BC’s multi-family investment market faces repricing as global economy downshifts

Shaken by the global credit turmoil, BC’s multi-family investment market faces a repricing of properties, according to Avison Young (Canada) Inc.’s “Fall 2008 BC Real Estate Multi-Family Investment Report”, released today.

“There is now a standoff between purchasers, who in the wake of the global credit meltdown have changed their pricing expectations; and vendors, who are looking for yesterday’s pricing in a much more challenging market,” comments Avison Young principal, Rob Greer. “The number of listings will continue to increase until assets are re-priced and purchaser confidence returns.”

According to Avison Young’s survey, sales in BC’s multi-family market have slowed to an almost standstill, with the total number of trades year-to-date November 2008 representing only 50% of the total number of transactions in 2007. (The number of trades during the first 11 months of 2008 totals 76, versus 153 in 2007.)

The total value of multi-family investment transactions year-to-date November 2008 amounts to $270 million – approximately 52% of the $519 million recorded in all of 2007. Local private investors represent the majority of the buyers and sellers to-date in 2008.

Greer says the average prices per unit in Metro Vancouver’s various submarkets, based on year-to-date 2008 sales, do not reflect current pricing expectations from purchasers in the marketplace: “Should financing troubles continue through 2009, we may see values move as much as 20% as investors re-evaluate their required returns on investment.”

According to the report, the once prevalent multiple offer situations have shifted to ones of price reductions and lingering listings. Of the current 130 listings on the market, approximately one quarter has received at least one price reduction in recent months. This does not include any recent sales that involved a price reduction to induce the sale.

“The disappearance of the debt market has significantly changed the dynamics of BC’s commercial real estate,” explains Michael Brodie, Avison Young’s multi-family real estate advisor. “The inability to get yesterday’s lending has driven many potential purchasers from the market simply because they don’t have enough equity.”

Brodie continues: “Purchasers can no longer achieve the loan-to-value ratios (needed for their required cash-on-cash returns) they have become accustomed to. A purchaser who could once get 75% loan-to-value for a 5% capitalization rate purchase of a multi-family asset is now facing 60% to 65% loan-to-value amounts for CMHC (Canada Mortgage and Housing Corp.) insured loans. Either purchasers need to change their required return on investment or vendors need to adjust their pricing expectations. The answer lies somewhere in between.”

The report goes on to say that multi-family capitalization rates may be a cause of concern for some investors: “The market reached record low cap rate territory in 2007 and early 2008. However, as investors need a higher cap rate on their investment to match their cash-on-cash return achieved in yesterday’s lending markets, cap rates will have to adjust accordingly.”

Financing issues may also force some investors in 2009 to increase their equity in their existing multi-family assets. “With the complete turnaround in the credit markets, highly-leveraged owners who have to refinance in 2009 may be faced with the reality that they will have to put more money into their asset. This will be particularly true for buildings with low debt service ratios or those purchased at low cap rates,” says Greer.

According to the Avison Young report, the multi-family investment market is expected to witness more listings, fewer sales and lower sale prices in 2009.

“Listings will continue to grow as the number of able investors decreases,” comments Greer, who adds that annual rent increases aren’t reflective of the changing environment. “With growing costs for apartment building owners, limiting the annual rental increase at 3.7% makes it difficult for owners to keep their net operating income up.” (In September 2008, the provincial government announced that effective 2009, the allowable annual rent increase will be 3.7%.)

Even though BC’s market has not been affected nearly as significantly as other markets, Greer says the market slowdown is not limited to one asset class or one economy, and it may take several quarters for vendors’ expectations to adjust.

He adds: “However, it is important to note that investors are generally confident in BC’s economy, there is still a lot of money out there looking for a home, and multi-family assets are still one of the most stable investments. Housing is also one of the last places people stop spending money, and we can expect the region’s average rental vacancy rate (currently less than 1%) to remain at historically low levels.”

“Investors requiring high leverage may be sidelined for now, but even if the credit markets remain tight in the foreseeable future, multi-family assets should generally perform well operationally and provide relatively stable cash flows,” says Brodie.

Avison Young (Canada) Inc. is Canada’s largest independently-owned commercial real estate services company, with offices in Vancouver, Edmonton, Calgary, Regina, Winnipeg, Mississauga, Toronto, Ottawa, Montreal, Quebec City and Halifax. Through its alliance with Grubb & Ellis, one of America’s largest commercial real estate firms, Avison Young is able to provide clients around the world with a full range of property solutions.