Value-add assets are commercial real estate’s ugly ducklings, typically entering portfolios as less-than-glamorous acquisitions, but with the potential to catch the mainstream current and make a splash for investors. Prominent Canadian asset managers recently recounted their experiences in repositioning underperforming properties — including a shared example from two of the panellists’ portfolios — offering insight on turnaround logistics and the role value-add assets play in investment strategies.
Discussion moderator, Peter McFarlane, senior vice president with Fiera Real Estate, set the context with statistics showing the shrinking share of capital allocated to repositioning over the period from 2012 to 2017 as companies, funds and REITs shifted their focus more to core assets. In part, he suggested, that reflects a retrenchment after a pickup in activity immediately following the 2008 financial crisis.
“Value-add can be hard to keep rolling forward because a lot of it is in closed-end funds,” he told seminar attendees at The Buildings Show in Toronto.
“It’s an exercise that has a very, very targeted mandate,” concurred Angelo Di Palma, principal and portfolio manager with BentallGreenOak, defining himself as a niche player inside what’s chiefly a core management company. “It’s really designed to fix and then sell.”
Similarly, Theresa Warnaar, vice president, portfolio management, with KingSett Capital, confirmed that “value-add opportunities” are mostly channelled into the investment firm’s growth funds. In contrast, John Ballantyne, senior vice president, asset management, with RioCan REIT, connected his company’s repositioning efforts to a new direction for the portfolio that has seen it shed assets in the United States and smaller Canadian markets in favour of six large urban regions.
“Our business plan now is to add value to 225 properties,” he reported. “It’s really capitalizing on where there is density. What we are trying to do is not only grow value, but really create an atmosphere of live, work, play, eat, shop.”
Leveraging density for a mixed-use hub
The recently completed $300-million makeover of the Yonge Sheppard Centre is part of that strategy. Situated in a rapidly intensifying node of Toronto’s north Yonge Street corridor, the office-retail complex boasts connections to two Toronto transit subway lines amid a steadily growing population of local condominium dwellers requiring services and leisure attractions. Still more residential density is coming as construction nears completion on the 36-storey rental apartment tower RioCan is developing on the site.
Looking back to the acquisition, asset managers easily saw the nascent elements of a dynamic mixed-use hub, but had to squint a little around the reality. A swath of vacant retail spaces were barricaded behind an opaque, circa-1970s facade that could only be breached via subterranean or second-storey entrances. Other operational deficiencies abounded.
“It wasn’t pretty. You literally had a moat around the asset,” Ballantyne recalled. “The office buildings leaked like sieves. Water would come in; energy would go out.”
Today, it’s an outward-facing retail mall with an emphasis on food and lifestyle services, including a grocery store and fitness centre as anchor tenants. “We really touched every square inch of this shopping centre,” he said.
Adjusting the tenant mix — “Fashion is a killer,” Ballantyne asserted — was perhaps an easier aspect of the transformation. While inner city locations underpin the potential of value-add assets, a frenetic daytime pace and nearby population that wants to sleep at night create complications for scheduling some tasks and deliveries.
“It’s really tough to do the actual construction. You are going to be doing a lot of work at odd hours and it’s just going to take longer to get it done,” Ballantyne advised.
Reversing decline and diversifying tenancy
Turning to an office example, Warnaar outlined a dual-track process of stabilizing a building that had fallen behind on upkeep and priming it to compete for a new kind of tenant. In this case, the 250,000-square-foot, 22-storey tower in Ottawa’s central business district had enjoyed a long run on the federal government’s official accommodations list, but was in danger of losing its status.
With an ultimate goal of reducing dependency on government occupancy, the short-term priority, nevertheless, was to hold on to public service clientele. That took form in a $10-million capital injection to overhaul key building systems and update dowdy common areas, along with a new property management team tasked with improving strained relations with the tenancy.
“The capital spend was needed to stay on the government’s long-term accommodations list. If you’re not on the list, you don’t get the renewal,” Warnaar explained.
Yet, even without that pressure, she noted that prudent asset managers address deferred maintenance and explore retrofit opportunities as an inherent element of repositioning. There are often many low-cost upgrades that will serve investors well, particularly in older acquisitions.
“If you make your buildings run more efficiently, you can really find a lot of savings,” she reiterated.
