Government Operations Committee on May 1st, 2007

[Prof. James McKellar]

That's a good question. Let me comment.

This goes back to the issue of public perception. Normally buildings are sold on a commission basis. The public may ask whether you can really depend on the advice of people who are going to be compensated on the basis of a percentage of the sale.

It's a tough one. I don't know how they structured that; apparently it went out to a proposal call, etc. Certainly it is a good question. It's one that's going to be raised and is deserving of a good answer.

I don't have the answer, but certainly it's a question that I think would continue to come up: what is the motivation of the people who are giving the advice, and the objectivity? I'm not questioning their objectivity, but I'm saying there may be that perception.

[Peggy Nash, NDP, Parkdale—High Park, ON]

You said that when you were at Ontario Realty Corporation there were a number of buildings sold, and you were overseeing on that occasion. Was the entity that assessed the buildings and advised you on that aspect the one that conducted the transaction?

[Prof. James McKellar]

Well, this is strange. When I took over, I had to manage a forensic audit that turned up all sorts of nonsense. As a result of it, I told the board that it should never have asked for appraisals, because in every case those properties were sold at prices well below market—there was an appraisal saying it was worth such and such.

You have to realize that appraisals are a best guess. In the end, what's more important is the process you go through and the ability of the market to really price it.

[Peggy Nash, NDP, Parkdale—High Park, ON]

Did you use the company that did the forensic audit and the appraisals to do the sale?

[Prof. James McKellar]

I have to tell you that many of the appraisals I read were not worth the paper they were written on.

[Peggy Nash, NDP, Parkdale—High Park, ON]

You didn't hire those people to do the actual sale for you, then.

[Prof. James McKellar]

No. Appraisal itself is a separate profession.

This was certainly a case where people, I think it's fair to say, were committing fraud, or were duping people. But the people who actually put a value on something are doing nothing more than valuing the lease. They're basically taking net operating income and dividing it by what we call “cap rate” in the industry and are saying “It's worth this”. You can do it on the back of an envelope. Just tell me what the lease is and I can tell you the price, without 25 pages.

[Peggy Nash, NDP, Parkdale—High Park, ON]

Just on that, let me ask you another question, because it's great to have someone of your expertise here to help us understand this.

One of the issues you raised, which is a reason to sell, is maintenance and upkeep of the buildings. It strikes me as quite irresponsible that moneys were not adequately set aside to do that kind of maintenance. Nevertheless, we are where we are right now.

My question is, where will the money come from to do that upkeep and maintenance—as you say, the retrofit—of many of these buildings? They are 30 or 40 years old; they're probably big energy guzzlers. Will this be covered in the lease agreement as part of the moneys that government spends over time?

[Prof. James McKellar]

That's right. What will happen is, someone will buy these buildings, they will do a study of what it would cost to bring them up to scratch, they will borrow that money, and they will amortize those costs over the period of the lease.

The first comment is, isn't their money going to cost more than your money? I hate to say it, but in real estate today you can get money at a rate that isn't much above the rate government is borrowing at. It is kind of silly, but—

[Peggy Nash, NDP, Parkdale—High Park, ON]

Could I just ask about that? If the government is going to be paying, through the leases, for the retrofit and the upkeep and so on, why wouldn't the government borrow its own money, do that retrofit and upkeep, amortize it over a period of years, and at the end, own the building, which is now upgraded and presumably worth a lot more?

[Prof. James McKellar]

They could do that, but they've never shown any inclination over 40 years to do it. It would be startling news if they said they were willing to. But there's no government in the world willing to borrow money to fix up their buildings.

[Peggy Nash, NDP, Parkdale—High Park, ON]

Maybe Canada's new government will do that.

[Prof. James McKellar]

Furthermore, why should they? A good question is why you would borrow money to fix buildings when in fact we may borrow it for infrastructure. We may have to borrow it for other reasons.

[Garth Turner, Conservative, Halton, ON]

Buildings don't vote, though.

[Peggy Nash, NDP, Parkdale—High Park, ON]

Do I have time for one last question?

