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Tuesday, January 16, 2018

Avison Young 2018 Forecast: Change and opportunity will abound in 2018

by Mark E. Rose (Toronto)

We just released our 2018 Forecast and I’d like to share a few perspectives on commercial real estate markets for the year ahead.

Our industry has spent the last three years debating where we are in the real estate cycle. In 2017, we concluded that the real estate industry was in the late stages of the ballgame, but could be headed into extra innings. As we start 2018, the game is still going, but change is underway and the dynamics on the field are definitely in flux.

In general, conditions remain positive. Yields on commercial real estate are still attractive when compared with alternative investments. Equity and debt capital are still plentiful and available, and there is no shortage of demand for real estate investment. Employment data looks good and economies are growing in the major countries in which we operate. While markets are still a little uncomfortable with certain aspects of both politics and central-bank policies, these trends are a continuation from 2017, and not new concerns.

Importantly, interest and capitalization rates are still at historic lows. Interest rates are moving up incrementally, as they really only have one way to go, but short-term interest rates are being properly – and effectively – normalized by central banks.

Capitalization rates are another story. Commercial real estate has printed trades at historically low cap rates, but the bid-ask spread is widening – and acting as a brake on transaction volumes in major markets. Cap rates and corresponding return requirements will eventually move as the financing of acquisitions becomes more expensive.

As we head into 2018, it’s critical to note that, everywhere, change is in motion – change that is positive, powerful and moving very quickly. This is the type of evolution that creates opportunity.

These changes are evident in occupier behaviour that is challenging the market and, we think, fundamentally driving innovation and performance. Alternative workplace strategies are finally being accepted as strategic, and have expanded from hoteling, mobile workforces and outsourcing to include flexible office and co-working alternatives. When we begin to anticipate the impact of autonomous vehicles on everything from suburban/urban dynamics to repurposing of parking lots and logistics configurations a host of real estate challenges and opportunities opens up. While potentially disruptive in the short term, these trends will ultimately result in real estate used more effectively and with greater cost efficiency… which leads us to technology.

Technology is, potentially, the most exciting element of change in our industry. Technology adoption – including artificial intelligence – is gaining so much momentum that it is driving profitability and expanding capabilities exponentially.

Finally, wellness in the workplace is an emerging trend that intersects with occupancy solutions, the hunt for talent and also with technology. Whole health, or the combination of physical and mental wellness, is critical to the success of all enterprises. Tenants have always observed that a workforce is happier with access to natural light, plants and fresher air, but studies using sensors that measure workplace conditions now also confirm the tangible economic benefits of employee wellness.

These are just a few of the trends we’re watching in 2018.

We invite you to read Avison Young’s 2018 North America and Europe Forecast, covering 67 markets, here:

and my 2018 Forecast VIDEOCAST here:

We wish you all a very happy, healthy and prosperous 2018.

(Mark E. Rose is Chair and CEO of Avison Young)

Thursday, January 11, 2018

NAFTA Isn't Broken, Yet

By Amy Erixon, Toronto

On a visit to Boston just before Christmas, I noticed that every Christmas tree stand in town was advertising “Evergreen Trees, Fresh from Alberta”.   Given that Calgary is located more than 4,500 km from Boston, I found this very curious.  Don’t get me wrong, Alberta businesses deserve credit for working overtime to diversify their economy, but the point is - there used to be nothing but forests between Calgary and Boston.  Research revealed that due to the deep US led, global recession which began with housing in 2007, tree planting in the US was devastated, and this acute tree shortage is expected to be felt for at least a decade. 

For the past 3 weeks, a natural gas pipeline running from Nova Scotia to Massachusetts kicked into overdrive to keep the lights and heat on in Beantown, pursuant to long term contracts put in place years ago to protect against this risk.  Last weekend the deep freeze got so serious, Boston was forced to pay more than double market rates to bring in Natural Gas from Europe, which according to Bloomberg, some of which might have originated from Russia. 

Without getting into a debate about whether it is self-evident Climate Change is aggravating weather extremes, the obvious takeaway is that global trade serves an important purpose, and is largely working as intended.   Canada, Mexico and the US act as economic stabilizers for one another.  Different policy approaches are part of how this benefit is achieved. 

Oil exports from Canada (by rail) are expected to rise 60% this year, largely due to the US reversing course on development and integration of renewables.  Beyond energy, the recent newsprint and softwood lumber spats well illustrate the dilemma facing Canada and Mexico in the arena of the quickly deteriorating NAFTA negotiations with the Trump administration.   Beginning in April, the US imposed what it hoped, would constitute crippling tariffs against softwood lumber.  This was reported to be designed to achieve two objectives: to demonstrate to Canada how serious the US is about renegotiating NAFTA, and in protest to the Canadian approach to pricing timber based on long term, sustainable, replacement and stewardship management practices rather than spot private market pricing, (the very reason why Canada could provide a reliable supply of Christmas trees).  Canada may not be the most productive place on earth to grow trees, and it too suffers serious losses due to increasingly destructive fires, never-the-less, as a component of the country’s commitment to the Paris accord, trees are being planted on public and private land across the country at an escalating clip.  Planting 100 acres of trees offsets the lifetime carbon footprint of 87 homes, or an 150,000 sf office or shopping center.   Until we do more to improve our building practices, planting trees helps stabilize the weather and protect the planet’s biodiversity.   The Canadian government is considering a plan to allocate an additional $1.5 Billion to conservation this year, and planting much of this area in trees. 

