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episode # 158

What You Don’t Know About Commercial Real Estate Will Hurt You with Cory Wright

Commercial real estate is telling an interesting story but are you listening? It is one full of compelling characters, with names like Amazon & Microsoft, and set against a backdrop of low vacancy, increasing demand, and exciting investment opportunities. Owner/Broker Cory Wright of William Wright Commercial Real Estate Services sits down with Adam & Matt to discuss the state of the commercial real estate market and what it means for the future of residential real estate. Tune in to find out Cory’s top areas for investment, where novice investors should look to buy, and why commercial real estate may be the canary in the residential coal mine. “Whoop, whoop, whoop, whoop” – Arsenio Hall

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Episode Summary


 

About Cory:

Cory is the managing broker with William Wright Commercial Real Estate Services, which he founded just over five years ago. They have created a great team over the past couple of years. The company focuses on all asset classes within commercial, mainly in the Lower Mainland but they currently have expansion plans for Kelowna and Victoria. Typically, you see hundreds of brokers working out of one downtown office to service the Lower Mainland, but William Wright took a local approach. They have three smaller, boutique offices located within the communities they serve.

On how the commercial market is doing:

It’s been really good. There’s great inventory. Residential has affected development land prices somewhat, but retail, industrial, and multi-family have been great this past year and the outlook for this coming year is great, as well.

On why multi-family has been so popular:

Up until the NDP announced the 2.5% maximum rental rate increase, vacancy rates were extremely low. You get a lower cap rate when you purchase, but the trade-off is there is almost no vacancy. This made it very attractive for local buyers, pension funds, and large-scale investors to get into. Low maintenance also made it attractive. With the NDP’s maximum annual increase, multi-family saw a slowdown but it’s starting to pick up again (it can only go on for so long). The challenge is many people looking at building purpose-built rentals see more than that 2.5% increase on their costs each year, so are now putting them into strata markets or cancelling altogether. This is shrinking the rental supply, which could mean a good outcome for landlords in the future if things don’t balance out.

The NDP made a short-term decision. From a building owner’s standpoint, if costs are above 2.5% each year and revenues are capped, along with other pressures like rising interest rates, it is harder and less attractive to buy into the market if you haven’t been in it for awhile. Developers are looking at scrapping the purpose-built rental model and instead going into stratas and selling expensive condos. They’re also considering selling the land and looking at mixed-use opportunities. This means little or no supply coming in, so people who want to move can’t move, and renters trying to get into the marketplace cannot do so. Supply and demand then kick in, and eventually rental rates will go up higher than the government would have wanted: as people turn over, there will be too much demand from those wanting to come into these buildings.

On how the industrial market is doing:

Momentum is really good. If you’re looking to get into the marketplace with something less landlord-intensive than retail, for instance, then industrial is where to go. The challenge with it is zoning has become so much more flexible than it was 10 years ago that you can get so many more types of businesses to operate within industrial areas—it’s no longer just large warehouses; you may see businesses like apparel companies and law and accounting firms. This means you’re competing with $10-$15 per square foot as opposed to $50 per square foot downtown for a Class A building.

As well, when cities look for rezoning opportunities and create an official community plan in housing, industrial seems to be an easy option because there are large pieces of land available. They can take a 10,000 square-foot lot, put a 6,000 square-foot building on it and employ six to eight people, or they might put 300-500 people there as residents. For instance, take the Marine Drive and Cambie corridor: once the Canada Line came in, some of the old lots south of 10th Avenue were great opportunities for high rises. This creates more housing than job opportunities, which dwindles supply even more with demand on the tenant side as zoning opens up to various tenant options. Pricing is increasing in office markets, so tenants are more attracted to leave downtown and get into industrial space. Plus, land is being taken up. There is pressure from all points, making it hard to even buy as a long list of investors want to get into the market. Industrial will most likely continue with another good year.

On what’s currently driving the commercial market:

Overall, lack of inventory. Commercial is more of a “want”, while housing is more of a “need”. Also, there is no foreign buyers’ tax in the commercial marketplace. For those looking to invest in a Vancouver address – whether it’s a condo, house, or industrial property – to shift and save 20%, it’s definitely worth it. In industrial markets, there’s huge demand on the tenant side with very low vacancies, making it very attractive to investors.

On if buyers are international or local:

You do see a fair number of people from all over the world getting into the market here. Investors can look at cap rates from other places and, even as ours get lower, see that our rates are still higher than other North American or overseas locations. No vacancy is very attractive, whether in office, retail, or industrial marketplaces; this is making supply and demand kick in, which is driving up prices. Lease rates might climb 10-15% in a year.

