In This Issue...

OCTOBER 2009 ALTUS IN DEPTH – VANCOUVER

In this issue of Altus In Depth, we highlight some current valuation, construction cost, and property assessment issues.

1. METRO VANCOUVER REAL ESTATE – GENERAL COMMENTARY
2. THE POTENTIAL IMPACT OF HST ON NEW RESIDENTIAL DEVELOPMENT
3. 2010 PROPERTY ASSESSMENTS

COMMERCIAL REAL ESTATE INVESTMENT MARKET

2009 YTD has seen a number of transactions for all property types (office, retail, industrial, and multi family), and there are several buyers actively seeking acquisitions. Office transactions accounted for the largest dollar volume, primarily as a result of two major deals in Downtown Vancouver (Bentall V and the Grosvenor Building). If you would like a summary of some of the recent sale transactions, please let us know.

Several recent/pending transactions are ‘off market’ deals, with the typical buyer profile being ‘private’ who have less or little reliance on financing to complete the acquisition. These types of investors may find additional opportunities due to the constrained borrowing environment. Debt availability, however, is improving and could result in a wider market for properties listed to market over the near term.

Going forward, private buyers may continue to dominate the acquisition side in Metro Vancouver until debt availability improves and draws additional purchasers into the market. Based on recent transactional activity, they appear to be quite willing to invest in well located, well maintained, competitively priced properties. REITS may also be active again if their unit prices and market capitalization grows. It is our understanding that some REITS have raised considerable capital in recent months.

Institutional investors have so far demonstrated their desire to retain rather than sell their high quality properties during these interesting economic times.

The availability of quality product, especially in the office and retail categories, is expected to remain low for the short term.

Capitalization rates in Metro Vancouver continue to rank as being the lowest in Canada. The graph below shows historical Investment Parameters for a Downtown Vancouver Class AA office building. These parameters are sourced from the Altus Insite Investment Trends Survey, and represent the expectations of buyers and sellers rather than the results of actual transactions.

The results from the Altus Insite Investment Trends Survey for Q3 2009 reveal growing signs of a return to stability in the Canadian commercial real estate market, tempered by some cautionary sentiment that cash flows and values may face further erosion by any additional correction in rents and increases in vacancies. Overall, the survey results for the Canadian market in general reflect a more positive attitude and growing confidence in real estate investments, which follows a period of deflating asset values from the bull market peak experienced in mid 2007. The Q3 2009 Survey certainly reflects stabilization in the yield requirements for prime retail, office and multi family assets, and mixed signals for industrial real estate (i.e. for Canada in general).

OFFICE LEASING MARKET

According to Altus Insite, there are 552 buildings in Metro Vancouver comprising 46.974 million s.f. of total office area. As at October 7th, 2009, 3.668 million s.f. (7.80%) were available for direct lease and 1.156 million s.f. (2.50%) were available for sublease, resulting in total availability of 4.824 million s.f. (10.30%). This is a significant jump from Q4 2007 when total availability was 2.328 million s.f. (5.00%), but is off the peak achieved at the end of 2003 when availability was 7.07 million s.f. (15.30%).

Currently in Metro Vancouver there are 10 office buildings under construction (1.044 million s.f.) and 20 office buildings being marketed for pre-lease (1.803 million s.f.), for a combined area of 2.847 million s.f. In comparison, the previous market peak in Metro Vancouver was Q1 2002 when 2.80 million s.f. was under construction and 1.48 million s.f. was being marketed for pre-lease opportunity.

Burnaby and Richmond are exhibiting the highest availability in the suburban market, with availability as at October 7th 2009 of 12.1% and 18.6%, respectively. Previous peaks in these markets were achieved at the end of 2003 / start of 2004 when availability was 15.8% (Burnaby) and 17.7% (Richmond), respectively.

It is noted that the availability (both direct and sublet) of large block space in Downtown Vancouver is presently limited. Current downtown availability of 7.2% appears to have receded slightly from the end of Q2 2009 when it was 7.5%, with sublease availability declining from 3.4% to 2.6% during this time. Sublease offerings in the market generally reflect smaller suites with short remaining lease terms, and overall are less marketable. For reference, current availability downtown is considerably off the previous high achieved in Q3 2003 (14.3%).

When taking into consideration both the current availability and the potential future additional availability as a result of new construction, increases in office rents in Metro Vancouver (over current market levels) are not anticipated over the short term. Careful attention will need to be made, during the valuation process, when forecasting both the projected market rents on lease rollover as well as expected market rents and required tenant inducements on existing/pending vacancies.

LENDING

Commercial lenders are reporting improved activity, in particular over the last 90 days, with business prospects improving and a wider scope of money supply now reported. Credit spreads over 5 years Canada Bond Yields are at 275 to 325 basis points for assets with good occupancy in attractive locations. Applicant’s covenant is also a key consideration in lenders’ criteria for financing. Debt service coverage requirement continues to be greater than 12 months ago.

