The downturn, then and nowJan. 23, 2009 The downturn, then and now Source: TERRENCE BELFORD, Globe and Mail Update, January 20, 2009 at 6:00 AM EST Anyone who remembers the commercial property market in the early 1990s likely does so whispering a fervent prayer that this recession does not come anywhere near the meltdown that struck all forms of real estate then. Now, as landlords and developers brace for another rough ride in the looming recession, the early nineties crash serves as a reference point on how bad – or not – things may become this time. “The last one was dramatically different and resulted in a massive structural change in the industry,” says Pierre Bergevin, president and chief executive officer of Cushman & Wakefield LePage Inc. “This time, it will be transformational as well, but it will not rewrite the rule book.” John O'Bryan, vice-chairman of CB Richard Ellis Ltd., agrees. “There were different circumstances leading up to this one and there will be different effects. The fact is that we are far better off now to weather the storm and the result will be much less dramatic changes to the industry.” Indeed, if any good came out of the early nineties crash, it was the end to public companies and the rise of pension funds as the dominant force in the Canadian commercial real estate industry. And with that sea change came a new professionalism, increased caution in deals, little speculative construction and data-based decision making. At Avison Young (Canada) Inc., chairman and CEO Mark Rose says that if there is a single factor that characterizes the current situation, it is a lack of insight into what happens next. “There is a crisis of confidence, which is paralyzing decision makers. They don't know where the economy is heading and as a result they can't make decisions.” A sure sign of that paralysis is in the gap between what sellers are asking for commercial properties and what buyers are willing to pay, he says. “The result is a gap between bid and ask on properties that is the largest in memory. With a gap that wide there just is no room to manoeuvre in deals.” So what are the differences between the meltdown that occurred in late 1980s and early 1990s and today? First, there is the nature of ownership of properties. The late eighties were the heyday of entrepreneurs, both private and public, Mr. Bergevin says. Many worked deals out on the backs of envelopes and sealed them with a handshake and they wildly overbuilt. Today, 70 per cent of major holdings in Canada's largest urban centres are held by just six groups, mainly pension funds. “In the years between 1989 and 1991, the industry added 50 million square feet of commercial space,” Mr. Bergevin says. “This time, in the past two years, we have added only 12 million.” Then, there is a more manageable office vacancy rate, currently averaging 4.1 per cent, according to Cushman data. Interest rates were well into double digits in the late 1980s and early 1990s – today, they are at near historic lows. “In 1987, when the stock market went south, everyone moved their money into real estate,” Mr. Bergevin says. “When the inevitable crisis hit, you would find lenders foreclosing on properties like a hotel in Tillsonburg [Ont.] with four mortgages. Properties like that should probably not have even qualified for a second mortgage.” Many entrepreneurs and public companies had spent the 1980s assembling huge tracts of undeveloped land, most of which was highly leveraged. When the crash hit, they found themselves without the cash to pay the carrying costs and no ready buyers to sell their land banks to. “The last thing you want in a recession are vast land banks,” Mr. O'Bryan says. “The carrying costs will eat you alive. Today, those that have land are well financed, have cash and are able to carry it through the crisis.” Unlike the early nineties, property owners are also well informed, he adds. “Two decades ago, information was fragmented. Today, because of the huge amount of data of all kinds available, a good many people were able to see this recession coming and had time to prepare for it. “They did not know exactly when it would hit but they did know it would.” As a result of all these factors Canada is perhaps the best positioned of all industrialized nations to weather the storm, Mr. Rose says. “The U.S. is much more affected. I think prices for commercial properties there have to come down between 20 per cent and 40 per cent before the situation is resolved,” he says. “Frankly, right now I would rather be in Canada than any other country in the world.” Granted, Canadian commercial real estate will be hard hit in some quarters, the three men agree. Owners of A-class office buildings can be expected to cut rents and offer incentives to tenants of lower-ranked structures if their vacancy rates rise. In turn, B class buildings will try to draw from C-class buildings. “Those hardest hit will be the B- and C-class office towers and properties in smaller centres,” Mr. Rose says. “In fact, properties in smaller centres may find difficulty refinancing when mortgages come due.” On the broker front, crisis can bring opportunity. For example, large brokerages that have focused on providing a broad range of services to clients and are cash rich will both have the revenues from services to weather any downturn in brokerage income and the cash on hand to acquire other companies and expand their service offerings. “Our services business has been growing 30 per cent a year,” Mr. Bergevin says. “Last year alone, we acquired two more companies, one in project management and one in property tax appeals. I can see making more acquisitions in 2009.” Avison Young is also on the acquisition trail, Mr. Rose says. His plan is to turn the company into an international real estate brokerage and services giant, the only one based and owned in Canada. At the same time, all three men agree the worst is yet to come – consumer spending has yet to be felt in full force. “The factor we can't predict is the effect [consumers] will have on corporate instability,” Mr. Bergevin says. “If corporations begin to fail or consolidate, that will have an impact on demand for commercial real estate in all its forms.” “What we are looking at is Darwinism,” Mr. O'Bryan says, alluding to survival of the fittest. “And that is hard to predict right now.” Special to The Globe and Mail |