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By Altus Group | April 15, 2020

“Every challenge, every adversity, contains within it the seeds of opportunity and growth.”

During this time of uncertainty, keeping these prescient words by author Roy Bennett in mind can be rewarding. While the rapidly evolving pandemic situation continues to generate global economic upheaval, and the short- and long-term impacts on market value remain to be seen, for some commercial real estate portfolios there may be emerging opportunities.

While investors are typically looking to maximize the value of their portfolio, there may be certain strategic motivations to locking in portfolio values that reflect current market conditions. For example, for property owners contemplating a portfolio strategy to minimize capital gains and reduce the tax burden on a go-forward basis, this may include strategies such as share restructuring or moving assets through an estate freeze to a family trust. A downturn in the markets could be a good time to enact such a strategy.

For commercial real estate owners who wish to evaluate potential opportunities for leveraging lower real estate values, they may wish to consider the following approach.

 

Know the value of your portfolio today

Since real estate does not present the same value transparency and liquidity as the stock market, it can be more challenging to value in today’s volatile environment. Yet there are good reasons to do exactly that.

Understanding your portfolio is the first step to understanding the risks and opportunities today’s economic climate offers. While the situation is fluid, with circumstances and impacts changing rapidly, gaining an understanding of the current value of assets is key.

Striving to balance the well-being of tenants while preserving capital, owners and managers of real estate portfolios must make complex decisions for each property. At a time like this, a timely valuation can inform decisions in terms of navigating these challenges.

There are a number of factors involved to produce insight into investment risk related to current commercial real estate trends and transactions; net cash flows, shifts in market liquidity, the impacts of disruption and other uncertainties underlie the methodologies used in valuations.

Many special considerations must be taken into account in valuing a portfolio of properties today. Net operating cash flows and market liquidity are under stress so it’s critical to assess the impacts. A review of critical underlying assumptions, and other fundamental factors that influence a portfolio are key to understanding value implications.

Benchmarking meaningful comparables against peer portfolios can also deliver significant insights. Experienced valuators can contribute independent, consistent, deep data regarding real estate value in specific regions and asset classes across Canada.

 

Gain an understanding of the potential impact of the pandemic on your portfolio

Even small shifts in property cash flows and investment yields can have a material bearing on asset value. Acquiring a clearer understanding of the influence of these factors at this time can be especially productive.

  • Tenant profile ranking

Property owners have some control over risks related to rental flows and operating expenses. These include tenant mix, credit and lease duration.

A tenant risk profile ranking can be advantageous for decision making. How well capitalized are your tenants; are they able to ride this storm? How well insulated is your portfolio from disruption? These risks can be built into cash flow models to assess impacts in the coming months.

  • Lease rollover

The value of commercial real estate assets is a product of future cash flows and the level of certainty those cash flows will incur. Conducting a tenant rollover analysis will disclose near-term lease rollover exposure and how your leases compare to market.

This involves identifying lease expiration of tenants and analyzing the rollover risk each year. An analysis also compares current market rates with existing rents in a property: upon rollover of a tenant, the likelihood of achieving the forecasted market rent, along with the short-term and long-term cash flow implications.

  • Portfolio make-up

Each asset class has its own nuances and impact relative to the COVID-19 crisis. For example, hotels, parking garages, seniors’ facilities and shopping centres are among the classes with higher exposure.  Owners and investors should break down the asset classes in which they are invested and assess the short-, mid-, and long-term implications for each of those classes.

There should also be consideration of the homogeneous portfolio effect – whether to consider the impact of a premium or discount reflecting the makeup (property, asset class, market) of a specific portfolio. And multi-tiered structures with partial interest ownership of assets within a portfolio could also warrant valuation discounts.

 

Assess optional portfolio strategies

While there are more unknowns than knowns at this time, there are implications for short- and long-term market value as a result of unfolding events. While some commercial real estate owners and investors will choose to ride out the pandemic turmoil, for others this could be the right time to execute a strategy that involves minimizing future tax liabilities.

For some portfolios, share restructuring may be advantageous. For others, corporations holding property may wish to establish or update family trusts that hold shares indirectly for family members to facilitate opportunities for income splitting and estate planning. Work closely with a valuation expert and tax and legal advisors to fully understand the value implications and identify potential strategies.

Conducting a peer comparison is also helpful. How are properties like yours being disrupted? What are they doing and how does your strategy compare?

Overall, maintain a future-focused outlook because decisions you make now will determine the health of your real estate assets when the coronavirus turmoil subsides.

Most important: keep in mind that in adversity there can be opportunity. Lower values might offer you more of those opportunities than you expected.

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