By Neil Macpherson, B.SC. MBA, Senior Vice President, Commercial Lending, ROI Capital
Wilfred Vos, BCS, CFP, FMA, CIM, FCSI, DMS, CBV, MBA, CFA, President, Portfolio Manager &
Founding Partner, ROI Capital
from Real Estate Investments
Empire Communities: 2183 Lakeshore Rd. Toronto, Ontario
Canadian real estate continues to represent a significant
component of investment portfolios held by individual and
institutional investors. The Canadian commercial real estate
market, based on a variety of forecasts, is expected to remain
stable through 2013 with a healthy balance of risk and opportunity.
Low interest rates, low inflation and modest economic growth,
combined with a shortage of product and low vacancy rates
should provide for continued price increases within this market.
Informed observers expect it will continue to offer sound and
improving fundamentals across most sectors and asset classes.
Within the relatively stable and improving Canadian commercial
real estate market, multiple opportunities present themselves to
achieve the potential for superior risk-adjusted absolute returns.
These range from investing in lower risk, income-producing property
to investing in land held for future development, but the risk/return
differential between these strategies is potentially quite significant.
For example, an investment in a fully occupied, well-located,
urban commercial property with long-term leases in place may
yield annual unlevered returns of 5%–7% in today’s market.
Conversely, a parcel of land held for future development may yield
rates of return of upwards of 20% per annum upon successful
development and potentially a lot lower (if any) if it does not get
developed on a timely basis.
Overview of Real Estate Development
In general, real estate development assets are real property
investments held (at least during the development period) in
anticipation of increased value rather than to generate regular
income. For example, land held for development typically
generates no rental income (i.e., no regular return for the investor)
during its development phase, but value is created when specific
development benchmarks are met. For development land, this
capital appreciation could occur at various times including zoning
approval, con¬firmation of pre-leasing activity, completion of
construction and at tenant occupancy. At this point, the property
should be producing income, and the investor has two choices:
sell and crystallize the unrealized capital appreciation associated
with its transformation from undeveloped land to stable income-producing real estate asset; or continue to own the built-out
property for its regular income stream.
If this option is selected, liquidity is gained by placing
increased debt on the property, reflecting its higher value. In this
way, the investor should benefit from the continued regular return
from the property, while recouping much of the initial capital
investment outlay incurred during its development.
Characteristics of Real Estate Development
Investors in development properties typically expect a higher
rate of return on their investment as compensation for incurring
By its very nature, an investment in development property
carries higher risk as the achievement of forecast net operating