Despite early signs of recovery in the economy, the commercial real estate industry continues to struggle and investors in the sector should remain cautious, new research by PricewaterhouseCoopers finds.

According to PwC, commercial real estate is facing increasingly challenging conditions. These include tight industry-lending conditions, a lack of investor appetite for commercial mortgage backed securities, expectations for higher capitalization rates which imply decreased valuations, and financial weakness amongst tenants.

“The credit crisis and ensuing recession have dragged commercial real estate markets into very trying times, marked by value losses, rising foreclosures, and reduced property revenues,” said Frank Magliocco, partner and leader of PwC’s real estate practice in Canada. “There is simply scarce money and therefore limited buyers.”

As weakness in the industry continues to prevail, Canadian investors should be cautious of certain aspects of commercial real estate, according to PwC. For instance, real estate in rural and industrial areas or small- to medium-size strip malls typically carry higher risk than properties in large urban centers or iconic mall spaces, the company notes.

In addition, PwC says investors should be wary of property types such as hotel and leisure, suburban offices and industrial space, which are considered to be more vulnerable to the downturn than other types.

PricewaterhouseCoopers also warns that a large cohort of commercial real estate leasors and renters are facing significant financial or operational challenges. Among flagship tenants, such financial distress carries especially high risk.

“Owners need to immediately implement monthly or quarterly cash flow reviews to understand exactly what their short-, medium- and long-term capital needs are and, perhaps even more importantly, immediately identify what options are available to overcome inevitable refinancing hurdles,” said Magliocco. “In some cases, a formal restructuring process, equity injection or other non-traditional strategy may be beneficial.”

Furthermore, PwC says certain real estate owners should consider divesting non-core or underperforming properties as a means to generate cash or capitalize on growth. On the other hand, the company suggests that well-capitalized investors may want to see if value can be extracted from the downturn via opportunistic acquisitions.

IE