Saturday, May 21, 2011
Last Tuesday, recently elected Toronto Mayor Rob Ford secured nearly 3:1 support from the City Council to privatize a portion of the City Garbage Workers contract, a reversal of decades of City policy. This contract was a sore point with local residents who suffered through a near summer-long garbage strike in 2009, resulting in contract concessions far in excess of the city’s ability to pay. While the City Council’s actions will disrupt the status quo, most of the 200 currently part-time city garbage workers are expected to find replacement work with successful bidders under new private sector contracts, and the city will obtain performance criteria in the new contracts which will be established at fair market pricing.
Two weeks ago any doubt about whether the Ontario public wants change was laid to rest with the Conservative sweep of the Toronto area in the Federal election; delivering Prime Minister Steven Harper with the coveted majority government needed to contain both taxes and spending at the Federal Level. A majority government outcome was not anticipated, and the massive exodus of support for the Liberal Party was truly remarkable. The Liberals campaigned for a balanced budget but promised at the same time to increase health care spending and failed to deliver specific proposals that could accomplish either. Their message fell so deaf to public ears that even the Liberal party leader lost his “safe seat” re-election bid to return to Parliament.
Could this be a precursor to upcoming electoral trends in the United States?
Local and National leadership is needed to deal with the vexing problem of shortage of public resources against rising need for public services. Creativity and technology will be essential components of delivering lasting solutions; the status quo is not financially sustainable. Commercial Property taxes in Toronto are already nearly double those of surrounding suburbs, in part reflecting the disproportionate inner city services burden, a common malady of older, large urban centers across North America.
A noteworthy illustration of the kind of innovation required in the years ahead is the retrofitting of the Mississauga public library system recently implemented by the 89 year old Mayor of Mississauga, Hazel McCallion. She used federal stimulus money to convert to an on-line delivery structure saving millions in operating costs while providing increased access and library services to Mississauga residents and workforce. During her tenure as Mayor, the City of Mississauga has grown from a bedroom community to urban center with population in excess of 750,000 while enjoying one of the lowest municipal tax burdens and highest service levels in Canada. This is the kind of innovative fiscal leadership needed to rise to the times.
The Canadian real estate industry through its trade association, RealPac, is working with the City of Toronto and other urban centers across Canada to develop strategies to cope with their growing financial burdens that will not disproportionately cost jobs, impair property values, or deny residents essential services. Contrary to some commentators, I don’t believe this is a case of “we” against “them”. The work required to get the balance of taxes and services “right” has just begun and it must be a collaborative effort between public and private sector. And strong political leadership matters.
Wednesday, May 18, 2011
I was at an industry roundtable yesterday (I won't call it by name since I'm sure the host will produce their own version of the proceedings) and there were a few key learnings that I was able to glean. The participants included developers, pension funds and managers, private equity and financing sources and, of course, brokers.
One learning was that almost to a person everyone was optimistic on the near and longer-term future of commercial real estate. Many assumed that the cost of money would remain low and that financing would continue to become more abundant. Also, core assets, with stable case flows, will remain the most desired investment class, especially in the biggest coastal cities. Everyone agreed that development, with the possible exception of multi-family, has been non-existent for at least three years now and with no new demand in sight. I was the only real cautious participant, as I still believe that there is a growing threat of near-term inflation which will cause an upward movement in rates (more on that below). Additionally, state and local governments are struggling with runaway operating deficits (when combined with pension fund under-funding it really gets ugly) which will serve to dampen the effect of any private-sector employment growth and potentially kill an economic recovery. Click for Merideth Whitney's latest comments on the municipal market mess.
The threat of inflation is apparently front-of-mind for corporate CFOs as they are rushing to the debt window to refinance at today's low rates. Billions of dollars of debt has been raised in the first quarter of 2011 by major US companies as they hedge against the possibility of a Fed sell-down of securities bought during QE2. Today's Wall Street Journal details the rapid corporate refinancing taking place. The impact of a 200 to 300 basis point increase in mortgage rates in the commercial real estate markets would be profound, driving cap rates up by similar amounts and erasing some property net cash flows that are present largely due to low borrowing costs. However, I do think the Fed and Treasury policy-makers are astute and will be able to correct this situation in fairly short order, and, as such, should keep any market disruption to a minimum.
There is a healthy sales and financing environment right now, albeit with minimum improvement in real estate market fundamentals (i.e. driven by low-cost money). Job growth is key to improved fundamentals and we've only begun to see those numbers improve (and again, watch what happens to the public sector employment numbers in the coming months). With a little luck and a lot of careful policy-making at the state and federal levels, we might actually be able to withstand a rise in rates and keep the flow of capital open to real estate. There are a lot of variables and virtually all of them must fall into the right place for success. If that happens, then my fellow participants in yesterday's roundtable might actually be right.
