Managing director and head of capital markets explains recent deal and the dynamics that introduces for pension landlords
The sale of 77 Peter St. a brick and beam office building in the heart of downtown Toronto last month might be quickly greeted as a salve for the much-maligned office sector. Buyer appetites for these properties has changed drastically in recent years as high interest rates and the impact of work from home make office into the poster child of struggling real estate asset classes. Major pension funds tend to be some of the largest office landlords in Canada, but some have already indicated their desire to trim their exposure to this asset class.
What’s notable about this purchase is that it was made by private capital. According to JLL, which represented the Seller in this $12.55 million purchase, there is a growing appetite for office real estate among private buyers, be they family trusts, wealthy foreign individuals, or private firms. So should pension funds be viewing these private buyers a bit like Gandalf at the end of Lord of The Rings: The Two Towers, emerging at the head of an army to relieve the beleaguered office sector? JLL’s managing director says that while private capital is introducing an important new dynamic in this market, the narrative isn’t quite so simple.
“We are receiving offers from some groups for assets north of $50 million, with greater regularity than we did in the past. But I wouldn’t say they’re the knights in shining armour because we haven’t seen as many successful conclusions of these transactions,” says Matt Picken, managing director and head of capital markets at JLL. “Privates are not going to gobble up office towers because most institutions are less keen to sell these trophy landmarks, but they (private investors) are certainly nibbling around the edges in peripheral suburban markets like Markham, Missisauga, North York, and Scarborough. They are absolutely stepping up and stepping in.”
Picken notes that when he began his career well over two decades ago, the private segment of the market largely did deals in the $500,000 to $3 million price range. Privates, however, have made so much money recently that they are able to transact in a far higher echelon. Now, he says, privates can buy assets at deals between $3 million and $100 million or go even higher.
While each private is entering the office market for somewhat different reasons, Picken has seen a few trends emerging. First and foremost is a growing number of investors who want to eventually take occupancy of the building, whether it’s one floor, multiple floors, or the whole building. In these cases, private businesses are rolling off of leases from 2019 — the peak of the Toronto office market. While rents have dropped, there may be a long negotiation process involved in a rent renegotiation. At the same time, prices have dropped on assets so there may be an opportunity to simply buy the building, occupy what you need, and rent out the rest of the space to defray debt servicing costs.
In terms of location, Picken notes that there is private appetite for those more suburban locations, as well as properties with some proximity to mass transit or the high likelihood of density arriving soon.
The motivation behind private purchases is also important. Many family office buyers, for example, are making these purchases with the very long-term in mind, as a means of building and preserving generational wealth. Foreign buyers may be looking more for a means of moving capital out of their country of origin. Immediate returns are less of a focus to these buyers, Picken notes.
So if privates are not the knights in shining armour for office real estate, what impact can we expect their entry to have? Picken describes a growing knock-on effect in office initiated by these private actors. As privates nibble at the edges of the office market, Picken expects that larger asset managers will start to experience a bit of FOMO and as the volume of transactions increases due to private buyers, those asset managers will re-enter this space. That, in turn, should start to lay the foundation for some more pricing data and better prospects in office.
While the rise of privates in office real estate is novel, potentially significant, and worthy of note, Picken believes that pension fund asset managers have the assets and the time horizon to continue to wait out this down spell in office real estate until such time as the market truly recovers.
“They own some of the best real estate in Canada. They are well positioned to weather whatever storm is put in front of them, and they can and will get through it,” Picken says. “If they are to sell, they will sell it when it makes sense. Or if there is a there's a way to make, I guess, effect, the most palatable transaction.