On the explosion of office space being built downtown and what that means for Vancouver:

Look at the companies coming into the downtown core – it’s the “Amazon effect”. They’re taking up hundreds of thousands of square feet, which puts pressure on supply, right away. Apple just took 60,000 square feet in Westbank’s downtown location, and Microsoft is expanding. These companies are taking space, but the biggest thing is they’re creating jobs. Young, very well-paid professionals are coming in, and they can afford to live and spend in the downtown marketplace. Cory can’t think of a market that has this boom with the Amazons and Apples of the world that doesn’t have a correction or pullback: there are too many jobs taken up by too many young professionals that make too much money. Whether it’s San Francisco or Seattle where these companies have come in, people are coming here with the means to afford $500,000+ condos. Last year in San Francisco, the average price per square foot for Class A office space was above $82. We just passed $50. So, there are a lot of areas in which we can continue to grow. With the weaker Canadian vs. American dollar, the training and education available here, and the population to pull from, these companies can still put people here at a lower cost than they can in Silicon Valley. From a lifestyle perspective, we’re cheaper than Silicon Valley, too. It’s all relative: someone might sell a $2 million bachelor suite in San Francisco and feel they’ve hit the jackpot in Vancouver.

On the impact these higher office prices have on local businesses and other offices that must renew their lease or are looking to be downtown:

There is no supply to pick from. Right now, in downtown Vancouver, there is a record (approximate) 1.6 million square feet either under application process, being built, or being ready to deliver between now and 2023. The absorption rate of this is huge because of tenants like Apple taking up huge amounts of space, and Amazon taking up roughly half of the Canada Post building’s 1.1 million square feet. There is nothing to pick from. Tenants who are currently operating downtown and need to stay there have leases coming up with increases but nowhere else to go; they’re stuck. If they don’t want the space, there will be someone else behind them who will fill it.

On how downtown will look in the coming years:

Possibly like Alberni Street. The mom and pop shops are long gone, and international brands have come in, such as Nordstrom. Smaller stores, such as The Bay, may not be as successful as they were 10 years ago because of the competition and different luxury brands available now. Young professionals with disposable income have the money to spend at these stores along with the demand for products. So, we will likely see even more luxury moving in than we already have.

On town centres and condos built around them, from a commercial realtor’s perspective:

Every major mall’s parking lot has become a development site, for instance Brentwood and Metrotown. Coquitlam Centre recently put forward an application, with various involved parties, for 11 towers. They’re creating hubs where you can live, eat, work, and shop within a very small radius. Plus, if you have to leave a hub, they’re all built around SkyTrain stops so you can be downtown in 45 minutes and not have to park. These hubs have totally changed how we look at retail from a mall standpoint versus how it looked 10 years ago.

Obviously, online business really changed the retail and mall landscape, years ago. They’ve been forced to be more creative. The boom in the real estate market, extension of SkyTrain stations, and the overall growth of our economy has forced mall owners to re-evaluate. These hubs will help redefine retail where they are and fill the void left by stores that competed with the Amazons of the world. These malls have vacancy issues, but the new hubs are filling the void and recreating and revitalizing the shopping experience.

On the part of the commercial market that’s hurting right now:

Overall, it’s been successful for many things. In the small window of, say, the past 12 months, development prices have pulled off quite a bit. This is because condo prices have slowed, and buyers and banks are more educated. Two or three years ago if you had a development site in Vancouver, you’d be fine spending the money before listing it—it would always sell. Now, you need to be savvier and more creative with marketing. Developers are also being more creative when buying; there is a lot of red tape in cities like Vancouver, so they might try to get things like longer closing periods of, say, two years. This means by the time they close, the permit is ready and they can start digging pretty quickly and minimize holding costs. Land money is another challenge: banks have funded so much land, especially in Vancouver, over the past three to four years that their lending portfolios are maxed out. They feel leveraged and exposed and are maybe looking to push money out of land and into industrial or shopping centre deals, not into, say, three homes they may not see return from for a few years.

On how the retail market is doing and where it’s going:

As an example, in Maple Ridge and other areas have enclosed shopping malls that are currently trying to be revitalized, but this is not always successful. To regain momentum, malls in suburban areas that have struggled should be looked at as development opportunities. Maple Ridge was anti-development for a long time, but this has recently changed. More housing should be brought close to malls to create a lifestyle environment, rather than a shopping environment. This means homes, not parking lots. Hundreds of thousands of square feet sit empty, and by building homes instead of parking stalls you are almost building a clientele right into the mall’s location. This is a pitch shopping centres can give to prospective tenants—customers are walking downstairs, right to their business. Another concept is open-air shopping (for instance, Abbotsford Highstreet). These places have more atmosphere than the closed-mall concept. West Edmonton Mall and the Mall of America were so ahead of their time; now, smaller malls are trying to mimic the lifestyle-entertainment concept they’d created, but on a smaller scale.