Tuesday, May 17, 2011
By Michael Fonda (Chicago)
Last week two prominent businessmen from Illinois made the case for a more rational government. Jim McNerney, CEO of Boeing Corporation, delivered a stinging rebuke of the National Labor Relations Board (NLRB) in last Wednesday’s Wall Street Journal. Who can blame him for doing so? Boeing has built a 1.2-million-square-foot plant in South Carolina and the NLRB has told Boeing that it can’t operate the plant. The plant is LEED (Leadership in Energy and Environmental Design) certified, will house 1,000 well compensated employees, and it will produce (if it is ever allowed to do so) the new energy-efficient 787 Boeing Dreamliner.
Doug Oberhelman, CEO of Caterpillar Corporation, was the guest host on Squawk Box last week. In reference to Mr. McNerney’s editorial, Mr. Oberhelman made the point that all the money that is spent on lawyers to defend against government boards like the NLRB is money that can’t be spent on research and development. Oberhelman asked, rhetorically: “Do we want more jobs or do we want more regulations?”
We need a more rational approach to business in the United States. We particularly need a more rational approach in Illinois. In the “Opinion” section of yesterday’s Wall Street Journal, there was a column entitled “States of Business”. The column referenced the annual survey of CEOs of the best and worst states for business. The survey was produced by Chief Executive.The columnist made the point that “Tax-raising Illinois has dropped 40 places in five years and, as the magazine puts it, “is now in a death spiral.”
Quotes by Governor Pat Quinn in last Tuesday’s Chicago Tribune, in reference to Illinois’ efforts to keep Hoffman Estates-based Sears Holding Corporation from leaving the state, do not help the business climate in Illinois. Quinn said: “I’m sure that we will work something out, something that will work for the company, but most importantly, work for the common good, for the workers, for the jobs.”
“Most importantly?” Why is the company and its shareholders secondary in importance? “Workers?” You would think that he was talking about Dickensonian London rather than the employees at one of the most beautiful and inviting business campuses in the world. But perhaps the governor is talking not about the employees of companies like Sears, Navistar, Caterpillar and Boeing, but about the “workers” who report directly to him and his department heads.
On March 8, the Wall Street Journal’s William McGurn wrote a column entitled “Caterpillar’s Problem with Peoria.” In the column he wrote: “When companies stop investing in a state, their workers take the first hit, whether they’re unionized or not. Because members of public-employee unions draw their pay and benefits from governments, there is a much longer delay before they feel any pain from an economic downturn. Sooner or later, however, a declining private sector will mean a declining tax base, and a squeeze on public finance.”
Here are the most recent scores of NBA and NHL teams that are located in Avison Young cities and are still in the playoffs.
Chicago Bulls 103 – Miami Heat 82
Vancouver Canucks 3 – San Jose Sharks 2
Tampa Bay Lightning 5 – Boston Bruins 2
Monday, May 9, 2011
The Calgary office market continued the recovery witnessed in 2010 with a strong first quarter. The overall vacancy rate in the city has declined from 10.6% in Q4 2010 to 9.8% in Q1 2011. According to a report published by RBC Economics, real GDP growth is estimated to be 4.3% in 2011 for Alberta, the best since 2006. The report also forecasts nearly 50,000 net new jobs to be created for the province in 2011, the highest since 2007. All of the aforementioned market factors will keep the recovery moving but our focus will remain on energy prices as we forecast just how strong the recovery will be.
With unrest in the Middle East, crude oil prices have spiked dramatically in recent months. What may further affect pricing is instability spreading to oil rich countries such as Iran and Saudi Arabia. Combined with the growing energy needs of emerging economies such as China, the abundance of untapped oil supply in Alberta appears increasingly attractive to global oil companies. This has been reflected in positive absorption of downtown office space of 375,000 square feet through the first quarter of 2011. The vacancy rate including sublet space for both class AA/A office space in the downtown core has decreased from 8.2% and 8.0% respectively for Q4 2010, to 5.9 % and 7.5%. Dominated primarily by oil and gas energy companies, improved economic conditions and a very positive outlook on energy pricing, tenants have strong confidence to expand and take on additional space.
