Mortgage – Why 2021 will be a good year for Canada’s commercial mortgage agents
Despite the ongoing economic turmoil inflicted by COVID-19’s powerful second wave, new data from Colliers International says investors, sitting atop mountains of dry powder and anticipating significant bargains, will be actively pouncing on commercial real estate opportunities in 2021.
Colliers’ 2021 Global Investor Outlook, based on survey data collected between November and December 2020 as well as interviews with Colliers Capital Market specialists, found that 98% of investors are planning to expand their commercial real estate portfolios in 2021, with 23% of them planning to increase their CRE footprints by at least 20%.
“A lot of institutional and private capital investors have been sitting tight, but with the flip of the calendar, fresh [profit and loss statements], and more optimism, the back half of 2021 is looking much brighter – not only for primary markets, but for secondary and tertiary ones as well,” Matt Rachiele, Colliers’ managing director and senior vice president of investment sales for Canada, stated in the report.
Mortgage Broker News reached out to Rachiele and his colleague Roelof van Dijk, Colliers’ senior director of national research and analytics, to get a fuller sense of why investors see light at the end of the commercial real estate tunnel when so many businesses are still going dark.
The following interview has been edited for length and clarity.
Mortgage Broker News: The survey Colliers’ 2021 Global Investor Outlook is based on was conducted in November and December. Do you think the rather dispiriting COVID-19 developments seen over the last few weeks – higher case numbers, more deaths, stricter lockdown measures – may have dampened the positive sentiments expressed in the survey?
Roelof van Dijk: I personally believe that a lot of the sentiment had that whole COVID second wave baked into it. When we were looking at the top five challenges all these investors were mentioning –in their outlooks, in their ability to move capital – number one was COVID-19 and what’s going on there, and then the return to work. I think it was absolutely top of mind. There was an understanding that there was going to be a second wave. Obviously, no-one knew what it would look like, or the extent of the lockdowns in some of the markets across Canada, but I do think it was baked into their thoughts.
Matt Rachiele: I think if we had a skinnier buyer pool than we have seen in the [Montreal-Vancouver-Toronto] markets in particular, you might have seen it sideswiped a bit, but there’s been enough depth and breadth there, for some time now, that I think everybody’s aware that they don’t have time to pause and risk losing out on some great assets right now.
MBN: So that positive sentiment is primarily the product of bargain-hunting and attempts to capitalize on a disrupted market?
RvD: Absolutely. The results that came out of this survey, and our anecdotal conversations with investors across the board, tell us people are looking for opportunities. That’s where a bit of a mismatch between buyer and seller expectations exists, because everyone wants that COVID deal, but there’s not a ton of COVID deals out there to be had. That’s my impression.
MR: I think it’s bifurcated. If you’re talking about industrial or multi-family, or you’re talking about core or core-plus, or even value-add, the bids are just too strong. If you’re talking retail, hospitality, or even lower-grade office, for example, it’s a completely different story.
RvD: And that’s exactly the same for both the actual buyers and lenders.
MBN: How much of a gulf is there between what sellers are expecting for their properties and what buyers are looking to pay?
MR: Bid-ask spreads started to converge, sort of across the board, in the back half of 2020. I think if it exists most broadly anywhere, it’s going to be back in that retail-hospitality space. We just haven’t seen that roll over. There’s a lot of interest in opportunistic buys on those asset classes, but, so far, we haven’t seen a lot of vendors capitulate because they’re getting enough provincial, federal, or lending support to get through at the moment.
When it comes to things like industrial, core office, and the like, it’s been trading.
MBN: The outlook says Colliers is expecting a 50% surge in CRE investment activity in 2021, which is a pretty eye-opening figure? Is it based on the survey responses or Colliers’ own data?
RvD: That is based solely on the survey responses, but I do think there is going to be a big uptick in activity this year compared to 2020, and a large part of that is because we saw a major fall-off between 2019 and 2020, so we’re regaining some ground there. But it just shows the strength of the buyer pool and interest in commercial real estate.
We have a lot of investors who are looking for yield and, like Matt said, when you’re looking at a solid core office asset, a solid industrial asset, or multi-family (even though vacancies have moved up), these represent great opportunities for buyers. That’s why there’s so much capital looking for those opportunities.
MR: At the global level, we had around 300 respondents, and 98% of them are expecting to expand their portfolios this year, with 60% or more of them looking to do so by up to 10%.
At the local level, what Roelof just spoke to is being confirmed by the boots on the ground, and by what we’re hearing and seeing. We’re seeing a lot of private capital activity; we’re seeing institutional money starting to move around a lot more. I think we’re going to see, late in Q2 and certainly in [the second half] of 2021, a significant uptick.
MBN: How close will that 2021 activity get the market to its pre-2020 levels?
RvD: It’s not going to get up to the activity levels we saw in 2019 or, on a quarterly basis, what we saw in the first quarter of 2020. There are some investors that want to be able to travel to an asset, and that might hold back a few people. But like Matt said, the quality stuff is going to move.
