www.globeandmail.com

The Globe and Mail
leaftheglobeandmail

  Real estate looking risky

BENJ GALLANDER and BEN STADELMANN

Friday, June 16, 2006

What seemed to be an endangered species has made a dramatic comeback on the streets of Toronto.

Colourful signs in desirable neighbourhoods beckon "Bright Suites," "Open House," "Near Cycling Paths," "Steps to Subway." These aren't the ubiquitous notices for condo sales, but for rental apartments.

Vacancy rates in the city were very low for over a decade, with long waiting lists at many buildings. Though some politicians credit the removal of rent controls for spurring new construction, the number of buildings that have gone up specifically for rentals has been modest.

A key reason for those empty apartments is that people, instead of continuing to pay high rents, have moved up to ownership, taking advantage of low mortgage rates, the lure of rising property values, and new housing choices in both the city core and suburbia.

There are other signals that the Toronto real estate market is cooling. Realtors love it when sellers underprice their properties, setting off frenzied bidding wars that sell houses quickly and reliably. From what we hear, those clusters of half a dozen frenzied buyers have given way in many cases to one or two more cautious parties.

On the commercial side of the business, it was interesting to note that property developer Trizec (a former member of our portfolio) is selling out for $4.8. billion (U.S.). Trizec chairman Peter Munk cited some "buy-low, sell-high" advice from his grandfather: "There's room for bulls and there's room for bears. But there's no room for pigs."

For those who believe as we do that the North American real estate boom has topped out, and remember the spectacular crashes of Bramalea, Cadillac Fairview and Olympia $ York in the early 1990s, one might wonder if now is the time to make on the short side.

It's an appealing idea, but one must be wary of potential takeovers by deep-pocketed equity and pension funds. Trizec is being bought out by a combo of Brookfield Properties and the private investment firm Blackstone Group, and something along those lines could happen to other shorting candidates.

Ski operator Intrawest of Vancouver is another property developer that appears to be at the top of its cycle; the stock, badly battered to the $16 (CDN) level in 2003 has marched smartly to a recent high of $41.94 before easing back to about $35.

But the numbers under the hood don't look healthy. Despite rising revenues, profits have been spotty, and with nearly a billion dollars in debt, and trading at book value ratio of 1.5, the company appears to be very fully valued, if not overpriced.

However, hedge fund Pirate Capital owns 16 percent, and estimates that a complete sale could fetch $45 (U.S.) a share. That sounds awfully high, especially considering that vacation properties tend to get whacked in a recession, but the pirates might find the treasure trove they seek.

Arlington, Virginia-based mall developer Mills Corp. looked like it was in big trouble in April when it violated debt covenants and slashed its dividend by 60 percent. Over the past couple of years, profits have been restated three times and the company is the target of shareholder lawsuits, not to mention a formal U.S. Securities and Exchange Commission investigation into its accounting practices.

You might think that that combination would make the enterprise toxic for investors, but the stock has actually rallied since then. Hedge fund Farallon Capital has scooped up a 6.5 percent stake, and another major hedgy, Stark Capital, has picked up another 8.7 percent.

The company also succeeded in nailing down $1.91 billion in financing from Goldman Sachs to keep the wolf from the door.

Do these hedge funds know something about the real estate cycle that completely eludes us? Perhaps. But we're content with sticking to the same side of the fence as Peter Munk's grandpa.


back