Vancouver Commercial Real Estate Podcast

What will 2023 interest rates mean for the commercial real estate market? Pat Wood shares what asset classes are down, why self storage is hot and what’s in store for 2023!

What is happening in commercial real estate in 2023?

The demand in commercial real estate is still there but buyers and sellers’ expectations are a little bit different. Sellers want the highest price, which they saw 6-12 months ago. But buyers want a cheaper price with the new cost of debt. So it’s a matter of connecting the two.

It’s about the changing perception of value. People who got 2.5 to 3.5% interest rates during covid looked at 4% interest and thought, “I’m not buying that!” But now that we’re at 7-8% interest rates, once they drop to 5-6%, people will be ready to buy. That’s because people have adjusted to the new normal and now that 5-6% seems like a deal.

Who is Pat Wood?

I’ve been with William Wright for 2.5 years after having spent the previous five years in the commercial appraisal industry, specializing in self storage valuation. That gave me a good foundation in the industry.

Within self storage we help clients find development sites, help groups acquire sites and help owners sell their assets.

How is the commercial real estate market in Victoria right now?

We were a bit concerned in the last couple of weeks in December after the big snowstorm. The phones were quiet. But things started to come back to life in the beginning of January. We’re now running as fast as we can to keep up. We’re seeing more leasing than sales and purchases. But it’s a very active commercial real estate market to start off 2023!

How is the self storage market?

We had some great success in the self storage market at the end of 2021 and into the beginning of 2022. We were seeing record setting cap rates and everyone was very happy with their purchases.

As 2022 progressed and interest rates went up, people took a wait-and-see approach. We’re currently working on some deals right now but it’s been quieter since financing has been harder to get.

Deals used to require a 28-34% down payment, giving you about 70% loan to value. That’s now switched where loan to values are under 60%. You need more cash to buy assets. Cap rates haven’t moved yet so you need to get creative with lending and making deals.

What is driving demand in self storage right now?

Because we’re in such an inflationary environment, self storage looks more attractive to buyers. Storage lease prices are only limited by what your customers are willing to pay. If your customers are willing to tolerate a 12% rent increase, you can push it through. With self storage, you’re better able to keep up with expense increases and cost of living increases.

We saw storage demand skyrocket during covid. It’s starting to come down a little but new storage facilities are still renting up at a quick pace. This is causing people to really look at this asset class as one to deploy their capital in.

“We have to educate people by letting them know that self storage is running a business, even more so than multi-family real estate. There are day-to-day operations; it’s not hands-off by any means. That’s why it commands a premium on the cap rate.”

What is the main challenge as a broker in self storage real estate?

The Canadian self storage community is very insular, though we are very welcoming. If you want to go to a self storage conference in the US, you can find one happening every few weeks. But in Canada, there are only two a year.

Unlike in the US, no one is collecting and making available information about Canadian self storage. So it’s hard to learn about the industry.

Where are we at with 2023 interest rates and inflation? Where are we going in 6-12 months?

I spent a lot of my time at UVic in the economics department and do find the topic very interesting. In December, we had the CPI rise 6.3% year over year. That sounds like a big increase but it’s actually down from the peaks we saw last summer.

They say when the US sneezes, Canada gets a cold. I think that’s where we’re at now. The Bank of Canada is announcing the next interest rate increase on January 25th and smart money says it will be 0.25% (ETA: That was correct). Whatever the US Fed does, Canada has to keep up. If we don’t, our currency will crash.

Over the last six months, inflation has actually been flat. The inflation we saw over the last 12 months all happened before June 2022, and has been flat ever since if you adjust for seasonality. The one caveat is the dip in December, but that was due to gas prices.

The Bank of Canada wants to see an inflation rate between 1 and 3%. As inflation gets lower, it’s harder to get it lower because there are less levers to push. I think inflation will continue to fall.

After this next interest rate increase on January 25th, I think we’ll see the Bank of Canada hold. They will mirror whatever the US Federal Reserve does. It sounds like the US is in a similar situation to us where inflation is slowing and the job market might be worsening.

I expect we’ll dip into a recession by June, see a few quarters of recession and then the Bank of Canada and the US Fed will have to start cutting rates in 2024, if not before that.

Is 2024 a year of recovery for the real estate market?

I think so. We’re already seeing people more active in real estate because they can see the end of the rate raises ahead.

In commercial real estate, deals take longer. There’s not a 30 day close like in residential real estate. Some of our self storage deals take 9-12 months to close. So it’s hard to make the numbers work if your interest rate goes up a few times in that time frame. Now that rates are stable or going down, we’ll see more activity.

