The deals appeared to promise a period of vitality for Canada's largest real estate developers. First, in early March cash-rich Trizec Corp. of Calgary, the second-largest real estate developer in the country, with $3 billion in assets, announced that it had agreed to buy control of Brama lea Ltd., a Toronto-based developer, for $60 million in cash and a $100-million loan. Then, last week privately owned Olympia & York Developments (O&Y) of Toronto, which ranks first in the in dustry with $13 billion in assets, created a stir among financial analysts when it arranged a $1-billion (U.S.) mortgage-
the largest in North American history—for three of its buildings in Manhattan. Those events marked a renewed vigor among the real estate giants after the setbacks of the recent recession.
But the future of the companies and that of the industry itself were thrown again into uncertainty last week by rising interest rates. Warned Michael Allen, an analyst with Toronto-based Davidson Partners Ltd.: “A major rise in interest rates will hurt the whole industry.”
Analysts agreed that the jump in the major banks’ prime lending rate last week by half a point to 11.5 per cent will not seriously affect the fortunes of the development firms. However, if the lending rate rises by a full two percentage points or more by
year’s end, as some experts predict, the damage could be significant. At that level the cost of money could force otherwise financially sound companies to rein in their future growth plans. At the same time, several firms that have not recovered from the devastating effects of the recession would find their ongoing fights against bankruptcy increasingly difficult to wage as demand for housing dries up and financing costs soar. Currently, the only consolation for such struggling firms as Vancouver’s Daon Development Corp. and Calgary’s Nu-West Group Ltd. is that interest rates are not expected to rise to the astronomical 20-per-cent-plus levels of the recession.
The possibility of renewed hardship from escalating interest rates comes at a time when many real estate firms have not recuperated from that recession. The downturn was a miserable experience for Canadian developers, who had expanded at a dizzying pace across North America in the previous decade. Their growth was fuelled by the belief that inflation was endless and would make even unsound deals profitable as land prices and rents soared. Firms such as Nu-West, Daon and Cadillac Fairview of Toronto accumulated residential properties rapidly, buying up housing, apartment units and acres of land. The companies financed some of their moves with floating-rate debts, which rise and fall in tandem with prime lending rates. But when the recession struck, the firms found themselves loaded with properties that spun off little or no profits, and, as interest rates soared, their huge debt loads became unbearable. To survive, many were forced to sell off
residential properties as quickly as possible, cut overhead costs drastically and overhaul their management strategies.
Cadillac Fairview was typical of the land-hungry companies. Between 1977 and 1982 it swelled its U.S. real estate assets to $1.3 billion from $100 million and boosted its Canadian assets to $1.6 billion from $1.2 billion. Cadillac president Bernard Ghert now believes the company was out of control during that period. Said Ghert: “Management was not concentrating on the things it could do well. We were into housing, condos and apartments—buying land in a helter-skelter fashion and financing it with short-term debt.” Company chairman Leo Kolber is more blunt. “Our prob-
lems,” he told Maclean’s, “were caused by an abiding faith in inflation and greed.” A crisis hit in late 1981 when Cadillac found itself saddled with $1.6 billion in floating-rate debts at a time when interest rates were rapidly escalating. The company took drastic action to turn its fortunes around. Most importantly, it put more than half of its $3 billion in assets up for sale in an attempt to get out of the residential market completely and concentrate on shopping centres, office buildings and other income-producing properties. To date, it has sold $1.9 billion worth of assets. Now, with its profits and cash flow restored, Cadillac has $1.3 billion worth of projects either just completed, under way or in the planning stage.
Campeau Corp. of Ottawa also expanded aggressively in the housing market. But it, too, managed to restore its health by selling off residential assets. Last year it put about $800 million worth of assets up for sale and, so far, has managed to dispose of about half of it. In the process Campeau has managed to reduce its debt load to under $1 billion from $1.45 billion in 1982. At the same time, profits have improved, rising to $15 million for the nine months ending Sept. 30,1983, from $3.6 million for the same period in 1982.
Trizec and O&Y survived the recession well because they had limited debt loads and little or no exposure to residential markets. O&Y’s private owners, Paul and Albert Reichmann, are secretive about the firm’s future plans. But Trizec president Harold Milavsky told an annual meeting this month that the company’s healthy earnings and cash flow will enable it to undertake an active acquisition plan. Still, extended high interest rates could sour the growth of the developers as long-term financing becomes more costly and difficult to obtain.
But for several companies still mired in debt and heavily involved in residential markets, the impact would be more immediate since they are already in fragile condition. Daon is still trying to win approval from its bankers for a refinancing plan for a more than $l-billion debt load. At the same time, Calgary’s Nu-West Group will seek shareholder approval in June for a plan that would reschedule its debt of more than $1 billion.
Harry Rannala, an analyst with Merrill Lynch inToronto, says those rescheduling plans will not be jeopardized since they are near completion. But, because the firms are involved in residential real estate, said Rannala, “they will be hit by a double whammy.” For one thing, he explained, “if house buyers believe interest rates are too high, they will back off, and the firms will have difficulty selling their product.” For another, he said, residential developers tend to carry more floating-rate debt than companies involved in commercial projects because it is very difficult to raise fixed-rate loans on land, which is a volatile commodity. As a result, increases in financing costs would soon match rises in interest rates. Said Rannala: “If interest rates rise by more than two per cent, the residential market will be stopped dead in its tracks.” For such firms as Daon and Nu-West, that would cause serious problems, even if their refinancing plans are approved. Declared Rannala: “I do not think it is a question of survival for them, but they will have to work very hard in the next
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