An interview with Adam Paul, President and CEO of First Capital Realty Inc.

Fuller Landau team • July 06, 2017

With a constant barrage of media coverage on an impending housing bubble, a significant cap rate compression across most asset classes over the past five years, a shift away from suburban sprawl, and a noticeable change in consumer retail preferences, the real estate development industry in Canada is in a state of transition. We sat down with Adam Paul, President and CEO of publicly-traded First Capital Realty Inc., to get some insight on what’s going on in the industry.

First Capital is a leading owner, developer, and manager of grocery anchored, retail-focused, urban properties in Canada, where people live and shop for everyday life. Adam has served at the helm of the company since February, 2015, following his previous role as executive vice-president of investments and leasing for Canadian Real Estate Investment Trust. First Capital currently owns interests in over 160 properties, with more than 25 million square feet of gross leasable area and an enterprise value in excess of $9 billion.

With a track record of delivering strong financial and operating results in the highly competitive Canadian commercial real estate market, Adam offered some great insight. Here’s what he had to say:

Fuller Landau (FL): There has been a great deal of press regarding a housing bubble. If the bubble bursts, how would it impact the demand for the types of services provided in your properties?

Adam Paul (AP): The bubble has been bursting for 15 years! Kidding aside, First Capital is a retail-focused company and does not invest in stand-alone residential projects, but we do look closely at the housing environment. In urban centres across Canada, a lot of high-density residential properties have been built which is where our portfolio is located, so we are talking about our primary trade areas. The reality is that this inventory is occupied. That gives us a lot of comfort with respect to our decisions around a potential bubble. If the properties weren’t occupied, we’d be concerned. If you look at Canada’s major cities, the population growth in urban centres is very strong so this appears to be a demand-driven market. Notwithstanding all the housing that has already been built, it still hasn’t been enough. Based on the data we’ve seen, it’s demand that’s driving the increased value in residential properties.


FL: What is First Capital’s wheelhouse? How does your recent development project in Yorkville reflect your core strategy?

AP: At First Capital, our expertise is in urban retail properties. Given the urban nature of our portfolio, mixed use is the natural evolution for our assets. That being said, residential development projects are always ancillary to retail, meaning they are situated in close proximity and in some cases on top of a meaningful retail position for us. When it comes to retail, the closer the customers, the better. To have them living right on top of the stores works, if the project is planned and designed well. Easier said than done, of course.

Our capital is invested in markets where the demographics are robust. We look for high density and household income, a growing population, and visible barriers to entry for new retail supply. Over time, this results in higher sales per square foot for our tenants and consequently higher rents than the industry average. The Yorkville area is very unique. It’s one of the only places in Canada where you find such a compelling combination of both high density and household income. Based on the high density residential projects that are under construction or approved and planned, we expect the population of the Yorkville area to double over the next 7 years or so. We are well-positioned in the retail landscape to benefit from this growth as our single largest position is in this area, where we have $600 million invested. In addition to our core strategy of grocery, pharmacy, fitness, etc., we always extend the strategic merchandising mix to meet the demands of the specific demographic. In Yorkville, this has resulted in a high-end, luxury brand offering as part of our mix.

First Capital’s core investment in the Yorkville area was the redevelopment of the mall, formerly known as Hazelton Lanes. In addition to offering a curated mix of both established and first-to-market brands, like Whole Foods, Equinox, Soul Cycle, TNT, and Palm Lane by the Chase Hospitality Group, among many others, we are evolving the mall into what we call the “Luxury Culture House” of Yorkville. We have a significant events program in place, with over 50 events planned for 2017. Thousands of people attend the events, which are all based on themes that tie back to the arts, fashion, culinary, or lifestyle and fitness.


FL: How does First Capital address the fierce competitive retail landscape?

AP: Our strategy is to bring people into the property by offering more than just a collection of shops. This is what we’re looking to do across the board for all our projects. When it comes to retail, what used to be good enough in the past, won’t be in the future. You need to offer more. We’ve done a lot of work to elevate a shopping centre from just an assortment of stores to a vibrant retail environment – an experience for people who live or work in the area. With so many online retail options, people need more reasons than ever to come out to a physical retail location. Our goal is to create a “sense of place” where people enjoy spending time.  Given the density around our centres, the fundamentals for retail based on this approach are very compelling and should result in the value of our space continuing to escalate over time, well above the industry average.  We have also merchandised our assets with necessity-based retail which includes goods and services that people buy, regardless of the economic climate.


FL: E-commerce has been a great disruptor for the retail industry. How has it affected the strategic marketing mix for your development projects?

AP: We have a lot of discussions internally at First Capital about how we merchandise our properties, especially in the face of e-commerce. We believe that the strongest retailers will have a presence in both the physical and digital worlds, not just one. A physical store-front is becoming a very important part of most online retailers’ customer acquisition and market strategy.

Having said that, we are very strategic with our tenant mix. 35% of our total retail offerings (total rent) are “e-commerce-proof” categories. In other words, you can’t purchase these products online. This includes fitness clubs, medical offerings like dentists and doctors, day care facilities, restaurants, and coffee shops. Our retail offerings in this category make up a much larger percentage of our overall marketing mix than it did five or ten years ago. Another 27% of our total income is generated from pharmacies and grocery stores. They are not totally e-commerce proof, but we believe that the physical store presence continues to be the main driver of their business. Then there are a bunch of other offerings, like cinema and dollar stores. These are all internet-resistant uses. Overall, roughly 90% of our total rent comes from “e-commerce-resistant” categories, and given the quality of our real estate, we are well-positioned to prosper as trends in retail evolve.