On how the current government is impacting the commercial market:

The problem with any government coming in is they all have a four-year window. The NDP hasn’t been in power for quite some time, but you can’t come into a marketplace and beat it up all at once. The residential markets can balance themselves out, to some degree. The new stress test and rising interest rates will put pressure on the market. It’s so far gone for many people that any government coming in needs to focus on creating housing for people today, rather than enabling the 25-year-old guy to buy the $7 million house tomorrow. They’ve created an overall negative effect on the real estate industry. 10 years ago, the model was to invest in a piece of real estate, have someone pay your mortgage down and, if you sell 20 years later for more, you win. The way people see it now is if it doesn’t double in value overnight, it’s broken. This is a problem! The NDP has created a lot of negative impact through trying to beat up the overall market. This has affected the commercial markets—people start thinking about jobs; landlords start thinking about rents and expansions they’d planned on that will no longer happen.

Multi-family is the most affected single type of industry with respect to development land. You just can’t come in and tell people what they can and can’t do with, essentially, private sector money. Eventually, the investment is not as attractive as it once was. Any government must have private sector money working with it, not against it. They can’t dictate how much rents can or can’t increase without understanding the development side of the business and the costs that go into it, or people won’t engage with them. Instead, they will build overpriced condos and sell those – which does nobody any good. A report by the Urban Development Institute stated there are 12,000 purpose-built [rental] condos that are either cancelled, under consideration to be cancelled, or pivoted to stratas—supply is being taken right out of the rental marketplace. With next to no vacancy as it is, we need supply and we need it fast. Rather than focus on how to get the 25-year-old kids of today to buy the $17 million-dollar Shaughnessy house of tomorrow, let’s create housing for these people right away. If it’s attractive for the private sector to invest with you, they will. Eventually, if you remove restrictions and make it inviting for people to spend their money in purpose-built and multi-family, you’ll increase supply. For the first time in three years since they lifted rental controls, Seattle actually saw a plateau or decline in downtown rental rates.

So, short-term wins bring long-term problems due to lack of supply.

Yes. Cory has clients who wanted to build purpose-built rentals and are now questioning whether they should do it. The price people pay to buy multi-family houses and condos and develop these properties are tens of millions of dollars. Yesterday, New Westminster looked at making some of the stiffest “demoviction” rules that we have. Cory fully understands the concept of the renter who has been there for 10 years, paying $500-600 per month, and then someone comes in to buy, renovate and try to charge $1,500 per month. That would force people to move to Abbotsford or Chilliwack and uproot their whole lifestyle. At the same time, you can’t tell the guy paying $6 million to buy the building that he’s restricted in what he can do with it; he will just take his money elsewhere. These places will just become decrepit, really old, and inhabitable down the road because nobody will be able to recoup the cost to fix them up.

Plus, they won’t build new supply while the old stock gets worse at the same time.

Yes. This puts so much pressure on the rental market. Government makes decisions to appease voters today without addressing the problems we’ll have four or 10 years from now. The Liberal government isn’t perfect, but you can’t come into a housing market that generated $1.2 of your $1.4 billion dollar surplus and throw everything at it so soon, from speculation tax to stress tests. Eventually, you’ll slow down your income. The Province’s savings account is getting smaller, yet they’ve built billion dollar bridges they’re not charging users for. This doesn’t add up. These decisions will affect us, and maybe even our kids, years down the road. You can’t govern based on the political areas that vote for you. Tsawwassen is a booming market and the George Massey Tunnel has so much pressure to get people through–there is great investment for commercial, such as at the Deltaport. Amazon just took 450,000 square feet of industrial space there. This is a “pocket” market blowing up faster than we can maintain it, but the government is not spending money on needed infrastructure there because nobody voted for them (in Steveston, they have 10’-high dirt piles with weeds)!

Thinking back two years: if there were no policy shifts and we had seen three or four increases to the interest rate and projections of four or five this year. There wasn’t as much discussion six months ago about the BC speculation tax or even the empty homes tax; everyone was freaking out about interest rates. If they would have let it play out, would we be in a very similar situation now, without “putting your hand on the scale”?

The stress test was probably coming, regardless. It makes sense why it’s there: nobody wants to have the situation the US did in 2009-2010. We need to ensure people getting into the market today can afford it today and five years from now. It’s there to protect us all. If the Liberals remained in power, interest rates would have rose, and the stress test would have come out. The market would have somewhat plateaued and cannibalized itself.

On a presale development that illustrates the potential impact of the stress test:

There is a single-family home development being done in phases, and the phase coming to market for delivery has many units that were bought pre-stress test. Many buyers were likely very dependent on the equity of their homes at the time of purchase, and they probably talked to their banks up to two years prior about affordability. The stress test then came in, the market declined, and equity evaporated a bit. Cory understands that about half the buyers in the current phase (roughly 10-20 people) are running into problems. He’s seen developers’ signs on properties once purchased by someone else. These people put down $250,000 deposits. This could be their life savings!

