant and using all the resources you have available to you is crucial. Beyond that, brokerage firms should reach out to incubators, accelerators, business schools and like minded landlords who target startups or other dynamic tenant groups (for example TAMI tenants; technology, advertising, media, information). Engaging and spending time prospecting startups is not without risk. Many of these companies fail before they get their feet off the ground. A proficient broker will evaluate new-venture clients more intensely and take a venture capitalist approach when targeting these companies. Does the business make sense? Are the principals committed? What have they accomplished to date? Ultimately, engagement must be a calculated endeavour and as efficient as possible.

The bottom line

A mentor and founding partner at Avison Young once said to me, “Jesse, think of two rotating gears when working with any company. The large gear is human resources and the little gear is real estate. The large gear costs the company much more than the little gear and looks more important – but if you screw up on the little gear, the large gear will grind to a halt.”

Startups should be focused on their business and not get bogged down in acquiring new office space. Brokers who represent these types of tenants need to ensure that they provide solutions that position clients in an optimal place for future growth and success.

(Jesse Fragale is an office leasing advisor who specializes in tenant representation focusing on startup and tech firms. Based in Avison Young’s Toronto office, he focuses on the Downtown and Midtown markets. Fragale is currently completing a Master of Business Administration (M.B.A.) degree in Finance and Strategy from Wilfrid Laurier’s Lazaridis School of Business.  He holds a Bachelor of Arts degree in economics. He has also completed a joint program on negotiation through Harvard University and the Massachusetts Institute of Technology (MIT).

Thursday, December 29, 2016

Toronto Real Estate Forum: The Ying and the Yang?

By Robin White (Toronto)

The 25th Toronto Real Estate Forum wrapped up earlier this month, and a soldout audience was treated to a potpourri of executives from major real estate companies, banks and pension funds; developers, economists and politicians opining on a variety of topics relating to the real estate business.

Having attended all 25 Forums, as well as many of the Property Forums that preceded the Real Estate Forum, I always found that I came away with a consensus on the state of the real estate markets, and where the business was headed.  

This time, it felt different. There were many contradictory opinions; here are just a few:

·         Interest rates were going up; interest rates were going to stay lower for longer.

·         Bond yields were heading up leading to higher financing costs; therefore, higher cap rates and, thus, lower prices. The recent rise in bond yields is short term, and they will revert to their previous levels or drop even lower, thereby reducing financing costs and, consequently, cap rates.

·         There will be an ongoing trend towards urban development as millennials seek opportunities to live and work in the urban core; the suburbs will experience a rebirth as millennials seek more attractively priced homes in which to raise a family.

·         The effects of the Trump presidency and Brexit will have a major impact on the future of the U.S. and European economies; the powerful secular forces that are present around the world will transcend any of the impact of Trump or Brexit.

·         Canada is in a wonderful place right now. We are seen as a good place to invest, because of our stable and transparent government and economy; Canada is irrelevant in the global scheme of things.

·         All levels of government have massive levels of debt to contend with, and are still running deficits; we have never amassed such a high level of cash looking for a home.

·         In the next 10 to 20 years, technology could affect up to 70% to 80% of the existing workforce; unemployment levels in the U.S. are at a low point.

My father used to say if you are not confused, it is because you have not been paying attention.  There is no question that anyone who was paying attention at the forum must have been somewhat confused.

So what are we to make of it all?

In my career, I have been through four recessions. Some have been more severe than others. Looking back at all of them, there were telltale signs in advance of the recession that should have been harbingers of things to come. These signs included companies overleveraging, undisciplined financing, speculative development, undercapitalized developers, junk bond activities, commercial mortgage- backed securities and so on.

There will be another recession. That is a fact. The questions are: When? And what can we do to prepare?

Coming away from this year's forum, although there were many conflicting views expressed, it is difficult to pinpoint any particular reason why we will see a recession in the near term. I am in the camp of interest rates being lower, at least for the next few years. There may be some short-term corrections, as we saw with the recent rise in bond yields, but I do not see any major forces likely to increase long-term interest rates – a situation that is good for our business.

Possibly, the biggest takeaway for me was the air of positivity that existed throughout the conference. Despite the confusing signals expressed in the breakout sessions, my many conversations with attendees at the coffee breaks, the cocktail parties and the dinners were all extremely positive and uplifting. 

And, perhaps, this is the most important takeaway of the 25th Real Estate Forum. When the attendees are positive and the mood is uplifting, they generally spell a positive outlook moving forward.

So let's make a toast to that, and may I wish everyone the best for a very happy and prosperous New Year.

(Robin White is Chair of Avison Young’s capital markets group and a founding Principal of the firm. He is also a Company Board Member and sits on the firm’s Executive Committee. During his career, which began in 1977, he has co-ordinated the sale of more than $5 billion worth of commercial real estate and completed several significant lease transactions, including several high-profile office buildings and industrial properties.) 

