What seemed to be an endangered species has made a dramatic comeback on the streets of Toronto. Colourful signs in desirable neighbourhoods beckon with "Bright Suites," "Open House," "Near Cycling Paths," and "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 more than 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 the empty apartments are people paying high rents who have moved up to ownership, taking advantage of low mortgage rates, the lure of rising property prices, and new housing choices in both the city core and suburbia.
There are signals that the Toronto real estate market is cooling. Real estate agents love it when sellers under-price their properties, setting off frenzied bidding wars that sell houses quickly and reliably. From what we hear, what was once half a dozen frenzied buyers have often been replaced with one or two more cautious parties.
On the commercial side of the business, it was interesting to note that property developer Trizec Canada Inc. (a former member of our portfolio) is selling out for $4.8.-billion (U.S.). Trizec chairman Peter Munk attributed some buy-low, sell-high advice to 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 thing to be wary of are potential takeovers by deep pocketed equity and pension funds. Trizec is being bought out by a combination of Brookfield Properties Corp. and the private investment firm Blackstone Group, and something along those lines could happen to other shorting candidates.
Ski operator Intrawest Corp. of Vancouver is another property developer that appears to be at the top of its cycle. The stock, badly battered to the $16 (Canadian) level in 2003, has marched smartly to a recent high of $41.94 and eased back to $34.95. But the numbers under the hood don't look healthy. Despite rising revenue, profit has been spotty and, with nearly a billion dollars in debt and trading at a book value ratio of 1.5, the company appears to be very fully valued, if not overvalued. However, hedge fund Pirate Capital owns 16 per cent, and estimates that a complete sale could fetch $45 (U.S.) a share. That sounds awfully high, considering that vacation property tends to get whacked in a recession, but the pirates might find the treasure trove they seek.
Arlington, Va.-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 per cent. 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-per-cent stake, and another major hedgy, Stark Capital, has picked up another 8.7 per cent. 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.
Benj Gallander and Ben Stadelmann are co-editors of Contra the Heard Investment Letter. This column first appeared on GlobeinvestorGOLD.com.