John Stewart is a senior managing director focused on investments in Marcus & Millichap’s IPA division.
Specializing in trades of institutional properties, Stewart has represented some of the largest public, private and institutional investors in Canada. Over his 18-year career, he’s worked on more than $10bn of transactions and has held leadership positions at BMO Capital Markets and Colliers. He’s also the president of NAIOP’s Greater Toronto chapter.
Stewart spoke with Green Street News about how institutional investors are reacting to market uncertainties, the impact of interest rate cuts and shifting attitudes in the office market.
Your business is focused on institutional investors. How are they responding to uncertain market conditions?
Investors are looking inward right now. It’s obviously been a more challenging market, so they’re very focused on asset management. They’re looking at their portfolios, focusing on leasing challenges … and reassessing what their portfolio allocation should be on a long-term basis.
They also want to make sure that the assets they own are the ones they want to continue to own for the long term. There might be some shedding of assets in regard to that changing portfolio allocation.
So they’re really thinking about their long-term strategies — How are the assets performing? Do we have the right assets? If not, what are the right assets for the future? — and looking inward.
Amidst that reassessment, what are the assets they’re holding on to?
We recently did a market overview roadshow with about 45 of our institutional clients and … the overall sentiment is very similar. There are a few asset classes that are in favour and a few that are, let’s say, less in favour.
The asset classes that are very much in favour right now are retail, particularly daily needs in grocery-anchored retail. That is maybe No. 1 in terms of where people would like to place their money. However, those almost never trade. There’s a huge scarcity value there.
Multifamily and apartments continue to be high on the list. Same with industrial. However, we’re starting to see the very, very strong rental rate growth in those asset classes kind of plateauing.
Office is the one that probably has the biggest challenge in terms of sentiment. So that’s more where people are really spending their time deciding, “Is this an asset that we want to really work on? Is this an asset we want to own long-term?”
What are the sentiments you’re seeing towards office?
I would say overall the sentiment towards office is almost way too negative. From my perspective it’s way more negative than it needs to be. Yes, there have been some significant changes in terms of how tenants are thinking about using space and the types of space they’d like to use.
Yes, there’s a lot more work from home. Companies don’t necessarily need to have employees in the office five days a week. Although, personally, I do think over time that will continue to normalize.
“Overall the sentiment towards office is almost way too negative”
If employees are not in the office five days a week, maybe companies don’t need as much square footage. So, you’ll see them downsizing. But what’s happening in the downsize is that they’re going up the quality spectrum. They’re going to a higher-quality asset.
Maybe they’re paying more on a price-per-square-foot basis than they were previously, but they’re occupying less space. I think one of the biggest factors in office continues to be flight to quality.
So, the best buildings in the best markets, whether that’s downtown or suburban, are going to drastically outperform the rest. I think if you own those or if you’re in the market, those are great assets to own or invest in right now.
Are any of those trading?
No, almost none. From a downtown Toronto perspective, there has not really been a Class-A office trade in 24 months. That’s partly because sentiment has been so bad. A lot of those assets are very large as well. Those would be big-ticket transactions, hundreds of millions of dollars.
Historically, the buyers and owners of those buildings are large institutional investors, pension funds, etc. It’s very difficult for that cohort of owner to go to their investment committee and say, “This is an awesome building, we should buy it right now,” because of all the negative press.
They already have a large portfolio of assets that gets appraised on a regular basis and those office values have come down dramatically. They’d almost get laughed out of the room at their investment committee. So, we haven’t seen a lot of those trades over the last 24 months.
“It seems like investor sentiment is starting to come back to [the office sector] for those large deals”
However, it feels like we’re on the cusp. It seems like investor sentiment is starting to come back to that asset class for those large deals. I’ve had a few conversations recently where real potential buyers are saying, “Yeah, I would do a deal for the right building. We think this could be a good time to get back in the market.” So, it feels like we’re at the bottom, or very close to it.
What makes it feel like we’re at the bottom?
It’s always very difficult to pick the bottom, but I feel like we’re within 10% of it. Sometimes I think things have already improved. Sometimes I think we’re at the bottom.
We’ve seen a number of deals where, I don’t want to say it’s vendor capitulation, but we’ve seen transactions occur where pricing is dramatically lower than it would’ve been before Covid. Those investors have decided that they don’t want to wait out the recovery. They’d rather move it now.
“We’ve seen transactions occur where pricing is dramatically lower than it would’ve been before Covid”
There are examples of buildings trading in suburban markets in the GTA, in Ottawa and in other comparable markets, for prices per square foot in the $100 to $150 range. To replace those buildings today, new, it would be like $450 to $500/sq ft, if not more.
They were trading pre-Covid at $250 to $350/sq ft. So, a pretty significant decrease. We are starting to hear positive stories about leasing momentum again. I think those two factors, combined with the rate-reduction sentiment, I can’t imagine sitting here a year from now and it being worse.
What is the feeling towards rate cuts? Have they had an impact on the market yet?
The interest rate cuts have helped things from a sentiment perspective. Anecdotally, after the first rate cut, a number of our clients reached out to us to value a couple of new assets. It was relatively quiet earlier this year in that regard.
So, they may have already spurred activity to a certain degree. But I don’t think they’re going to change pricing until we start to see more like 75- to 100-bps cuts.
The Bank of Canada rate adjustments, they’ve almost made the bid-ask gap slightly larger. Sellers were thinking rates would come down, and if they couldn’t get their number before, they’d be closer to getting it now. And they’re expecting buyers to pay up.
But buyers are still thinking 25 bps is nothing. They’re still at a low number. So, I think overall good sentiments, but we definitely need to see a few more cuts before it materially makes a difference. And in the short term they might have actually made the bid-ask gap larger.
What other factors are influencing investors right now?
It’s very much a higher-yield environment. Obviously, interest rates have gone up fairly dramatically over the past little while. But not only have debt yields and financing yields increased, that’s put upward pressure on equity yields.
So beyond just real estate and cap rates, investors have other options to park their money. Real estate used to be super attractive because it offered premium yields to other products, like bonds. But now you can buy bonds, which are very low risk, at pretty attractive yields. Higher yields across the whole investment landscape are having implications for investor sentiment in general.
With the end of the summer approaching, where are you focusing your attention for the remainder of the year?
I think because this is an uncertain time, our clients really need our insights. We talk to a lot of different investors on a regular basis. We have a lot of knowledge and information. I think they really look to us to help and guide them.
So hopefully we’re doing more deals, but more importantly we’re able to help our clients in their decision making.
