Cash-laden trusts lift commercial real estate

Well-financed real estate investment trusts that hoarded cash during the recession are lifting the commercial property sector out of one of its worst slumps in a decade.

Industry tracker RealNet Canada said $5.4-billion was spent on 990 transactions in the Greater Toronto Area, down from $12.5-billion in 2007, the industry's best year. However, sales increased markedly as the year ended, increasing 74 per cent in the fourth quarter from the third quarter, as confidence began to return.

REITs are driving much of the activity. As the credit and equity markets thawed last year, many trusts found that they could raise money through equity sales, anticipating bargains when distressed sellers looked to offload properties.

Now, they're sitting on as much as $1.5-billion, according to some estimates, and are beginning to spend it.

A healthy real estate sector is key to the broader economy because commercial and residential properties underpin a hefty portion of the assets of banks, pension funds and other institutions. Huge trouble in the sector contributed to the demise of some large trust companies in the early 1990s.

However, while the declines in prices and sales activity have halted, properties are still selling at lower values than they were a couple of years ago. "We're starting to see buildings come to market as owners realize maybe their dreams aren't quite going to work out," said Michael Emory, chief executive officer of Allied Properties REIT.

"They won't fetch a stupid price like they were able to when private equity was chasing everything that moved, but they are getting fair prices."

While access to both debt and equity has been elusive in the United States, where prices have fallen much more dramatically than in Canada, the REITs have been able to capitalize on long-standing banking relationships and strong balance sheets to raise funds.

"For the small private buyer the difficulty is in getting debt on reasonable terms," said Michael Smith, an analyst at Macquarie Securities. "REITs are in a good position today as capital, which is the life blood of the sector, is both cheap and plentiful. I think they are in a sweet spot and will be major buyers during the course of 2010."

Allied, for example, spent $180-million to buy a downtown Toronto data centre last quarter - not exactly a typical investment for the owner of traditional office properties. The building is used by telecom companies to house equipment that is critical to their national fibre-optic networks. It features optical check points and dozens of security cameras. There are back-up diesel fuel tanks to keep the power running, but companies can also place their own back-up generators on the rooftop.

The recession pushed down the building's value just enough that Allied was able to buy the property, taking ownership from a smaller company that decided to focus its attention elsewhere rather than hold on to a property that wasn't a huge priority.

"There is absolutely no question that this building would have been out of our range before the credit crisis," said Allied's Mr. Emory. "The recession may ultimately prove to have been a good thing for public real estate entities that remained disciplined. Companies are culling their portfolios, and this has created an opportunity for new buyers."

There have been few disasters, however, as distress sales accounted for just 3 per cent of the dollar volume of sales, according to RealNet, in line with other more typical years as most owners were able to refinance and avoid putting their properties up for sale.

"You haven't seen many big train wrecks," said RealNet president George Carras. "The properties that do come available are going to smart money that has identified targets they may not have had a shot at before."

The Toronto market, the largest in Canada, saw almost two years of declining activity going into the middle of 2009 as the credit crunch made it difficult to finance acquisitions and buyers with cash waited for properties to decline in value. Data are expected for other cities later this month.

Now in a more stable position, many property owners are opting to sell buildings that aren't performing to expectations or don't fit in an overall strategy in a bid to solidify their balance sheets. REITs are increasingly stepping up, compelled to spend money that is gathering little in the way of interest.