Although strong energy pricing bodes well for many Alberta companies, there is an economic reality that will complicate the economic recovery if energy prices continue to rise: higher energy prices equate to lower consumer spending. Bloomberg Businessweek recently ran an interesting article which detailed the comparison between gasoline prices and job growth in America. The economic reality is that as gasoline prices rise consumers have less money to spend elsewhere in the economy. As consumers rein in their spending fewer jobs are created which further stymies the fragile economic recovery. The full Bloomberg Businessweek article can be read here.
Avison Young's complete first quarter Calgary Office Market Report can be accessed here.
Thursday, May 5, 2011
Stephen Harper and the Conservative Party of Canada were elected into a majority government on May 2nd after serving for the past five years as a minority government. However, the bigger story may be the almost total obliteration of the Bloc Québécois (BQ), the federal party dedicated to promoting the sovereignty of the Province of Quebec which was reduced to four from 49 seats in the House of Commons. I can see two possible positives effects on Canadian real estate from this election.
After the Quebec Referendum of 1995, during which the Province of Quebec chose to remain part of Canada, many Canadians viewed the likelihood of Quebec pursuing separation again in the future as extremely low. However, some international investors did view the issue as a political and economic risk related to investing in Canadian real estate. I believe that the most recent election will likely render the BQ defunct as political party in Canadian politics and will remove the risk premium, perceived or real, international investors had associated with investing in Canada.
In the 2006 federal election, when the Conservatives won the first of two minority governments that led up to their latest victory, their election platform proposed a deferral of capital gains on the sale of assets when the proceeds are reinvested within 6 months. A structure that is similar, for real estate, to the 1031 Exchange in the United States. However, the election promise has not been fulfilled to date and one might speculate that the Conservatives will use their majority in the Canadian House of Commons to pass a law allowing for capital gains deferral for real estate in this country. I believe such a law would increase efficiency in the Canadian real estate market by reducing the tax burden on the industry and adding to the supply of product.
Currently corporations are taxed on gains from real estate assets either as revenue (and taxed at the corporate tax rate) for active real estate companies (eg developers) or as a capital gain. Regardless of the structure a corporation has employed, the overall result has been the over taxation of the real estate sector in Canada as measured by the OECD (OECD data, "Taxation of Corporate and Capital Income", 2005) and the Fraser Institute (Grubel, Herbert, The case for the elimination of capital gains taxes in Canada, Fraser Institute, pg. 34, 2001).
I believe the lack of a rollover provision has reduced the efficiency of the Canadian real estate market by restricting the supply to the market. The reason for this is that some Canadian cities, Vancouver included, have extremely fractured ownership. Many owners are families or individuals that are unwilling to sell due to a relatively large capital gains liability. As a result, properties are held for extended periods with little motivation for the owner to maximize return or pursue the highest and best use of the property. I believe individuals and corporations would be better off being able to sell their property and reinvest the proceeds in larger higher quality assets as market prices rise. In turn, this more regular turnover would provide greater supply to the market.
Monday, May 2, 2011
Among the many regulatory changes being discussed by FASB and IFRS to improve financial transparency, the ones being discussed impacting lease accounting, may dramatically change the real estate industry.
Under the new proposed rules, companies using Generally Accepted Accounting Principles (GAAP) will have to capitalize leases for their facilities. This means that all rents over the term of a lease, including operating expenses, renewal options and contingent rents, will become liabilities on the balance sheet and may dramatically affect financial ratios, loan covenants and EBITDA.
Avison Young published a white paper last year on the topic that has more detail regarding the origianl proposed changes. Since then, FASB/IFRS have had over 800 responses from industry stakeholders who have expressed the need for major revisions and clarification of many of the proposed changes. Currently, FASB/IFRS is pushing to absorb this feedback, make their recommended updates by June of this year, and then move forward with a proposed timeline for implementing these changes.
It appears that having to capitalize a lease from an accounting standpoint is definitely happening. This will impact any lease that is longer than 12 months. As a result, companies may move to shorter term leases to minimize the reportable liability. This effect is potentially devastating to real estate values as the shorter term lease adds more risk to the investment and will surely show up in loan underwriting. In addition, there will be a significant cost to companies to change their financial reporting processes to retroactively convert operating leases to capital leases and to provide more required detailed quarterly financial reports for their leases.
The current GAAP rules for lease accounting have been in place for decades and are clearly understood by corporate america, lenders and wall street analysts. Personally, I really question the need for reform in this area. It seems as though there will be an inordinate amount of cost for very little gain in improved transparency. Why burden corporate america with non-productive costs at a time when our country needs more job creation?
What brought down the house was a completely unregulated derivatives market...let's focus on fixing that!