Property Biz Canada: Deferred Capital Expenditures Impediment to Multi-Residential Deals

Property Biz Canada (Sept 2011) – Paul Brent from Property Biz Canada Magazine interviewed Jason Castellan, CEO & Co-Founder of Skyline, regarding deferred capital expenditures that impede multi-residential deals.  To read the full article please click on the title above.

A major impediment to multi-residential deals is proving to be deferred capital expenditures as neglected repairs and upgrades result in wide valuation gaps between owners and prospective buyers.

“We have had deals fall apart because the vendors just can’t wake up or realize that they have neglected it so long and it is so much money” to repair,” said Jason Castellan, chief executive officer of Skyline Apartment REIT. In some cases, the wakeup call from a prospective buyer’s engineering report causes a buyer to pull a property off the market. “They will just keep it or refinance it and then go ahead and do the work.”

Castellan, who is taking part in a panel at the CAIC September meeting discussing the deferred capex problem, said he is currently in the midst of a $10-million deal that is deadlocked on a $1.4 million garage repair. “That’s 15%” of the purchase price, he said. “They still want us to pay $10 million and then we have to go deploy another $1.5 million to bring it up to snuff? You can’t charge more rent for something that has to be there.”

In his experience, it is deferred maintenance and repair to the outside of buildings that is an issue. Those are often important safety and liability concerns that need to be addressed but are not always upgrades that tenants appreciate or are willing to pay for in the form of increased rents.

“You can do above the guideline increases to do those repairs but tenants are paying you rent and they want to see value for it,” said Castellan. “They don’t mind as much seeing an above the guideline increase on new carpets in hallways and new things to their units that they experience and make their homes more cosmetically friendly. But if you are putting a new roof on that needs to be done, they expect that.”

Typically, those “cosmetic” interior changes are not what prospective buyers are facing. “It is a lot of concrete, a lot of balconies, the outer envelope of the buildings,” he said. “There still is interior stuff too but that capex is more what you would call cosmetic than functional or structural.”

The observation that many multi-res owners are facing major capex spending is echoed by fellow CAIC panel Aik Aliferis, a principal of Primecorp Commercial Realty Inc., who said: “Some people have to spend a lot of money on their buildings to keep them going forward, those guys have to make a decision: do I invest more capital or do I just take my gains and move on?”

The Skyline REIT president notes that “no building we ever buy is perfect” but estimates about half of multi-residential purchases require “substantial” capital expenditures upon closing and that the REIT has walked away from a “handful” of deals because the gulf on capex requirements between it and the seller were too great.

“It’s a function of the previous owner, taking it all and not putting in what they need to maintain the value,” Castellan said. “These owners don’t do those kind of things so they get spanked on the value.”

The Skyline president said the “prudent buyers” he competes against are experiencing the same capex concerns with regard to the acquisition of established properties. “There is no rocket science, there are so many systems in the building that you have to look at and maintain and we all do the same work.” In the end, “you make the decision on whether you are going to pull the pin on it and make the deal or walk away.”

Castellan had just got off a conference call with his fellow panellists (including representatives from MetCap Living Management Inc., Realstar Management Partnership and Carson Dunlop Weldon & Associates Ltd.) and said there was consensus regarding the issue of capex underspending among multi-residential sellers that they all encounter. “There is no magic to this business. One does it, we all do it, it is all the same, we just do it our own way a little bit differently.”