WINTER/SPRING
Real Estate and Construction Newsletter 2015
Real Estate and Construction Newsletter
In this edition In order for investors to continue to prosper from direct real estate holdings through the next wave of the economic cycle, greater attention to net operating income performance will be critical. It is unlikely that past capital appreciation—resulting from cap rate compression—is going to yield sizable returns over the longer term, notwithstanding recent interest rate cuts by the Bank of Canada. The new order towards enhancing potential yield will have to be done the old-fashioned way: hard work and management’s attention to detail. This will involve underwriting quality leases with quality tenants in an effort to keep property occupancy rates high. There will be a war to secure financially strong tenants, and managers must do everything possible to ensure that they attract and retain tenants. This will include asset and property managers alike ensuring that they are on top of tenant renewals so that good tenants don’t leave looking for greener pastures. Structuring leases in creative ways that ensure lease escalations keep pace with rising operating costs will also be key. To this end, proper planning will be necessary. This involves asset managers, on behalf of owners, listening to property managers, and leasing agents to ensure properties remain competitive. Spending wisely on overdue capital expenditures and making sure common area costs are managed efficiently will be critical for tenant retention. Operating efficiencies, achieved by leveraging the latest building technologies, will be important to ensure maintenance and utility costs are managed so that non-recoverable cost are minimized and tenant borne costs are competitive with other properties.
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Real Estate and Construction Newsletter WINTER/SPRING 2015
There is a true opportunity for asset managers to make a difference, but it will take active participation with leasing agents and property managers, as well as balancing the return expectations of investors. For non-residents investing in Canadian real estate, there are specific tax compliance requirements associated with owning and disposing of Canadian real property that can impact the bottom line, and foreign investors should seek professional advice to ensure all requirements are followed with the Canadian tax authorities, as there are penalties for non-compliance. Knowing your investor risk profile has become increasingly important to designing a tailor made strategy for managing Canadian real estate. In this edition, our “Road to Success” feature interview with Forvest Financial Services Corporation illustrates how one asset manager is keeping ahead of the challenges by providing transparent communication with overseas foreign investors. The motivation is to ensure that real estate portfolios are successfully managed and fitting into the overall investment strategy and expectations of the multi-family office.
Mike Stoyan Practice Group Leader Real Estate and Construction
Road to success How Forvest Manages Real Estate Assets and Investor Expectations
Forvest Financial Services Corporation is the Canadian representative office of the Forvest Group, a wealth management organization based in Geneva. We spoke with Rob Wollach, Director at Forvest Financial Services Corporation in Toronto. Rob manages all the investments of the Forvest Group in Canada, the US and Australia. Fuller Landau: What is Forvest’s primary focus when it comes to real estate? Rob Wollach: Forvest is focused on long term wealth preservation and diversification, making real estate the most popular asset class for our international investors. The value can be maintained and good investments can make it through the ups and downs of economic cycles. We are modernizing our approach to real estate investment, such as improving the quality of the reporting for our investors. As well, quantifying the administrative burden of international investing is more of a concern today, not just on the part of the investor, but also for the wealth manager because of administrative variations in foreign countries. There’s more paperwork and more technical legal, accounting and fiscal expertise needed, which becomes expensive for international investment advisory services. For European investors, North America provides a faster route to leveraging money in real estate. Development timelines are shorter than in Europe. There’s more land and more growth. At the same time, there’s more fear from European investors regarding the volatility of real estate values in North America due to the recent history of the US markets. Many of our investors wanted to get into Florida, and then the recession happened. On the other hand, Canadian real estate has been some of the best-performing real estate that our investors have because it has not suffered like some of their US assets.
