Commercial real estate and facing high costs | RENX

(Image courtesy: MNP)

Inflation, interest rate hikes, labor shortages and a possible real estate downturn on the horizon — 2022 has not been an easy time for Canadian real estate. If you’re a commercial real estate owner or decision maker, you’re likely facing higher costs now while dealing with economic uncertainty in the future.

Some of the circumstances you face are beyond your control or unavoidable; but there are steps your business can take to weather the storm with resilience and possibly outpace your competitors on the other side.

The short game

Future-proofing your business is a long-term game, but some of the hurdles your business faces are already there. What can you do today and in the short term?

First, you can examine your cost structure. Revisit and review your existing contracts and agreements with the aim of spotting opportunities to reduce or delay costs. Here are some questions to ask yourself during this process:

– Sales contracts: What’s in it and what are the terms? Is there flexibility in the contracts to reduce your costs?
– Rental and lease contracts: Which of your costs can be passed on to tenants and which cannot? How many of your leases are up for renewal and how likely are they to renew at a different rate? Do you charge the market rate in your location for rent, and if not, do you have market rate adjustment clauses in your agreements?
– Creditor or loan agreements: Are you working with lenders who offer you the best possible terms, or is there an immediate financial benefit to switching? In this era of rapid rate increases, can you negotiate a lower rate with your lenders?

Next, and this principle applies to all businesses, not just real estate, look internally to spot inefficiencies in your business model. Cutting costs and increasing income aren’t the only strategies for dealing with inflation, there are probably ways to do more with what you already have. For example, are there opportunities to increase productivity and reduce wastage of your labor, or to review your capital and funding structure?

Auditing your agreements and business structure requires an immediate investment of time and resources, but those who do fare better in the long run.

Finally, you can bridge the gap between long-term and short-term strategy by setting aside time in the near future to plan scenarios. The scenario planning itself will take place over several years, but there’s no better time than the present to begin.

The long game

The truth is that even with the best possible short-term strategy and execution, rising costs are inevitable. Rising labor costs, interest rate hikes totaling hundreds of basis points in a single year, and a six to seven percent inflation rate will squeeze revenue regardless of your past performance or preparation.

But that shouldn’t stop you from planning or being proactive. In all likelihood, events since 2020 have already prompted you, to some extent, to look ahead and assess what your greatest risks and sensitivities are.

Many of the decisions you will make and the options available to you will depend on where your properties are located. For example, those in areas with lower demand for commercial space and higher vacancy rates will have less leverage to pass on increased costs to customers.

The most successful real estate and commercial real estate groups have very detailed cash flow forecasts, where they plot the next five or ten years based on their current lease or rental agreements. They perform a pro forma cash flow analysis that takes into account various possible scenarios. They undertake a lot of contingency planning and sensitivity analysis.

Cash flow will be the biggest difference maker in the uncertain times ahead. If you have access to significant credit facilities or equity, you won’t need to be so reactive to immediate changes and crises.

Navigate the road ahead

As your biggest expenses increase, your attention to detail about your business should increase accordingly. Headlines will attempt to predict and project the future of Canadian real estate, but whatever happens, your decisions will affect how you weather the good times and the bad.

You don’t have to navigate the road alone. MNP’s senior advisors can help you look under the hood of your business and assess the best path forward.

To find out more, contact:

Cary Frank | Partner, Real Estate & Construction | 604.637.1552 | [email protected]

Yohan Thommy | National Leader, Performance Improvement | 905.247.3254 | [email protected]

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