MR: For most major markets in Canada, 2019 was a high-water mark, so it’s better to look at three- and five-year averages. If we’re actually at 50% [growth] year-over-year, we’re probably going to be falling more in line with slightly above what that five-year average was. Don’t forget, part of that’s pent-up deal activity.
MBN: I’m curious about the interest in office properties that popped up in the Outlook. Are investors looking to snap them up and use them as traditional office spaces, or are they having to innovate new uses for them?
RvD: I don’t think there’s a huge desire to snap them up and try and repurpose them. I don’t think that’s really a big part of the investment play right now in core office.
There is an expected return to the office. When we look at attendance levels when the market started opening up, we saw people coming back in. And the surveys that we’re doing are indicating that both employers and employees are looking to come back into the office.
When you break it down into the types of spaces, everyone’s looking for high quality, healthy, wellness-certified-type space. It’s generally the core-type buildings that fit that bill. Those are top performing assets. We anticipate them to continue to be top performing assets in the coming years and decades when we get past this COVID situation.
MBN: If you’re a retail investor and you’re hoping to swoop in and score some deals, are you going to have to show your lender that you have a plan to revive the property before you get it funded?
MR: I don’t think we’re seeing lenders race to the door to provide new money to fresh names at the moment. I’d say that relationships are king in periods like this, and I think banks have done an exceptional job of supporting the long-term relationships of theirs through [the pandemic].
The other element to that is that banks are not set up to operate assets. They do not want to force their tenants into a foreclosure and then end up being thrown the keys to something they have no business operating. I think we’ll potentially see more of the [Brookfield Asset Management] model, though. Brookfield has started to put equity into tenants in certain retail spaces. In fact, they’ve raised significant funds on the side to do more of that.
RvD: When [lenders] are looking at a management team that has been through recessions that tested them, those are the people they want to continue investing in. If these people see the opportunity, [lenders] will probably hang on for the ride, too.
MBN: The report mentions a lack of supply, which most Canadians associate with residential real estate. How would you describe supply levels in the most active commercial categories?
MR: I think part of it is vendors’ unwillingness to transact last year for fear of selling at a low and/or bottom of a cycle, bid-ask spreads being as wide as they were, and development in many areas across Canada ceasing.
Part of that new supply in-flow had been choked off last year, and when development ceases for a long stretch of time, it can be a delay of anywhere between half a year to several years before you see that product return. We are certainly expecting development to pick up in major markets mid- to late this year, if not sooner, and that product will be coming on late 2022 and into 2023. That’s going to be predominantly in the industrial/logistics front, probably multi-family. Any others – office, retail – are a big question mark right now.
RvD: In markets like Toronto or Vancouver, there’s a ton of office space under construction. For the most part, those projects are multi-year projects, so when you have a delay of a month or two because a project is shut down it’s not a big deal. But when you look at an industrial project, those are generally completed in less than a year, and if there’s a delay of one, maybe two months on construction, or there are delays in planning or permits here and there, that adds up pretty quick.
What you’re seeing, specifically in a lot of industrial markets, is vacancies moving up a little bit because some of the smaller tenants are having some trouble, but that vacant space is not matching up with what’s in demand right now. What’s in demand is e-commerce fulfillment, large warehouses, cool space for grocery fulfillment. Developers are working overtime to try and meet that demand and, as a result of some minor slowdowns, you’re going to see vacancy across the country move down later this year and developers continuing to play catch-up. It’ll drive rents up and it’s here for a few years at least.
MBN: What advice would you give to commercial mortgage brokers who may be viewing the 2021 market with uncertainty? What are their clients going to need from them going forward?
RvD: It’s interesting looking at the lenders because, similar to the people who are actually bidding on these assets, a lot of these lenders want in on the same action. What we’re finding is that on these great assets that someone’s looking to put a mortgage on or refinance, they have a list of lenders that are knocking down their door to get in on that.
But it’s that narrow bit – the right market, the right asset – that everyone’s looking at, and if you want to get your lending book open this year, you’re probably going to have to broaden your perspectives. Look at some different assets, some different locales where the growth potential might be there that you haven’t been paying attention to previously. Not everyone is going to be able to allocate all of the capital they want to this year without doing that.
MR: Deals in this market are going to need a lot more security and comfort, particularly on less established assets and/or lendees. I would say it’s important to keep in mind that lenders always think in terms of RAROC, which is risk-adjusted return on capital. If you’re negotiating on rates, think about what that looks like over the curve. Even if there’s some sticker shock initially, if you can show a path of greater returns slowly stepping up over the course of time – something that’s more palatable to a lender – that’s going to help their RAROC math. It’s going to make it easier for them to actually lend on.
And I’d think about tightening up durations. To the extent that you can do a shorter-term deal and revisit on more attractive terms out two or three years instead of trying to push for five-plus, it may be in your best interest because you may get a far more palatable deal once things normalize again.