In a record year of natural disasters, from hurricanes to fires, these tariffs could not have been more ill- timed.  Due to a trio of environmental consequences: desertification, pollution and now extreme weather (in the form of forest devastating storms and fires), combined with the 2008 financial crisis, the US has a serious deficit of domestic timber production, and to meet this challenge more than 60% of all Canadian timber production is currently exported to America.  Timber is a commodity with one of the largest trade deficits in the US/Canadian trade relations.  Oil and natural gas are #2 and #3.  Autos, followed by machinery are the largest exports to Canada- high value-add sectors, more than offsetting the timber, oil and gas deficit numbers.   This is how NAFTA is supposed to work:  Americans get commodities at attractive prices and Canadians get high-tech equipment to modernize its factories. 
According to the Toronto Star, "In a move intended to protect the domestic lumber industry, the U.S. this year slapped duties of as much as 31 per cent on imports of timber from Canada, which supplies more than a uarter of what American builders use each year.  Prices surged, increasing costs for American buyers - and boosting profit for Canadian producers.  Shares of Canadian softwood lumber producers Canfor Corp. and West Fraser Timber Co. are outperforming their American peers with gains of more than 40 per cent this year, placing them among the top performers on the BI Global Paper and Wood Products Index.  By contrast, shares of U.S. rival Weyerhaeuser Co. are up about 10 per cent."

Canadian businesses, which lack the economies of scale of their US counterparts, and must absorb the currency volatility, must innovate or look long term to sell products in the US.   Accordingly, the recent move by the Trump administration to punish Canadian pulp and paper producers who supply massive amounts of paper for book publishing in the US as well as nearly all of the newsprint to the likes of the “failing New York Times” and most of the small-town newspapers throughout in the eastern United States, has been recognized by a significant number of US Senators as potentially threatening as many as 600,000 publishing jobs in the United States.   What are the Canadians doing wrong this time, you must be asking?

Most of this paper is coming from Resolute Forestry Products of Quebec and Kruger, Inc and Catalyst Paper Corp of British Columbia.  Contrary to Trump administration claims, these businesses are not being subsidized by the Government.  All three companies operate in Provinces reliant nearly 100% on supercheap hydroelectric power.  In addition, all three companies make vigorous reuse of their biofuel waste material to produce a significant share of their power requirements, via co-gen.  Third, Resolute co-locates their hydroponic farming operations with pulp and paper facilities to ensure zero CO2 emissions by feeding the plants with the paper waste outputs nourishing to plants, enabling them to further lower their cost structure in order to sell newsprint. 

In a break from tradition, these complaints lodged by US companies do not claim Canadian companies are “dumping” - meaning they are selling their product for less than cost.  They are claiming that the Canadians are selling their product for “less than fair value” in the United States.  In other words, the Canadians are not exploiting the wood shortage in the US to gouge longstanding customers.   It appears that the NAFTA negotiators reject the idea that the point of fair trade is designed to reduce costs to American consumers and to ensure the stability of the supply chain for essential commodities, services or products, but rather to ensure the ability of US Corporations to exploit price opportunities created by “spot shortages”.    It is no wonder these talks are getting nowhere. 

NAFTA discussions resume on January 23rd in Montreal.       

Thursday, December 14, 2017

State of Atlanta market discussed at Bisnow event

By Nadine Melo (Atlanta) 

The room was teeming with excitement on December 5th, an odd sight given the time of day –7:30 am to be exact. 

Atlanta real estate professionals gathered by the entrance of Bisnow’s state-of-the-market event, grabbing their badges and greeting fellow peers as they made their way to the coffee station to continue their conversations. Some even provided their own projections on what can be expected of the market in the upcoming year. 

After an hour of networking, The Ardent Companies CEO and event host Mark Shulman kicked off a three-panel discussion.

“Today, Bisnow is all about projects and predicting the future,” he said. 

Here are some of the topics discussed on where the Atlanta market is today and where it will be in 2018: 

While the first panel made it a point to discuss all commercial real estate asset classes, panelists did so through the use of mixed-used developments. Mixed-used projects, and in particular retail, served as the framework for most of the discussion, and it was not surprising why. 

In fact, retail, more than any other asset class, serves as the foundation for most mixed-use developments that we see today in Atlanta and elsewhere. Look at Avalon, the Battery and Colony Square and retail is, indeed, the common denominator. However, panelists stressed that, to be successful, mixed-use properties must provide consumers with an experience. 

