What the sale of two Vancouver office towers means for commercial real estate, pension holdings

Reports of the death of office real estate may have been greatly exaggerated. Last week Canada Pension Plan Investment Board and Oxford Properties Group Inc. — the real estate arm of OMERS — sold two office towers in downtown Vancouver to Germany’s Deka Group. The deal was valued at around $300 million and offers some much-needed clarity on office real estate valuations.

“It’s been quite difficult to ascertain pricing,” says Keith Reading, senior director of research at Morguard. “It’s not like residential housing, where even when the market’s quiet there are enough recent sales that you can get an idea of where pricing should be. We haven’t had demand for office buildings, especially buildings of this size, in Canada or across the world. It becomes hard to ascertain value, which becomes a concern for the vendor and purchaser.”

Reading believes that the Deka Group moved on these properties despite the cloudy market conditions because of the quality of the buildings and the quality of their tenants. Both buildings are around 100 per cent occupied, with tenants like Amazon and Desjardins. There may yet be some downside on the valuation side over the short-term, but Reading highlights that Deka is gaining a solid source of income from these buildings. At the same time, both the CPPIB and OMERS divest themselves slightly from a segment of the commercial real estate market that remains under some pressure.

This deal, Reading explained drives home the gap between class A buildings in prime locations, and the class B and C buildings in secondary locations that lack the income generation to attract buyers. While we’ve just seen two major pensions shed a pair of class A buildings, Reading notes that the income generation from this kind of building should continue to make them attractive to pension funds and institutional investors. CPPIB and OMERS got some freedom and capital from the deal, but those properties are not necessarily the kind that we’ll see pension funds offloading en masse. Rather they may hold more properties like this on their books to retain that stability of income.

Office real estate is most risky in the class B and C buildings found in suburbs and secondary cities. The dynamics introduced by the pandemic, hybrid work and high vacancies, are still playing out here. Reading does expect those buildings to recover somewhat as the economy eventually transitions into recovery mode, driving up office demand. He also expects some of that excess office supply to come off the market as buildings are repurposed into residential, industrial, or retail applications. He notes that a few buildings in both Calgary and Ottawa have sold to private capital at rock-bottom prices, with the expectation that they’ll be repurposed.

While office real estate continues to transition out of crisis mode, Reading sees some of these properties beginning to fit into an outlook driven by industrial and multi-family residential real estate. This so-called ‘beds and sheds’ approach has been historically strong, both through previous downturns and in the wake of the pandemic. He also notes that there has been some steady uptick in retail real estate. The recovery of retail from the pandemic has been faster than office, and last year we saw two significant deals on class A retail properties that could point to a more attractive outlook. Namely, the sale of a 49 per cent interest in Vaughan Mills by Ivanhoé Cambridge to LaSalle Investment Management and the recent sale of Pickering Town Centre which is currently slated for redevelopment, with the addition of condo towers to the retail complex. Those deals also drive home the value still found at the top-end of commercial real estate subsectors. It’s those top-quality assets that Reading believes pension funds should and will focus on.

“The top-quality assets will continue to sell. Beds and sheds will, but so will office and retail with a caveat that the top-quality stuff will sell relatively easily because what’s what institutional money is interested in,” Reading says. “But the minute you go down the quality ladder in office and retail, the interest level wanes pretty sharply. Those are the assets that pension funds and institutions are trying to get rid of because there’s definitely some risk over the next couple years. I think you’ll continue to see institutional investors and pension funds trying to prune their portfolios to get rid of these B assets while maintaining that cream of the crop in their portfolios.”