HARMONIZED SALES TAX – VALUE IMPACT

The commercial real estate sector will be impacted by the introduction of the Harmonized Sales Tax (HST), with the multi-residential and development sectors particularly affected. There continues to be an active lobby from individual landlords and associations requesting modification of proposed thresholds to be more in line with the BC market conditions as opposed to those benchmarked in the Ontario HST program.

Although income properties with net leases in place will be affected to a lesser extent, HST will still require monitoring to gauge potential gross operating cost impact. It will also be important to review tenancies that will be directly impacted by any potential decline in consumer spending (i.e. retail, restaurants, etc.).

Since the recent announcement of the implementation of the HST by the provincial government, this has been a hot topic among the development community.

From a residential developer’s point of view, the impact of HST ultimately comes down to the ability to sell a unit to a final purchaser for an expected profit. Most developers would currently agree that the implementation of the HST will have a negative impact on their business, but this will be dependant on whether the market can absorb the potential price increases once the HST is implemented.

A few points for developers to consider during the implementation and transition period are as follows:

IMPACT ON CONSTRUCTION COSTS

• When entering into a contract with a contractor or subcontractor prior to July 1, 2010 whose work will span this period it is important to know that an invoice submitted prior to this date will include embedded PST however an invoice submitted after this date will not as they will now be entitled to claim a full rebate for the HST charged. Therefore the contractor or subcontractor will gain an immediate savings of the PST they previously had to pay on their materials and this should be reflected in their pricing.
• When entering into a contract with a contractor or subcontractor after July 1, 2010 the developer needs to be aware that the contractor is no longer paying PST on any materials but rather they are paying HST for which they receive full rebates, therefore this should be reflected in their pricing. Further bid analysis should be undertaken to ensure these savings are being passed along however this will be ultimately based on current market conditions.

IMPACT ON SELLING PRICES

Based on an initial analysis completed by Altus Cost Group of past projects, the estimated HST impact at different selling points is as follows:

• At $300 to $400 per square foot of saleable area the estimated impact is a 0.00% to 0.50% price increase
• At $400 to $600 per square foot of saleable area the estimated impact is a 0.50% to 1.10% price increase
• At $600 to $800 per square foot of saleable area the estimated impact is a 1.10% to 2.50% price increase
• At $800 to $1000 per square foot of saleable area the estimated impact is a 2.50% to 5.00% price increase

We note for the above analysis it is assumed the market and unit conditions are constant and that the savings achieved from the embedded PST are passed on to the Developer by the contractors and then subsequently passed on to the final purchaser.

As you can see above, the impact of the HST is generally minimal as long as the embedded PST savings are passed on. As the purchase price increases the HST impact becomes greater.

We previously published a report for the Canadian Home Builders’ Association outlining the potential impact of the HST on the construction renovation sector. A few key points from this report are as follows:

• It will increase the annual tax burden on homeowners and rental housing investors in Ontario and B.C. combined by close to $1 billion annually;
• It negates substantial on-going efforts by governments to promote housing affordability and choice;
• It shifts more activity into the “underground economy” with implications on government tax revenue, renovation quality and homeowner liability; and
• It stands to negate on-going programs by governments to promote economic development and environmental objectives through targeted homeowners renovation assistance.

The complete Altus Group report on the potential impacts of Sales Tax Harmonization on the residential renovation sector can be found at http://www.bildgta.ca (see second link).

2010 ASSESSMENTS – WHAT DOES OUR CRYSTAL BALL SHOW?

2010 is going to be a crucial and interesting year. This will be the first assessment roll after the so-called assessment “freeze” in 2009. In many markets, there is considerable uncertainty & a lack of comparable sales.

Taxpayers should closely scrutinize their “unfrozen” value contained on the assessment notice. This is the value that would have been used if the freeze would not have been in effect. For many markets & property types, our early discussions with BC Assessment have indicated that the 2010 assessment will likely be somewhere between the 2008 assessment (“frozen” value) & actual 2009 assessment (“unfrozen” value).

The implications for many properties could be a substantial increase in assessed value & more importantly, in property tax for 2010.

WOULD YOU LIKE YOUR 2010 ASSESSMENTS EARLY?

In BC, the 2010 assessment notices will be publically issued during the first week of January with an appeal deadline of January 31st. We can obtain your values much earlier, in mid to late October.

Often we can resolve our client’s issues before other taxpayers receive their notice. Over the years, we have found that BC Assessment tends to have more flexibility during this pre roll (from mid October to early December) stage than during a formal appeal.

If you are interested in having us obtain your values, please don’t hesitate to call or email.