Any government in play must look at the housing market differently. Nobody is jumping into the Shaughnessy market if it goes from $7 million to $6.8 million. The government needs to focus on a “stepping stone” marketplace, where our kids will grow up having to rent places for a couple of years, then buy a condo, then a townhouse. Then, maybe they can get a small house and even a big house after that. These $1.5-$3 million homes are an average of 2,500-3,000 square-feet, not the mansions you would assume for these prices. BC has so much debt because many people have used their house as an ATM machine. But, you can’t get into a position where enough equity gets wiped out that the banks start calling. Additional lines of credit and security then start coming into the marketplace. In 2019 and 2020, the first batch of historically-low five-year fixed rate mortgages will become due. People might have credit changes in their lifestyle and not qualify to return to their own bank so will have to look elsewhere, like credit unions, but they may not be able to afford to buy their house back.

On 2019 predictions and three to five-year projections for commercial real estate:

Overall, we’re seeing the population move further and further out. Areas like New Westminster, a city that just five years ago was forgotten and considered ‘nowhere’, are now the centre of everything. When proactive councils get in, they understand and start forecasting what’s coming down the pipe. They make things developer-friendly to attract developers, who build houses, which brings in people, which creates jobs, which drives the commercial real estate market.

Along with New West, suburban areas like Tsawwassen, Abbotsford, Maple Ridge, and Mission are now good opportunities for the average investor due to the population that keeps growing. Much of the younger population may not have the financial resources to live in Vancouver or Burnaby. Even if they grew up in Coquitlam, they may still move out to these suburbs. If you get a good footprint in these markets and pay down your mortgage now, in five to 10 years you’ll see rents will increase, cap rates will go up, demand will come in, and vacancies will be low.

On a starting price point in these suburban markets:

Industrial properties are very “brainless” to invest in (they don’t require a lot of education as they’re literally four walls and a door). Many people who rent these spaces just want parking and highway access. In places like Mission, Maple Ridge, and Abbotsford, you can find good industrial units with high rental demand and low impact on the landlord side for $300,000-$400,000. They’re a great starting point and won’t break the bank. As a landlord, you won’t have to know what you’re doing to the extent you would in retail (for instance, when tenants want improvements and you need to approve drawings with engineers). “Mom and pop” investors buy and “mom and pop” businesses rent—they cooperate, and this creates a positive outcome for everybody.

On financing for people considering commercial real estate:

Many people buying for the first time look at what they put down on a house. This is different because you have insurers, CMHC, etc. that help get you into the market. With commercial, many banks want to see the property cash-flow itself. They look at the lease rates of the building coming in and will come up with a down payment amount that allows the building to pay for itself, so they don’t have to rely on you. A 20-25% investment is likely on the low end, unless you have other property as collateral, and it can go up to 35-40%. Sometimes, with, say, a long-time family-owned property, lease rates are low and the opportunity to increase rent is there once the lease expires, but the bank doesn’t see it this way. They don’t look at the potential; they look at how much can the debt service today. You must get to the potential that exists. Put the money down today if you have it, and re-finance with new lease rates in two to three years when you can take the money back out.

On commercial real estate pricing over the next one to three years:

As an investor or end-user, there isn’t a lot of supply available. Rising lease rates, whether office, industrial, or retail, drives up income, which drives up price. Prices, especially in the suburban markets, will continue to rise. If you get into the right asset class at the right time, there will be a really good wave. If you only have short-term thoughts, you won’t get rich overnight; you need a long-term outlook. There will be some great opportunities. Bigger assets maybe weren’t the best purchase choices for people—there were really high interest rates (some were interest-only). When the market went up, everyone was a developer. When a property doubled in value, it wasn’t the market, it was the developer. People who got in at the wrong time might get pinched. There may be opportunities for larger-scale assets if you’re in a higher income bracket.

Cory often sees residential brokers come in with a client, whether on the tenant or purchase side, and not know what they’re doing. They’re here to educate and help them as best they can but can’t do their work for them. This can be problematic for the purchaser, as maybe they’re not getting the best deal.

Yes. It’s so important to use a commercial broker for commercial real estate transactions.

The five-wire:

  1. Favorite neighbourhood in Vancouver: Yaletown
  2. Favourite restaurant or bar: Carderos
  3. Downtown penthouse or west-side mansion: West-side mansion
  4. First place Cory brings someone from out of town: The aquarium
  5. Something he’s bought for under $500 that majorly impacted his life: The black tie he wore for the interview (much less than $500!)

To find out more about William Wright Commercial Real Estate Services, visit www.williamwright.ca or drop by one of their offices: Vancouver (at Robson/Seymour), New Westminster (on 7th), or Langley (just off 200th).

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