Bubble bursting potential now lies in an expanded range of risks to commercial real estate. Senior ranking valuation specialists speaking in Toronto last week, as part of the 2018 RICS (Royal Institution of Chartered Surveyors) conference series in seven major North and South American cities, agreed that new uncertainties around fraying trade agreements, political instability and climate volatility have broadened the scope of their worries well beyond rising interest rates.
“What we’re concerned with on value is not what we used to be concerned with,” acknowledged Jim Moran, executive managing director and global chief operating officer with Cushman & Wakefield. “There are risks attached to the global disarray that we are in right now, all of which come to real estate.”
However, panellists tasked with exploring the topic, How does the shifting investment landscape impact risk management?, also rejected ominous labels for current market dynamics. Despite historically low cap rates in some markets, they argue that asset values are still tied to economic growth and reflect sound investment decisions.
“I think the word ‘bubble’, itself, is just a sound bite,” said Michael Hedden, a director with Houlihan Lokey in New York. “I don’t necessarily see the irrational exuberance.”
“In terms of what we’re calling this market, I’m not sure I’m in the ‘bubble’ camp,” concurred Paul Morassutti, executive vice president, national investment, with CBRE. “Bubbles are a sharp incline in asset value decoupled from the fundamentals and that’s not an accurate description of what we’re seeing in Canada. I think the fundamentals here really shouldn’t be discounted.”
As one example, Colin Johnston, president, research, valuation and advisory, with Altus Group, cited multifamily rental housing. “On the surface, cap rates of less than 3 per cent in Vancouver sound crazy, but we’ve underdeveloped purpose-built rental for years and it looks like we’ll go on under-building it,” he said.
Nevertheless, Canada’s predominant institutional investors are also among its most active developers — now with an economic rationale that complements the mixed-use projects urban planners have long championed. “You need high densities because you are paying a lot for the land,” Johnston explained.
Tallying the uncertainties
The usual suspects — inflation, unemployment, a liquidity crunch — figure prominently on any list of the threats commercial real estate faces. The unwelcome influence of political events was obvious in the United Kingdom in the summer of 2016 when commercial property funds were forced to suspend trading after a spate of investors cashed out their holdings following the Brexit referendum. Similarly, bumpy NAFTA negotiations and other trade upheavals have real estate players watching with some wariness.
“The uncertainty of not being able to predict what’s going to be happening in the next Tweet is driving us crazy in our countries,” Hedden mused.
Meanwhile, rising interest rates are identified as a leading probability that could both undermine values and steer more investors toward other asset classes. “We may not have the capital flows that we are currently seeing,” Hedden warned.
The impact on consumers and how that might flow through to the broader economy is also cause for worry. “The Canadian household debt is the highest in the G7,” Morassutti noted, while stressing that government overspending is of equal concern as deficits grow in Canada, the United States and the European Union. “We are sitting on something globally that scares me and governments don’t seem to be doing anything about it.”
Liam Brunner, senior managing director with Newmark Knight Frank, suggested that’s in line with regulators’ approach to managing economic cycles. “They tend to be lenient on the way up and too severe on the way down,” he said.
Drilling down to real estate, panellists sketched out some of the trends they’re monitoring, along with the risk management strategies and tools the industry is deploying. Vulnerabilities are easy to pinpoint.
“The obvious one to kick at is retail,” Johnston said. “We haven’t finished backfilling Target space and now we’re backfilling Sears space.”
Yet, many strong performers remain even if stock prices don’t accurately reflect that. Morassutti pointed to key properties Brookfield is acquiring with the U.S. based GGP portfolio — “They are some of the best malls in the world,” he said — and argued there are other such gems to be found.
“Incredible negative sentiment is pulling all stock down and tarring the entire sector with one brush,” he asserted. “I think investors have been spooked. The retail headwinds are very, very real, but it doesn’t apply to every asset equally.”
Retail closures can also free up highly sought locations that are prime for repositioning. “There are going to be some golden nuggets,” Hedden said.
Tools for reading the marketplace
The commercial real estate industry may be better equipped to read the signs of a downturn than during past cycles. “We have great data. We’re in real time in terms of analyzing capital flows,” Hedden noted.
Moran likewise recalled the days of spreadsheets when analysis was an exercise in looking back in time versus today’s ability to see costs and trends on a daily basis. “It’s going to help the real estate community. It’s going to help the investment world,” he said.
Johnston also applauded the efficiencies of consigning tasks he categorizes as “busy work” to automated, algorithmic interpreters. “After you read 10 or 20 leases, there’s not much more to the learning curve. Technology like that can be pretty useful,” he observed.
Even so, panellists called for experiential insight and skepticism in tandem with the deployment of data analytics and artificial intelligence (AI) applications. They foresee continued reliance on human judgement, particularly for complex valuations like shopping centres.
“Don’t believe the data in your hand is all the data you need. The technology risk might be if it gives you a false sense of what you know about the market,” Brunner cautioned.
“The concern for us right now is the veracity of the data,” Moran agreed. “I think five of us could look at the same pool of data and interpret it differently.”
Alternatively, looking to RICS’ mandate and expertise, standards provide the structure and discipline for determining how data should be collected, verified and shared. Panellists saluted the RICS Valuation Global Standard as a tool that has harmonized previous varying approaches and eased their job. “We’re down to very minute differences today,” Moran said.
It’s one of a suite of RICS standards gaining traction in an increasingly global marketplace.
“What’s going to win out at the end of the day?” Johnston reflected. “Professionalism and ethics.”
Barbara Carss is editor-in-chief of Canadian Property Management.
