BUSINESS

RISING ONCE AGAIN

Commercial real estate shows signs of life, but not in time for Trizec

BRENDA DALGLISH July 18 1994
BUSINESS

RISING ONCE AGAIN

Commercial real estate shows signs of life, but not in time for Trizec

BRENDA DALGLISH July 18 1994

RISING ONCE AGAIN

BUSINESS

Commercial real estate shows signs of life, but not in time for Trizec

The atmosphere was subdued as disgruntled investors gathered last week in the underground auditorium of Bankers Hall, the Calgary office tower that serves as head office for Trizec Corp. Ltd., one of North America’s leading real estate developers. During four meetings spanning two days, four separate groups—secured creditors, unsecured creditors, preferred shareholders and common shareholders—voted on a restructuring proposal that offered partial repayment of their investments. Three of the four groups quickly agreed to the bailout proposal put forward by a partnership led by financier Peter Munk’s Horsham Corp. of Toronto. One, however, remained strenuously opposed. The unsecured debt holders voted against Horsham’s proposal, hoping that a provincial court judge, who is scheduled to settle the issue on July 19, will cut them a bigger slice of the Trizec pie. But neither Horsham, which is proposing to invest more than $1 billion in Trizec in return for control of the company, nor the company’s secured creditors, who are owed almost $1.4 billion, were willing to appease the juniors. “We’re not baking a bigger pie,” declared Horsham spokesman Vince Borg. “There will be no more money from us.” Despite that confrontational tone, however, Trizec’s protracted restructuring efforts, which began more than two years ago, are almost over. Most observers expect that Justice Gregory Forsyth of the Alberta Court of Queen’s Bench, who has been asked to rule on the matter, will approve Horsham’s bailout proposal next week or, at most, make only small modifications. In fact, Trizec and Horsham are so confident of success, that after last week’s meetings they announced a list of proposed board members for the restructured company, including Munk as chairman. But even as Trizec’s fate was being decided, two surveys were released indicating that Canada’s commercial real estate market now appears to be on the upswing. The national vacancy rate for office space, by far the worst segment of the commercial real estate market, fell very slightly to 15.1 per cent in June from 15.3 per cent six months earlier, according to a survey by realtor Royal LePage. “By 1990’s measurement standards, that’s good news,” said Louis Burgos, executive vice-president of Royal LePage Commercial Real Estate Services in Montreal. “The market has turned around.”

But after four years of soaring vacancy rates and falling prices, analysts are still not predicting a strong rebound. Even the big public sector pension funds that have been “bottom fishing” in the depressed commercial real estate market say that they are not looking for a quick recovery. However, the best buying opportunities may have already passed. Says Charles Magwood, president of OMERS Realty Corp., the real estate arm of the massive Ontario Municipal Employees Retirement System: “Often the best time to buy is when the sellers are the most stressed out. Most of that has now passed.” Indeed, with the imminent restructuring of Trizec, as well as the impending breakup of Cadillac Fairview Corp. Ltd., which used to be considered the finest shopping-centre company in Canada, but which suffered a $2.7-billion loss in 1993, most of Canada’s leading real estate companies have now largely completed their bankruptcies or restructurings.

Trizec is one of the last companies to fall, in part because it was one of the best. It has a portfolio of 85 shopping centres and office buildings across Canada and the United

States, including Royal Centre in Vancouver and Place Ville Marie in Montreal. Some of Canada’s earlier corporate realn estate disasters occurred at companies such as Campeau Corp. and Olympia & York Developments Ltd., which were toppled by megaprojects such as O&Y ’s Canary Wharf in London that soured in the recession.

Trizec’s problems, however, were different. It suffered from the steady decline in real estate values and was embarrassed by a few bad assets, including the unfinished Bay-Adelaide Centre that is likely to remain for years as a barren concrete monument to 1980s excess in the centre of downtown Toronto. But investment analysts say Trizec’s worst mistake was timing. The company, which is 32 per cent owned by Peter and Edward Bronfman’s Carena Developments Ltd., was in the unfortunate position of having $1.9 billion worth of debt coming due at a time when Trizec’s cash flows were squeezed and the financial markets shunned real estate.

Enter Peter Munk, a Toronto financier whose corporate coffers were overflowing after a rally in global gold prices last year deliv-

ered a windfall to his mining company, American Barrick Resources Corp. In April, Munk, through Horsham, which has investments in gold, oil refining and German real estate, devised its plan to bail out Trizec by partially paying off existing creditors and injecting new cash into the company. Joined as a partner by real estate venture Argo Partnership LP of New York City, Horsham and Argo have agreed to put up between $1.1 billion and $1.2 billion in return for 68.5 per cent of Trizec’s equity. Horsham would get a 44.5per-cent stake in the company, while Argo would take 24 per cent. Under that proposal, the remaining 31.5 per cent would be divided up among existing investors as part of their

buy-out packages. The Bronfmans will be left with only two or three per cent of Trizec.

