The market to the north: the Canadian commercial property market is going through its own lean times, with an overbuilt office sector and increasingly cautious lenders.

Author:Warson, Albert

The Market to the North

For years, long before "globalization" became the buzz word of North American commerce and finance, Canadian real estate development companies behaved as if an international border didn't exist.

Their subsidiaries sprang up in major U.S. markets and financing was routine. Today, with a recessionary cycle lurking in the wings, financing is anything but routine.

Canadian developers are attracted to innovative financing devised in the United States, and Canadian financial institutions are more adventuresome in adapting those vehicles - and yet more cautious about whom they have a financing fling with.

Notably, several Canadian developers have reshaped much of the urban landscape in the United States. BCE Development, Bramalea, Cadillac Fairview, Campeau Corporation, Marathon Realty, Markborough Properties, Olympia & York and Trizec, are among those developers from the north who played key roles in the modernization of America's skylines.

Projects developed by these companies have been backed by Canadian and U.S. financial institutions, with investments totally in the billions of dollars.

As the scope of the projects and need for financing has expanded tremendously, European and Far Eastern investors have become involved particularly within the past five years. The $800 million yen-dominated first mortgage on the Merrill Lynch tower at Olympia & York's (O&Y) World Financial Center in Manhattan, arranged by Japan's Nomura Securities Company, Ltd., is just such a record-breaking example.

Financing vehicles developed in the 1980s have now evolved into a higher order of complexity. Interest rate swaps, forward rate agreements and securitization are among the more popular techniques used today.

While in today's overbuilt Canadian commercial real estate market, only borrowers who are among the financially fittest, as well as ingenious, have any realistic prospect of riding out the economic downturn and the rising inventory of empty office space.

Retreating from further U.S. development, Canadian developers are completing projects in the pipeline and selling off others. In addition, cautious lenders are spreading out larger safety nets.

a global view

Eyeing distant shores, Canadian developers are already hedging their bets on this continent with projects in Europe. For example, O&Y planned the four billion pound Canary Wharf in London and a 40-story tower in Moscow; Markborough Properties launched two office projects in London; other developers have descended on the Soviet Union and Budapest.

After serious analysis of the timing and market economy, major players are still commited to proceeding with high-quality real estate projects in Canada - but more cautiously.

In fact, Kenneth P. Leung, O&Y's senior vice president of finance and administration, is not the least bit apprehensive. In an interview at O&Y's head office in Toronto, Leung said financing for North American commercial real estate is abundant, with many alternative financing techniques available - no matter what the marketplace seems to be saying.

In 1985, O&Y started a trend with a $200 million Eurobond issue backed by a first mortgage and assignment of long-term leases on its Maiden Lane office tower in lower Manhattan. But, Leung said that the Eurobond market has cooled off and the Canadian bond market is presently active because of higher interest rates. When asked, "Where is the real estate lending action?" Leung commented on the differences between U.S. and Canadian international market strategies.

"Canadian financial institutions are more active in the United States than in Europe, [whereas] U.S. banks are doing more real estate financing syndications in Europe and the Far East than they are in Canada," Leung said.

Inventive techniques

Closer to home, lenders are trying different techniques to come up with an approach that works. Commercial mortgage securitization as a real estate financing technique is still feasible, but only for top quality projects. In 1986, O&Y made news with the largest-ever commercial mortgage transaction...

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