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Real Estate and Construction Newsletter WINTER/SPRING 2015
Fuller Landau: Has it been a steady rise when it comes to Canadian real estate investments? Rob Wollach: Yes. The capital gains on Canadian real estate have really helped our investors. When you look at the cap rates of, say, downtown Toronto, they seem low to our investors. We tell them 5% and 6% cap rates are hard to come by south of Highway 401 in Toronto, which is the core of the city. Despite that, investments in that area are solid and do not trade frequently. We also have a real estate portfolio in a smaller town in Ontario, which our investors would never have heard of if it were not for us. Cap rates in smaller towns can reach 7% and 8%. In reality, it was a better investment than buying the same amount of real estate in downtown Toronto. However, cap rates do not tell the whole story. There are other factors that play into value. Local data and intelligence is becoming more and more important as investments become more global. Particularly for our younger generation of investors, the data is very important. We can collect much more data today as compared to only five years ago. The steady rise of prices in Toronto can make investors uncomfortable because they think the tide will turn soon. We overcome investor nervousness by providing robust market information. Values are still going up, in part because of immigration putting pressure on supply and demand, but no one is looking at Toronto’s immigration numbers in Geneva. Plus, the housing market here is separate from the condo market, which is separate from the commercial and industrial markets, but they all get bundled into one big spreadsheet.
The Toronto market is quite unique. Toronto is now officially the third largest metropolitan area in North America after New York and LA. Typical real estate investing cycles do not apply quite as easily to New York, and I believe Toronto is in that same situation, which bodes well for foreign investors. Fuller Landau: What have you seen in terms of trends over the last five years with Forvest’s real estate investments? Rob Wollach: It is more competitive in rural Ontario because small towns are vying for fewer large tenants. Most of our assets on the rural side consist of commercial, industrial and medical properties. Given that we represent small, private high net worth investors, we are developing a more sophisticated approach to those portfolios to preserve value. For our commercial tenants, we look at additional rents and common area maintenance (CAM) fees, and how these factor into the profitability. Some use more water, electricity and/ or heat. To recover expenses, we must define them clearly in their leases. Therefore, leasing has become more technical, and the wording is focused on protecting landlords’ interests. On the other hand, tenants’ negotiation skills are improving due to the professional advice they are receiving, so we have to explain and defend our terms clearly during lease negotiations. Fuller Landau: What about your real estate investments in the US? Rob Wollach: We sold most of our real estate assets in the United States five years ago. By 2011, we had only a few holdings left in Florida. We have not made any new investments in US real estate since. It’s not so much tied to the economic environment as it is to the regulatory environment.
The agreement between the US Department of Justice and Swiss financial regulators makes it a big administrative hurdle for our investors wanting to tap into the US market. Foreign investors who invest in rental properties in the States have US tax filing requirements regarding rental income earned, and any capital gains earned on the sale of these properties. You must face how much time and money you will spend structuring your investment, repatriating your profit, and managing the regulatory component not only domestically, but also in the US. That’s what has prevented us from investing in the US again. Canadian investors, due to their proximity to the US, are not your average foreign investor, but for anyone else, it’s trickier. Fuller Landau: Do you foresee redevelopment opportunities in the market within the next couple years? Rob Wollach: In certain parts of Toronto, areas going through gentrification offer good residential and commercial investment opportunities. One issue we have encountered recently is if you tear down a building in one of those pockets, the city enacts its clawback bylaw. In other words, the city would take back feet to widen the adjacent laneway. No investor wants to lose land. The other alternative is to work within the confines of those brick walls. It’s delicate for the investor because a renovation has risks. With a reno, you quickly approach the price of a rebuild, so then why not do a rebuild? Then you’re dealing with the clawback again. Despite that, I do think the opportunity is there, because the rents that I see in those pockets are close to what new construction goes for.
The American Foreign Account Tax Compliance Act (FATCA) creates problems for foreign investors. Even though it was designed to make it more difficult for US taxpayers to conceal assets held offshore, it puts pressure on all financial organizations due to the compliance issues.
