Market and property risk

Demand, supply, and general economic conditions can move against a specific building, reducing its income, its value, or both — market and property risk covers these ways a holding can lose ground. Commercial real estate values and income depend on the demand for space in the specific markets where a property is located. This risk is present in every commercial real estate holding, including each of the Direct-Hold Solutions, and is not eliminated by any element of the corporate or financing structure described elsewhere in this wiki.

Vacancy and rent risk

A property generates income from tenants paying rent under lease agreements. If a tenant does not renew at lease expiry, or defaults during the lease term, the property loses income until a replacement tenant is found. The time required to re-lease space, and the rent achievable on a new lease, depend on local market conditions that are outside the company's control. A market with rising vacancy or falling asking rents can reduce a property's net operating income even where the property itself is well maintained and well managed.

Because a direct-hold vehicle's Interest Coverage Ratio is calculated in aggregate across every property it holds, a sustained decline in net operating income — whether concentrated in one property or spread across the vehicle's portfolio — reduces the vehicle's capacity to raise additional secured debt under the 1.20× covenant. This is a consequence of vacancy and rent risk working through to the vehicle's borrowing capacity, not a separate risk in itself, and it is not confined to any single property's distributions.

Property value risk

Property values are estimated through appraisal methods that rely on comparable transactions and capitalization rates observed in the market at a point in time. Capitalization rates move with interest rates, investor demand for real estate, and the perceived risk of a specific asset class or location. A rise in market capitalization rates reduces the appraised value of a property even where its income is unchanged. Because Investment Units are asset-specific, a decline in the appraised value of one property affects only the units referencing that property.

Tenant concentration risk

A property leased to a small number of tenants, or to tenants concentrated in a single industry, carries greater income volatility than a property with a diversified tenant base. The loss of a single major tenant at a concentrated property can have a proportionally larger effect on that property's net operating income than the loss of one tenant among many at a diversified property. The professional centre and commercial building formats that the Direct-Hold Solutions are designed around are intended to support a diversified tenant base, but tenant concentration risk cannot be eliminated entirely at any individual property, particularly during initial lease-up.

General economic conditions

Commercial real estate demand is sensitive to broader economic conditions: employment levels, business formation and closure rates, consumer spending patterns, and the general health of the economy in each market where a property is located. A regional or national economic downturn can reduce demand for commercial space across a market generally, independent of the condition of any specific property. As the Direct-Hold Solutions are established across their planned four jurisdictions, exposure to general economic conditions is intended to be distributed across multiple national economies; today, only the established Canada vehicle exists, so this diversification benefit does not yet apply. Once realized, this distribution reduces correlation risk — it does not eliminate the underlying exposure to economic cycles in each market.

See also

• About risks — how risk categories are organized across this wiki
• Financing and interest rate risk — how market conditions affect financing availability
• Development and construction risk — pre-leasing risk during construction
• Commercial real estate financial metrics — definitions of net operating income and capitalization rate