FL: Another change of the times comes from a shift in preferences brought on by the younger generation. How would you describe this shift, and is our infrastructure equipped to handle it?

AP: We’re in the midst of a secular shift towards urbanization across Canada (and the world), and it’s still in the early stages. If you look back in time to the 1960’s, it was the opposite. Back then, there was a shift to suburban sprawl. Highways and communities were built up to facilitate the outward expansion. Today, the younger generation has different priorities. They don’t feel a sense of pride or status in owning a piece of real estate or a fancy vehicle.  But they’ll spend a significant amount of money on a trip or the newest smart phone or a unique food experience. They take pride and are most focused on experiences, so they’re willing to spend a lot of money on food, travel, entertainment, and technology.

This is a big shift that will play out for many years to come. The population will continue to grow in major cities, because they are great places to live and that’s where people want to be. The younger generation really buys into the concept of “work/play/live,” and we’re well-positioned to fill part of that demand.

In terms of infrastructure, it definitely makes sense and is more efficient to invest in urban centers rather than suburban areas, but we’re playing catch-up. Here in Toronto, it’s reassuring to see that there is some investment being made in public transit, and the city’s policies are generally supportive of increased density. It’s a real issue that needs to be addressed and it seems that it’s now become a higher priority.


FL: Over the past 5+ years, there has been significant cap rate compression across most, if not all, asset classes. What is your outlook on cap rates and interest rates, in general? More specifically how does that outlook impact on your asset class in the near term?

AP: The average rent in our portfolio has gone up every single quarter, for many years. If I could give a credible answer on interest rates, I’d be in a different job, so I won’t even try! If you look at our debt strategy at First Capital, it’s reflective of the fact that we are not betting on where interest rates are going. Our debt maturity profile is well-staggered over 10 years, with all of our term debt being fixed rate, to mitigate the risk of any volatility in interest rates.  As well, we have a significant buffer between in-place interest rates and market interest rates so we can absorb a large increase in rates before it has a negative impact on our earnings.

As for cap rates, they are a little tricky. Bifurcation is something we are seeing. For urban retail assets, we are competing with more foreign capital then ever before and cap rates appear to be heading lower, meaning values higher. Cap rates are stickier, meaning they are not as correlated as they used to be for that type of product. Based on trades being done in the market right now, I believe there is a stronger likelihood for cap rates on our type of assets to go down rather than up, and there is evidence that this will continue over the short term. In other retail asset classes, that may not be the case, though.


FL: There have been a lot of insolvencies in the retail space, recently. What impact does this have on your own assets?

AP: We’ve considered this quite a bit, at First Capital. The media has been very active of late, particularly in the US, and the narrative is overly pessimistic versus what we’ve seen happening on the ground. Bifurcation is the right word to describe retail, today. Even in the mall space, which reportedly is taking the brunt of the damage, sales are higher than they’ve ever been before and traffic is still very strong. Canada’s largest retail malls are getting stronger and have never been more productive. A different scenario is playing out in many US markets.

At First Capital, we don’t operate in the mall space, but for our projects, we continue to do new deals at the highest rents we’ve ever achieved, especially on our new developments. This is because retailers are under represented in the urban markets, and as a result, our tenants can generate higher sales out of these spaces. Most of our tenants are in expansion mode: grocery stores, pharmacies, coffee shops, liquor stores, fitness clubs, and daycares. Those categories are expanding in the markets we’re in. So, the fundamentals in Canada’s largest urban markets are sound.

But anecdotally, I would say assets that are secondary in quality or location are having a tougher time. This is not an area in which we invest. In fact, we’ve sold over $1Billion of real estate over the last five years which included some of these types of assets. Target is an interesting example. The best locations previously occupied by Target were taken up relatively quickly and represented an opportunity for landlords. The secondary Target space that is left over is going to struggle with few, if any bids, for the space. These secondary markets don’t have barriers to entry for retail product and the population growth is slower than in the urban cores. So generally, we’d be advocates of divesting that type of real estate. The worst investments I’ve made in my career have been when I got a good deal on something, and I suspect you could get a “good deal” on inferior real estate today.


FL: Looking forward to the next years, what are the biggest threats to remaining competitive and how do you mitigate this risk?

AP: In my opinion, complacency is our biggest threat as a sector. This is a young industry in Canada, and as a whole, we have to be more innovative than we have been in the past. The world is changing at a much faster pace than ever, but real estate is generally a slow-moving business. Nothing major happens to a property in a few months. It’s a slow rot when a property is going downhill. And if you ignore it, you can wake up in real trouble. So, our biggest threat is not being proactive or understanding what’s going on in the world, and failing to anticipate or respond. We mitigate this at First Capital by being proactive and embedding innovation in our corporate culture. We carve out time as an executive group to focus on it, specifically, by looking outside of Canada and what is going on in addition to what we see here. We travel around the world to see what other landlords and retailers are doing, and how new concepts are evolving. We bring our ideas back to Canada and implement some of them here, for the first time.


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