Real Estate and Construction Newsletter WINTER/SPRING 2015
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ADVISORS POINT OF VIEW Managing Real Estate Holdings through Sound Property Management
Over the last several years, our buoyant economy has contributed to a run-up in prices of real estate held for investment purposes. Since good real estate deals are harder to come by, property investors are turning to maximizing the value of their current real estate holdings through quality property management. A good property management company can mean the difference between generating a healthy profit from your real estate holdings, and leaving money on the table. It is clear: the goal of property management is to maximize revenues while minimizing expenses associated with the investment property. While this is a simple idea in principle, it’s the execution of the property management company and the monitoring by the property owner that are necessary to realize this ultimate goal. As set out below, there are some basic activities that you, as a property owner, may undertake to monitor your investment.
Reports It is a given that your property manager should be providing you with status reports (budgets, monthly financial statements, rent rolls, arrear rents, etc.). First, you should make sure that that the reports are telling you what you are interested in knowing. Second, you need to review the reports and ask questions. Asking questions will not only increase your knowledge level, but will indicate that you are taking an active role in monitoring your investment. Do not let the reports sit unopened.
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Real Estate and Construction Newsletter WINTER/SPRING 2015
Separate bank account and accounting records Each building should have its own bank account and accounting records. This enables effective review of results on a month by month basis and also decreases the likelihood of the “sharing” of costs with other buildings, perhaps even those buildings with different owners that are overseen by the same property management company.
Rent You should ask, and your property manager should be easily able to answer, the following questions: • What are you doing to maximize occupancy? • What are the vacancies and turnover compared to the neighborhood? • How are the building’s monthly rents compared to the neighborhood? • What are you doing to maximize rents? • What improvements have been made related to tenant screening? • What activities are undertaken concerning rent collection issues? Monthly updates should be provided by your property management company, giving you details of all leases expiring during the following three months and the progress made in negotiating new leases. You should review the rate of commission charged by the property manager on rents and the negotiation of new leases and compare the rate to the market.
Marketing An effective marketing plan in 2015 should be different from that of the 1990s (and 2000s). The use of social media and online presence should be evaluated as a component of the overall marketing plan. Tenant surveys and referral programs should also be considered as potentially useful by your property manager. Happy tenants may be your best and most cost-effective marketing activity, as referrals from current tenants can be a valuable source of new tenants.
Expenses First, you should review the annual budget prior to the commencement of the year. Second, review the budget compared to actual results on a regular basis. There should be a policy in place that requires that more than one fee estimate for larger expenditures must be obtained. As owner, you want to ensure that benefits from volume pricing are realized on your investment, not other buildings. Asking questions surrounding any larger expenditure is necessary. You may also want to test one of the larger expenditures for compliance to the policies in place. In addition, an annual review of all insurance should be provided.
Red Flags Not all property management companies are able to maximize value for owners. Red flags to look out for include unit rents that are lower in your building than the local average, vacancies and/or turnover rates that are higher than average, exceeding the spending budget without your approval, and a lack of transparency by the property management company in their communications with you, which can include missing or late reports, or not providing you with the information necessary to make good decisions. If you suspect that your property management company is not maximizing value, have a valuations expert conduct a review of the books and records in order to quantify losses, if any. Over the years, we have surveyed the economic performance of various property managers at the request of building owners for litigation and other purposes. By conducting a review, we can determine if a property manager has the owner’s economic best interests in mind. In summary, although you may be very comfortable with the increasing value of your property, there are some basic steps that you should take to monitor your property manager to realize on your investment on an ongoing basis.
by Patricia Harris, CPA, CA-ifa, CBV, DIFA Patricia Harris is a partner with Fuller Landau’s Valuations practice. She focuses on business valuations and litigation support services, as well as investigative and forensic accounting. Patricia can be reached at (416) 645-6570 or pharris@fullerllp.com.
Real Estate and Construction Newsletter WINTER/SPRING 2015
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ADVISORS POINT OF VIEW Non-resident Investing in Canadian Real Estate – Keep the Taxman in Mind
Canada has long been an attractive destination for foreign investors looking for a stable environment to invest in real estate. What many non-resident investors may not realize are the tax compliance requirements associated with owning Canadian real property.
