Despite continued signs of “green shoots” in the macro-economy, there remains significant obstacles to recovery in the commercial real estate industry (CRE). In fact, according to PricewaterhouseCoopers (PwC), there are increasingly challenging conditions in CRE, the main culprits being:
– Tight industry-lending conditions
– A dearth in investor appetite for commercial mortgage backed securities (CMBS)
– Expectations for higher capitalization rates which imply decreased valuations
– Financial weakness and/or sluggish growth amongst tenants
“The credit crisis and ensuing recession have dragged commercial real estate markets into very trying times, marked by value losses, rising foreclosures, and reduced property revenues,” says Frank Magliocco, partner and leader of PwC’s Real Estate practice in Canada. “There is simply scarce money and therefore limited buyers.”
According to PwC, there are several pockets of weakness for Canadian investors, including:
– Secondary and tertiary geographies: CRE in rural and industrial areas or small- to medium-size strip malls typically carry higher risk than properties in large urban centers or iconic mall spaces
– Vulnerable property types: Hotel and leisure, suburban office and industrial space are considered to be the most vulnerable to the CRE downturn
– “High Risk” tenants: A large cohort of CRE leasors and renters are facing significant financial or operational challenges, an especially notable risk if “flagship” tenants are in deep distress
“Owners need to immediately implement monthly or quarterly cash flow reviews to understand exactly what their short-, medium- and long-term capital needs are and, perhaps even more importantly, immediately identify what options are available to overcome inevitable refinancing hurdles,” notes Magliocco. “In some cases, a formal restructuring process, equity injection or other non-traditional strategy may be beneficial.”
Furthermore, certain owners of CRE should consider divesting non-core or underperforming properties as a means to generate cash or capitalize on growth. On the other hand, well-capitalized investors may want to see if value can be extracted from the downturn via opportunistic acquisitions.
In either case, according to PwC, it is critical to keep abreast of the current dynamics in the CRE M&A market. Identifying and building relationships with the key capital providers, buyers and sellers in the market is a critical first step, which should be followed by the implementation of an appropriate M&A positioning and go-to-market strategy. Such careful contemplation and planning may mean the difference between success and failure.