I'm from Toronto, and the real estate market there has been going up and up. Every so often I meet somebody who says, yes, we sold, and we're going to rent for a while. And every time they do that and want to get back in, they're kind of priced out of the market.

You may say, well, that's fine, that Canada never wants to get back into the market. But when these leases expire, presumably new leases will have to be struck, except we won't have the assets to bargain good rates, assuming we get some.

[Prof. James McKellar]

Again, you can build into your agreement how you factor in what I would call the residual value. My guess would be that over a 25-year period, the value may be more in the land than in the improvement itself. But you can build that in. You could have right of first refusal.

[Peggy Nash, NDP, Parkdale—High Park, ON]

We could be in a weaker position in negotiations, though.

[Prof. James McKellar]

It depends on how you structure the deal. For example, let's say you structure the deal in such a way that you don't take all the cash up front. In fact, you use some of that to get a lower rent. So there are ways you can offset that in structuring the deal. That's why I keep saying to go back to the details. You can certainly offset that risk. It may occur in 25 years. In 1991, you could buy office buildings in downtown Toronto for $90 a square foot, as some wise people did.

Real estate goes up and down. I'm not a believer that it continues to go up. I think whether you go for 20 or 25 years is a good question. Some people may say there's a tipping point, and if you know you're going to be there for 25 years, but you may be there for 50 years, why sell it? It's like leasing a car. Do I buy or do I lease? Well, if you're going to keep it for three years, lease. If you're going to keep it for longer, buy.

So there are technical questions that could be looked at.

[The Chair, Liberal, Diane Marleau]

We'll go to Mr. Turner.

[Garth Turner, Conservative, Halton, ON]

Thank you.

It's a pleasure to have you here.

Our job on the committee, at least on this side, is to assess whether or not this is a good deal for the taxpayers. In order for us to do that work, it becomes necessary for us to know certain information, as you have alluded to in your discussion so far.

Could you give us the sort of top five things we should be looking for to determine whether this sale and leaseback is a good deal for the taxpayers, from a financial standpoint? What would you be looking for? What would you be asking for if you were sitting on this committee?

[Prof. James McKellar]

Let me think.

I would still come back and say this isn't a real estate play; this is a business decision. So the question you would first have to ask is why I need that space, why I need it for 25 years, and why I want to be in this location. So as in any business, the first decision you have to make is a business decision. Do I want to be in this building with this use?

Second, I would then begin to say that if at the moment I believe I'm going to be there for 25 years, there's a lot of uncertainty. There's the impact of technology. I may in fact be using less space in the future, so I'd want to make sure I had some options. And you have to remember that there's a price to be paid. I remember doing a study of the London market. People were willing to pay more for short leases because they felt that in a business, about three to five years was as far out as they could go. So I would be certainly looking for some flexibility over that 25 years.

[Garth Turner, Conservative, Halton, ON]

But I was also thinking, in terms of our ability to assess this as to whether it in fact makes sense to the taxpayers, obviously we need to have an estimation of what the buildings are going to sell for. We need to know what the terms of the lease are going to be, and not just the length of the lease but obviously the....

We need to know the base rent. We need to know the additional rent. We need to know the amortization of any leasehold improvements over that. We need to know what the buyback is going to be at the end, and if there is a buyback, we have a word that there is.

I guess we'd need to know the closing costs. We need to know the commission payable on the sale. We need to know other costs that are involved, would we not?

Are those reasonable questions? Is that knowledge we would require as to whether it's a good deal or not?

[Prof. James McKellar]

I think government would require the same knowledge as any private person undertaking this.

The dilemma you always have is that it's hard to go in with the private sector if everything is going to be negotiated in public. It's always a difficulty. You can't negotiate in public, but there has to be a process by which you are assured that you've had professional advice, it's objective, and you've analyzed those numbers.

[Garth Turner, Conservative, Halton, ON]

Right. But that is reasonable information for us to be asking for in order to understand whether it is in fact a deal the government should do. Correct?

[Prof. James McKellar]

It is. The problem is, when do you ask for it and when do you get it?