Earning Rental Income from Canadian Real Property Withholding tax is imposed on the gross amount of rent paid or credited to a non-resident landlord. The rate of withholding is generally 25%, unless specified in an income tax treaty. The tenant or the withholding agent for the non-resident landlord is responsible for remitting the tax to the Receiver General of Canada, who collects on behalf of the Canada Revenue Agency (“CRA”). If there are expenses related to the rental operations, the non-resident landlord may choose to file a Canadian income tax return within two years from the end of the taxation year in which the rents were received pursuant to section 216 of the Income Tax Act (the “Act”) and deduct expenses related to earning the rental income, including capital cost allowances (“CCA”) to arrive at the net rental income. Tax is calculated on the net rental income. This is an option that the non-resident landlord can decide on a year-byyear basis. For a non-resident landlord who is an individual, form T1159 is used but no “personal amounts” tax credits can be claimed. An overpayment of withholding tax can be claimed as a refund. If CCA has been claimed and the property is subsequently disposed of, any recapture of CCA previously deducted must be included in income in the year of disposal. It should be noted that filing a tax return under section 216 of the Act does not change the requirement to remit withholding tax on 25% of the gross rents. It merely enables the non-resident to obtain a refund if the tax so calculated on the net income is less than the tax withheld.
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Real Estate and Construction Newsletter WINTER/SPRING 2015
An option to reduce withholding tax can be made if an agent files form NR6 on behalf of the non-resident landlord, and makes an undertaking to file an income tax return within six months after the end of the taxation year. It permits the withholding of tax to be calculated based on 25% of the estimated net rental income (instead of 25% of the gross rents). This is beneficial if there are recurring rental expenses. Form NR6 must be filed and approved by the CRA before the first day of the following taxation year or before the first payment of withholding tax is due. For example if the monthly gross rent was $1,000 and monthly expenses were $800, filing form NR6 for the undertaking means that the agent would only need to remit $50 of tax based on $200 of net rent ($50 = 25% x [$1,000 - $800]). If no undertaking was filed, the amount required to be remitted would be $250 (25% x $1,000). Another reporting requirement is to file form NR4 to report the gross rent received and the withholding tax remitted of the previous calendar year. This filing is due March 31st of the following calendar year.
Disposing of Canadian Real Property By definition, Canadian real property is a taxable Canadian property (“TCP”) for income tax purposes. A non-resident who disposes of TCP is subject to rules which constitute a prepayment on account of tax. A person or entity who purchases Canadian real property from a non-resident vendor is required to withhold 25% of the purchase price and remit to the CRA on account of the non-resident vendor’s tax account, unless the non-resident vendor has posted security for payment of the tax liability, or has agreed to request a tax clearance certificate (also known as a section 116 certificate) from the CRA in advance of the closing or at the latest, within 10 days after closing and pay the estimated tax liability. Generally the purchase and sale agreement will ask the vendor for status of Canadian tax residency.
CRA form T2062/T2062A is to be used by a non-resident vendor to request for a tax clearance certificate. The non-resident vendor is required to disclose the name and address of the purchaser, the date of the transaction, a description of the property, the sale price and the vendor’s tax cost or adjusted cost base of the property. The filing also requires submission of documents to support the original purchase price, invoices that support additions to the property, the sale agreement, etc. The form implies that the non-resident vendor to make a prepayment of tax on account equal to 25% of the estimated capital gain. If the estimated tax calculated is not paid or if security is not provided, the purchaser will be obligated to withhold and remit the 25% from the gross purchase price to the CRA within 30 days after the end of the month in which the transaction has closed. Since 25% of the gain is generally less than 25% of the gross sales price, it is to the non-resident vendor’s benefit to pay the former amount. Once the processing of the request is complete, the CRA will issue the tax clearance certificate on form T2064. The certificate will set out an amount called a “certificate limit”. In the event where there’s an adjustment to the purchase price after the issuance of the certificate and the final sale price exceeds the certificate limit, the purchaser must withhold and remit to the CRA 25% of the amount by which the actual sale price exceeds the certificate limit.