In economics we like to say “all things being equal” which is our disclaimer that we don’t know what we’re talking about. But if something crazy happens, all bets are off.

“Things could change if there’s a major geo-political issue. But all things being equal, I think we’ll see rates start to come down by the end of the year.”

A note on CPI (Consumer Price Index) calculations:

The US and Canada are changing the way they calculate CPI as of January 2023. In the past, you looked at the last two years but as of January, they’ll only look at the last year.

So we’ll see the covid effects fall off a lot quicker. In my opinion, this new calculation will overestimate price decreases and underestimate price increases. That will get us back to our ideal inflation range before we’re actually there, but it’s still good news for the economy.

Are you seeing more interest across all commercial asset classes?

We are. Multi-family is a bit quieter right now. Stuff that would’ve sold in a week in January 2022 has been sitting for two to three months now. That asset class is a bit rough as cap rates got tough. Development land is tough because financing is non-existent unless you can put 75% down.

But on the leasing side, everything is hot. And on the sales side, light industrial is still very hot. There’s very limited supply right now, but more coming to the market later this year. But overall, everything is picking up.

What do commercial real estate buyers need to know in 2023?

A broker in Toronto shared with me, “I’m telling my clients that you marry the property but you’re just dating the interest rate.” The property is your long term purchase while the higher interest rates are just temporary. You have to factor in the extra interest costs for the next 18-24 months, knowing you’ll refinance later.

“This is a chance to get a slight discount or get into a market or asset class you may not have had an opportunity in last year. As long as you’re buying smart, it’s a great time to make a deal.”

There’s so much diversity in the commercial real estate world. When one asset class is hot, another might be cooler. But you have steadiness throughout the industry.

In an area like Victoria and Vancouver Island where there’s so much interest, it doesn’t take a lot to push it in a positive direction. Everyone still wants to buy and there’s pent up demand. We just have sellers expecting 2021 prices and buyers expecting 2023 discounts. But the market is going to take off as financing gets easier.

Where are you seeing industrial real estate opportunities?

We’re seeing a lot of leasing happening in West Shore Business Park in Langford. We sold that out last year and it’s hopefully completing this year in Q2. It’s kind of the only industrial space available in the area!

We’re also seeing a lot of activity in Nanaimo and around Nanaimo. It’s the place to invest! However, it’s tough to invest in Nanaimo because it’s a pretty local market. But that’s slowly changing. Even south and north of Nanaimo are good areas to find deals around the hub of the island. You can still get industrial land there.

Have developers missed the boat on Langford?

I don’t think so! I’m actually currently building a house in Langford and I’m very excited about the city. There’s a new council in Langford that hasn’t been disastrous for developers, but does want to put more thought into what is developed.

Depending on what you want to build, there are still great opportunities in Langford. It’s still easier to develop in Langford than anywhere else on the South Island.

When I went to put in my building permits, I was told to come back since my project was still a couple of months out. They told me they only needed two days. They were wrong – it was done in a day! No other municipality has a turnaround time like that. So even if land is more expensive, it’s still a great place to develop. You just have to make sure you’re building the right things.

The 6 Pack: Getting to Know William Wright Commercial Agent, Pat Wood

What’s your new year’s resolution?

I’m not a big resolution person; if there’s something I want to change, I try to do it right away. But I actually did come up with a resolution this week with my fiancé.

Our local mountain got a powder alert and we decided that we want to set up our lives so that we can take advantage of that next year. I want to be diligent with everything so I can take that time off and get out to the mountain.

What’s your last meal on death row?

It’s got to be an all you can eat buffet! That way I never stop eating and they can never kill me.

Favourite vacation spot?

I was raised in Hawaii and my mom still lives there. I’m not a tropics person though. We went to France this summer, visiting Paris and Bordeaux. We had the most amazing time in Bordeaux with amazing people and amazing wine. Immediately, we wanted to go back!

What are you binge watching right now?

We don’t actually have a TV at home anymore because we weren’t using it. But I like watching some Netflix stuff on flights. There’s one documentary on pizza where they go around the world and talk to people who make pizza. Any documentary about people cooking works for me.

What’s your go-to karaoke song?

I’m going with the super-cliched Don’t Stop Believing by Journey. Everyone knows the words to that one!

What advice do you have for commercial real estate buyers in 2023?

Make sure that you’re confident in your timelines. Everything is taking significantly longer than it should. If you can do your due diligence in 30 days, ask for 45. It’s easier to ask for more up front than to ask for an extension. Environmental stuff is taking longer; financing is taking longer; it’s all taking longer! So plan ahead for that.