Meanwhile, the government’s evolving workplace fit-up standards and associated reduction of its mandated space-per-person ratio served up another dilemma. Ottawa’s flourishing tech sector presents a lucrative source of demand expected to become increasingly important as the government’s office footprints shrink, but KingSett strategists concluded characteristically freewheeling tech personnel wouldn’t necessarily mesh with the Department of National Defence (DND) recruiting office at lobby level of the building. They made the seemingly paradoxical decision to terminate the DND tenancy when it came up for renewal.
“We had to get rid of the people we were trying to keep,” Warnaar reflected. “We’ve re-launched this property without having the DND office on the ground floor.”
Notably, of the three model suites KingSett introduced — one in accordance with the government’s workspace specifications; one targeting the tech sector; and one aimed at a general private sector audience — the tech space was the first to lease up.
Rightsizing to a competitive market position
Rightsizing has been central to the repositioning strategy for London, Ontario’s Westmount Shopping Centre — a process the previous asset manager, Bentall Kennedy (forerunner to BentallGreenOak), instigated before KingSett acquired the property in 2017. Both Di Palma and Warnaar characterize the now nearly 50-year-old enclosed mall as weak competition for the city’s regional malls, which include CF Masonville, ranked 14th in the Retail Council of Canada’s Top 30 most productive shopping centres with sales of $974 per square foot in the 12 months ending June 30, 2019.
“This was a case of too much (within London) built in the same asset class. It was too big for its market position,” said Di Palma, hearkening back to 2006 when Bentall took ownership. “On the bright side, it had some really strong anchor tenants. You had the makings of a strong community shopping centre even though it was dressed up to look like something bigger.”
Taking what he terms “a less-is-more approach”, the asset managers opted to demolish a 130,000-square-foot section of the mall. They moved all non-anchor retailers to the main level and began the process of converting vacated upper level units into office space. The latter strategy proved prescient given sometimes unforeseen retail sector upheaval during Bentall’s tenure.
“We were hoping Target was going to show up and be a good anchor tenant. It was there for about 10 minutes and then we were in another pickle,” Di Palma quipped.
After holding the property for approximately three years longer than the initially envisioned seven-year period, Bentall cashed out its gains. The new owner took on the ambitious task of filling two vacant two-storey anchor stores — formerly Target and Sears — sticking largely to the previously launched plan.
At roughly halfway through KingSett’s projected redevelopment timeline, a portion of that lower level space has now been leased to a fitness centre, while the upper level of the former Target space has been converted to office uses. Prior to leasing, facade upgrades and proactive fit-up of the new commercial space, including installation of a green living wall in the entrance lobby, were aimed at giving prospective tenants a tangible sense of the retail-to-office transformation.
“For them to actually walk through and see it, that was a game changer,” Warnaar maintained.
As of December, deals were in place for more than 26,000 square feet of that office space. On the ground floor retail level, the first vendors have arrived in a newly forged food court with expectations of an expanding customer base as the office space fills.
“We built on what Bentall had started in the upper level,” Warnaar said. “Bentall had reached the end of their investment horizon. It was the next owner’s (work) to do.”
Delivering on a realistic vision
For both owners, that work aligns with her advice for repositioning projects in general: “Be true to the vision you can deliver.”
“We didn’t think this would be a competitive mall in the London market,” she said. “The vision was that we wanted to fill a void. We worked with the team to find a way to market this to the community.”
And the construction, project management, property management and leasing teams that panellists typically turn to have an understanding of value-add assets. “You really need specialists in this area,” Di Palma submitted.
Repositioning is also a matter of re-establishing credibility. “Stigma is something that develops over a long time. It takes years to develop and you cannot fix that fast,” Di Palma asserted. “Until the community buys in, you’re going to be working hard to try to win them back.”
Missteps and/or unforeseen turmoil do occur. “You don’t know what you don’t know sometimes. Sometimes the market demographics outgrow your property,” Ballantyne mused.
However, there is a consistent starting point for a successful turnaround. “You have to be realistic in your underwriting. Don’t underestimate the cost and time you need,” Warnaar said. “If you’re underwriting something that’s unreasonable, you will never achieve the expectations.”
Barbara Carss is editor-in-chief of Canadian Property Management.