Independent from the clearance certificate process, the non-resident vendor is required to file a Canadian income tax return after the end of the taxation year to report the transaction and pay the tax liability if there is a deficiency. Tax will be refunded if there is an overpayment. A non-resident investing in Canadian real property should always seek professional advice to ensure all requirements are followed with the Canadian tax authorities, as there are penalties for non-compliance.
By Andy Yap, CPA, CA Andy is a Partner in Fuller Landau’s Tax Practice. He has over 20 years of experience working with entrepreneurial business owners. Andy can be reached at (416) 645-6536 or by email at ayap@fullerllp.com.
Real Estate and Construction Newsletter WINTER/SPRING 2015
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Fast facts, trends and recent news Will a decrease in the interest rate by the Bank of Canada offset the effects of falling oil prices on the real estate and construction sector of our economy? Fuller Landau is here to help you weather what may be a stormy 2015.
Residential
It was widely accepted interest rates would commence increasing in 2015. However, in what some are calling a surprise move, the Bank of Canada shocked markets with a cut in its key overnight lending rate by a quarter of a percentage point on January 21, 2015. Lower interest rates translate into higher housing prices, which are hard to imagine given the increases the residential market has experienced over the past several years. The Toronto Real Estate Board (“TREB�) reported very strong year-over-year increases in sales units and average sale prices in December 2014. Attached/row/townhomes experienced the highest increase in average sale price between December 2013 and December 2014 of 11.6% in the City of Toronto and 10.2% for all regions reporting to the Toronto Real Estate Board. As well, attached/row/townhomes reported the highest increase in the number of units changing hands of 17.0% in the City of Toronto and 12.3% for all regions reporting to the Toronto Real Estate Board.
Residential home sales trends1 year-over year summary for the month of december
The Toronto Real Estate Boards reports data on the number of sales by housing type and price range. Of noteworthy mention is the sharp increase in properties selling in the $1,000,000 + price range. With the exception of semi-detached, who saw their biggest year-to-date sales increase in the $900,000 to $999,999 price range, the remainder of property types saw their highest increases in the $1,000,000 + range.
AVERAGE PRICE 2014
2013
% CHANGE
$934,039
$864,351
8.1%
$738,334
$685,787
7.7%
City of Toronto
$387,612
$367,376
5.5%
All TREB Regions2
$362,758
$343,943
5.5%
DETACHED City of Toronto All TREB Regions
2
CONDOS
ALL HOME TYPES
Source: Toronto Real Estate Board Market Watch December 2013 and December 2014. All TREB regions include Dufferin, Durham, Grey, Halton, Hamilton, Kawartha Lakes, Northumberland, Peel, Peterborough, Simcoe, Toronto, Wellington, and York. 3 Includes row homes, co-operatives, co-ownerships, detached condominiums and link properties. 1
3
2
City of Toronto
$574,539
$541,771
6.0%
All TREB Regions2
$556,602
$520,189
7.0%
sales by price range and house type1 all treb regions2 - december 31st year-to-date DETACHED PRICE RANGE
2013
21
25
% CHANGE -16.0%
2014
2013
% CHANGE
107
166
-35.5%
$100,000 to $199,999
343
441
-22.2%
2,042
2,427
-15.9%
$200,000 to $299,999
1,711
2,374
-27.9%
7,093
6,607
7.4%
$300,000 to $399,999
4,649
5,623
-17.3%
6,754
6,004
12.5%
$400,000 to $499,999
7,217
7,955
-9.3%
3,042
2,531
20.2%
$500,000 to $599,999
7,742
7,584
2.1%
1,308
1,039
25.9%
$600,000 to $699,999
6,534
5,669
15.3%
702
470
49.4%
$700,000 to $799,999
4,644
3,742
24.1%
301
229
31.4%
$800,000 to $899,999
3,381
2,651
27.5%
134
106
26.4%
$900,000 to $999,999
2,160
1,598
35.2%