It is that proposed division of assets, however, that upset Trizec’s unsecured creditors. Richard Orzy, a Toronto lawyer who represents the group of mostly so-called vulture funds, U.S. investors who specialize in buying distressed assets cheaply, says that they believe that the common shareholders are getting paid back too much. According to the established hierarchy of debt repayment, secured creditors come before all other investors because their loans are secured by specific assets. (In return for that security, their loans also pay a lower rate of interest.) Unsecured creditors take more risk, eam a somewhat higher rate of return and, in the event of a financial collapse, can lay claim to assets left over after the secured creditors have been paid. Preferred shareholders follow the two classes of creditors. Common shareholders, who take the greatest degree of risk in return for the highest potential return, are entitled only to what is left after all other investors have been repaid.

In Trizec’s case, that would amount to

nothing. But in the interest of resolving the company’s financial problems quickly, the secured creditors say that they have agreed to claim about $100 million less than what they believe they are entitled to take, leaving it for the other investors. But the junior creditors, who are owed $330 million, say that they have been asked to give up too much. Declares Orzy: “A lot of what’s going to the common shareholders came out of our hides. There is no legal precedent for shareholders to rank before creditors.” As a result, he says that the junior creditors will ask the judge for an additional $25 million.

But if Horsham’s proposed solution is not overturned, Bill L’Heureux,

Trizec’s president, says the company hopes to complete the deal by July 25. Horsham spokesman Borg adds that the next step will be to review Trizec’s business plan. Says L’Heureux, who has been confirmed as president and chief executive officer of the restructured company: “For the last two years, our plan was based on survival. Now, assuming that things go right, we’re beyond the survival stage. We can lift our eyes a little bit and plan for the future.”

Whatever continuity there may be at the helm of Trizec, the consensus is that the company’s future growth there—and in the real estate industry, overall—will be very different from the boom that characterized the past 20 years. L’Heureux says that in the next three to four years Trizec expects to undertake only one new construction project, in Denver, Colo. “In the past, we might have announced a project like that every week,” he told Maclean’s. “People don’t realize how overdeveloped the market, especially the office market, has become.” In the future, according to L’Heureux, Trizec will grow primarily by acquiring undervalued buildings to build a critical mass of assets in strategic markets and then managing them more efficiently. Specifically, he says the company is interested in the Vancouver-Seattle area, as well as the southeastern United States, where the economies are recovering at a faster-than-average rate.

In general, however, future real estate investment is expected to require more focus on management and less on construction. At OMERS, which since 1989 has increased its real estate portfolio from $500 million to $2 billion of its total $20-billion investment portfolio, Magwood says that property managers will have to pay more attention to consumers than they have in the past. “Success in real estate,” he says, “will be about things like air quality, whether there’s a food court and how often the windows get washed.”

Part of the shift in emphasis is precipitated by the changing ownership of major buildings. Brian Muzyk, vice-president of real estate at the Ontario Teachers’ Pension Plan Board in Toronto, says that his group has

SPACED OUT

After years of steady rises in the vacancy rates for office space across Canada, the market has stabilized in the past six months.

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spent $1 billion investing in real estate in the last three years and other large pension plans have been equally active. Muzyk says that he is optimistic about the growth potential for real estate because property values tend to ex-

pand directly in proportion to the growth in population and in the economy. He says that despite the perception that growth in Canada will go into decline as the baby-boom demographic bulge passes, the reality is that Canada’s population will grow by 3.2 million during the 1990s, 300,000 more than during the 1980s. “Those are good numbers,” said Muzyk. “People just don’t realize it.”

That enthusiasm for real estate is touching other investors, as well. For his part, Ira Gluskin, a Toronto investment manager and former real estate industry analyst, says that the Canadian market is due for an upturn. “There are always lots of people, who at times like this, will argue that everything is different, the world has completely changed, and that real estate will never come back,” notes Gluskin. “It’s all nonsense. I love real estate.” Despite his enthusiasm, Gluskin and other experts recommend selectivity and caution. Adds Royal LePage’s Burgos: “It’s no place for amateurs. For a while in the 1970s and 1980s, it seemed like everyone was getting into real estate. The industry suffered for that. These are sobering times. Even the pros are being very careful about what they do.” If that attitude had prevailed 10 years ago, the hungry investors who gathered in Calgary to pick over the bones of Trizec might have got more satisfaction.

BRENDA DALGLISH

JOHN HOWSE