“For retail, it's the overall experience that developers have to create to get people in there,” said BBG Director Grant Griffin. 

A fact which was furthered addressed by Franklin Street Director Reid Mason, who attributed the success of Avalon, a mixed-use development located in Alpharetta, GA, to the marketing and programming of the project.

“It goes back to the consumers and the consumers these days want an experience,” said Mason. “They want something unique. These developers are looking for that (uniqueness) to put in their center.”

HFF Senior Director Chip Sykes opened the capital markets discussion with the following statement: “You are going to hear as a general theme that capital is abundant and that it’s being put thoughtfully and with discipline, and very unlike what we saw in the previous cycle.” 

“Office has been restrained and is good, because markets like Atlanta can get in trouble for overbuilding,” said PCCP Director John Randall. 

In addition to the change in real estate fundamentals, there has been an increase in insurance companies lending money to developers and landlords seeking debt financing outside of the typical CMBS loan.

“Insurance companies are lending more money now on an annual basis than they ever had previously – about $80 billion annually over the past three years, which is a high-water mark for the industry,” said Sykes.

Later, the developing southside of Atlanta’s downtown area, along with the issue of affordability and transportation, dominated much of the third panel discussion. While most panelists agreed that the burgeoning renaissance of south downtown is a huge boost for the overall marketability of the city as Amazon considers Atlanta for its HQ2 site, the fact remains that the city’s growth can be stymied if the issues of affordability and transportation are not dealt with now. 

“I think we do have an affordability issue, both on the development and the production side of our business,” said Shelton McNally, Principal of Conor McNally, “It’s just harder to make yields work on the more expensive, in-fill, higher-cost deals right now.” 

McNally went on to say: “If you do have a good transportation infrastructure you can move people around the city effectively, and you can deal with the affordability issue.” 

Despite the growing concerns over affordability, transportation and overbuilding, panelists projected a positive outlook for commercial real estate in 2018.

(Nadine Melo is the marketing co-ordinator in Avison Young’s Atlanta office. She works closely with her office’s capital markets group.)

Tuesday, December 12, 2017

Senior Housing Reaches New Heights

By Dan Baker (Washington, DC)

The senior housing industry has reached new heights in its relatively youthful existence as a real estate asset class as it continues to distinguish itself from multi-family, health care and hospitality as a viable institutional investment.

A multitude of factors have combined to create one of the largest bull runs in the history of the senior housing market, making it a great time for owners and/or operators to sell, refinance, or otherwise recapitalize their properties: 

  • Low interest rates for construction, bridge and permanent financing;
  • New entrants and capital to the space;
  • Increasingly favorable long-term demographics;
  • Turmoil, high pricing, and decreasing yields in other real estate assets; and
  • A dramatic increase in operator sophistication and transparency.

 Much of the new product being developed today is different from most of the existing inventory in the market. Amenities, such as bistros, game rooms, theaters and outdoor space, are becoming standard. Key-card access, advances in lighting, Wi-Fi, telemedicine, and the use of electronic health records are also commonplace. Larger units and fewer studios (except in memory-care facilities) are what one would expect in a recently constructed senior housing community.

However, the sky is not all blue for the industry, which is beset with challenges from numerous angles. Increasing regulations and media coverage in the wake of recent natural disasters in Florida, Texas, and California have required operators to invest resources into emergency preparedness. Incorporating quickly evolving technologies into communities to be a more appealing partner to other operators in the healthcare space also requires investment in resources and personnel. Additional headwinds are:

  • Labor, in terms of both availability and quality, is the dominant challenge for large and small operators alike;
  • Affordability remains a pressing issue that the industry has yet to resolve, as middle- class prospective residents, who account for the majority of the baby boomer generation, have enough assets to not qualify for government assistance, but not quite enough to afford the high-end product that is mostly being developed today. As one industry observer said: “They’re too rich to be poor – and too poor to be rich.”
  • When entering a senior housing community, the typical resident is increasingly older and more frail, with more complex medical requirements and in need of assistance with daily living activities, further encumbering an already thin labor force.
  • A tremendous inventory of first-generation senior housing, built in the 1980s and 1990s, is on the market seeking a buyer, and there is concern about the competitive abilities of that real estate in the future due to physical-plant limitations.

These factors are often much more burdensome on smaller, individual owner-operators than larger, regional or national operators due to a lack of efficiencies and economies of scale. As a result, a typical seller in today’s senior housing market has only one property, or a small number of them, and is faced with the decision to grow to remain competitive or sell to capture a market where valuations are historically high.

In all, the senior housing market is alive and well, with unprecedented levels of capital chasing returns in the space, but investors and operators must not believe that simple demographics will lead to success. Proactive operations, thoughtful design and development, and properly structured deals will succeed over the long run as new competition intensifies in the space.

(Dan Baker is a Vice-President in Avison Young’s Washington, DC office. He specializes in senior housing dispositions on behalf of REITs, private-equity firms, and individual owner-operators. His career in senior housing began in 2007 working for an operator in facilities.) 

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