100
80
25.0%
$1,000,000 to $1,249,999
2,720
1,848
47.2%
137
88
55.7%
$1,250,000 to $1,499,999
1,494
1,155
29.4%
77
56
37.5%
$1,500,000 to $1,749,999
838
648
29.3%
39
23
69.6%
$1,750,000 to $1,999,999
488
350
39.4%
22
12
83.3%
1,078
748
44.1%
57
49
16.3%
$2,000,000+
10
Q3 Real GDP Growth
CONDO
2014
$0 to $99,999
Economic Indicators
Real Estate and Construction Newsletter WINTER/SPRING 2015
2014 2.8%
2013 2.7%
Toronto Employment Growth As at November 30 -1.0%
2.4%
Toronto Unemployment Rate As at November 30 7.8%
8.2%
Inflation (Yr/Yr CPI Growth) As at November 30 2.0%
0.9%
Bank of Canada Overnight Rate As at December 31 1.0% 1.0% Prime Rate As at December 31
3.0%
Chartered Bank Fixed Mortgage Rates 1 Year 3.14% 3 Year 3.44% 5 Year 4.79%
3.0%
3.14% 3.95% 5.34%
Source: Toronto Real Estate Board Market Watch December 2013 December 2014
Building Permits
According to Statistics Canada, the overall dollar value of building permits for the City of Toronto decreased by approximately 1.61% during the period January to November 2014 compared to the same eleven month period in 2013. The most significant decrease came from the dollar value of industrial building permits issued. During the period January to November 2014, approximately $747 million dollars of industrial building permits were issued in the City of Toronto, compared to approximately $859 million during the period January to November 2013. This is a decrease of approximately 13%.
Building Permits - November Value of Construction (thousands of dollars) Residential
INDUSTRIAL
COMMERCIAL
January to November 2013
$8,685,289
$858,525
$3,783,348
$1,055,945
$14,383,107
January to November 2014
$8,863,415
$746,760
$3,404,898
$1,137,029
$14,152,102
2.05%
-13.02%
-10.00%
7.68%
-1.61%
% Change
INSTITUTIONAL AND GOVERNMENTAL
TOTAL
Value of Building Permits1 Toronto, Ontario ($000) $16,000,000 $14,000,000
Disclaimer: The information in this section has been provided by external sources and is subject to change. Fuller Landau LLP is not responsible for the accuracy, reliability or timeliness of the information supplied by external sources. Readers wishing to rely upon this information should consult directly with the source of the information.
$12,000,000 $10,000,000 $8,000,000 $6,000,000 $4,000,000 $2,000,000 $0
1
January to November 2013 January to November 2014 Residential
Industrial
Commercial Institutional and Governmental
Total
Source: Statistics Canada “Building Permits� November 2013 and November 2014 (Catalogue no. 64-001-X).
Real Estate and Construction Newsletter WINTER/SPRING 2015
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Questions? Comments? Please contact our Marketing Director: Marla Chang 416-645-6572 mchang@fullerllp.com
Our Real Estate & Construction Team Michael Stoyan 416-645-6545 mstoyan@fullerllp.com Gary Abrahamson 416-645-6524 gabrahamson@fullerllp.com Jonas Cohen 416- 645-6574 jcohen@fullerllp.com Patricia Harris 416-645-6570 pharris@fullerllp.com
About Fuller Landau
Brian Joffe 416-645-6516 bjoffe@fullerllp.com
Fuller Landau LLP is a leading mid-sized accounting, tax and advisory firm. We are committed to helping owner-managers and entrepreneurs build value and grow their business. We are uniquely positioned to do just that because, as business advisors and entrepreneurs ourselves, we know first-hand what it takes to meet those challenges and succeed in any business environment.
Andy Yap 416-645-6536 ayap@fullerllp.com
Our Real Estate and Construction practice group
Fuller Landau LLP 151 Bloor Street West 12th Floor Toronto, Ontario Canada M5S 1S4 www.fullerllp.com
We know that companies within the construction and real estate sector are subject to many challenges ranging from rising material costs to cyclical demand. We have hands-on experience helping construction and real estate-related companies like yours make sense of the business landscape.