Friday, December 9, 2016

Outlook for 2017: It’s the seventh inning, but how long is this ballgame?

by Mark E. Rose (Toronto)

Take me out to the ball game!

It is only fitting that, in a year full of upsets, the Chicago Cubs celebrated their first World Series win in 108 years. The nine innings of American baseball have become a metaphor for the global real estate market cycle, but given the many variables of the current climate, just like the World Series finale, this cycle may be going into overtime.

Redux, or changes ahead?
The commercial real estate industry will end 2016 as it began – with low interest rates, low cap rates and moderate GDP growth in most nations. But it does not feel like the same environment heading into 2017. Rising protectionism and political unrest have introduced a healthy dose of fear and skepticism as to where we are in the current market cycle and what comes next. Despite job growth, improving market fundamentals and superior yields to alternative investments, commercial real estate owners, occupiers and investors disagree about how long this cycle could – and should – continue.

Pundits have taken both sides of the interest rate debate – from low rates indefinitely to a gradual return to historical levels (normalization). Meanwhile, virtually all developed countries piled on additional debt, ensuring that no government would lead the charge to raise rates. Economists disagree about how best to proceed, but a majority of business executives understand that we need to normalize rates one day – and sooner rather than later. It is hard to conceive a climate with less consensus.

Buyers and sellers used Brexit and the U.S. presidential election to pause and gather data points. Decision-making might have slowed in 2016 but, as we discovered while compiling the Avison Young 2017 North America, U.K. and Germany Commercial Real Estate Forecast (due out January 12, 2017), the appetite for investment in real estate continues unabated. The overarching themes of global financial growth from a depressed base and global population topping 10 billion in the next few decades provide strong support for everything related to real estate. Technology is a game-changer, potentially impacting what, where and how properties get used and constructed. If history is a guide, technology – like immigration – has redistributive impacts but can create meaningful positive economic growth for decades to come. 

We will start off from a similar place in 2017. Prices are at historic highs, liquidity is available, but natural tensions are rising. Decision-making has slowed and fear of this cycle coming to a close is stressing financial models and generating negativity. New York-based retail and housing are examples of city-specific product types that are going through a correction, but retail and housing in general are alive and well. Investor Sam (Grave Dancer) Zell is calling a top again, but the timing of such predictions remains to be seen. It is likely that markets that enjoyed disproportionate gains earlier in the cycle are taking a pause as investors look more broadly for opportunities. In a classic cycle, what we would expect next is a wave of consolidation that pushes prices even higher prior to a broad-based market reset.

The case for extra innings
Let’s pivot back to the baseball analogy. The widely held opinion is that real estate is in the seventh inning. At Avison Young, we disagree. We see something very different. We might be in the seventh or eighth inning from a pricing perspective, but given the market forces and attributes that currently exist, we could be in the seventh inning of a very long extra-innings game for our industry. Real estate is a legitimate investment alternative and is currently producing higher current yields than stocks and bonds. In fairness, interest rates are providing support, if not stimulating over-performance, due to the capital intensity of property investments. As long as rates hover near zero in most advanced industrialized countries, real estate will remain a preferred option for pension funds and other global investors. 

Geopolitical events, such as Brexit, are mainly playing out in the currency markets with the British pound and the euro taking significant hits against the U.S. dollar. Energy and commodity volatility are also repricing countries like Canada, whose currency lost ground against the U.S. dollar. But in each case, the change in currency has made these countries more competitive for exports and, effectively, put hard assets “on sale” to investors flush with cash and benefiting from a stronger currency. The U.K., Germany and Western Europe, Canada and Mexico boast some of the largest GDP markets in the world and global trade has not seized up – nor will it. The U.S. and Canada, in particular, are blessed with resources, technology hubs and growing workforces. As a result of these factors, along with safe-haven status and low interest rates, North America has been the preferred destination for global capital, and will continue to be in 2017.

Additionally, investors in this region are beginning to harvest gains, creating a “wall of capital” to take advantage of any dislocations in the marketplace. This wall is one of the reasons we are predicting that North American global investors will have the U.K. and, specifically, London in their sights in 2017. We believe that well-timed portfolio acquisitions could produce significant returns.

To get the full story on Avison Young’s outlook for 2017, including forecasts for the office, retail, industrial and investment markets throughout North America, the U.K. and Germany, watch for our 2017 Forecast Report on January 12, 2017. To ensure that you receive a copy, please contact the Research Manager at your local Avison Young office or sign up here:

On behalf of the board of directors, Principals and the entire Avison Young family, we wish you the happiest, healthiest and most prosperous 2017!

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