The Canadian commercial property market has surpassed its 2007 pre-recession peak and shows no signs of slowing, according to the latest findings of the Q1 2012 Investment Trends Survey and Outlook from Altus InSite.
Based on cap compression rates, the market has moved beyond the prior 2007 top and continues to power forward, driven by low interest rates, a shortage of supply and “discipline” in commercial development. The industry has also shaken off negative global events, such as the European sovereign debt crisis, softening economic outlook in Asia or the US political gridlock.
As a result, there is a continued compression in yields, increasing rents and a run up in values. Altus finds that yields have not yet compressed to the point of investor discomfort and confidence is sustaining.
The major difference between today and 2007 is ultra-low interest rates and little prospect that they will move upwards in the near future. At the prior Q2 2007 peak, the 10-year Government of Canada bond rate was around 4.0% compared with the current rate of 2.0%. “In 2007 financing was available but it was more expensive then it is now to borrow money,” said Marie-France Benoit, a director with Altus InSite. “There is a lot of liquidity and a lot of financing available.”
Cap rate compression slowed in the fourth quarter of 2012 amid the worst fears of the European sovereign debt crisis before picking up again in this quarter, noted Benoit. “In the last quarter we wondered if we hit bottom or was just a pause. Now we know it was just a pause.”
The Altus survey said most asset classes are now beyond the 2007 peak, especially the most sought-after asset classes such as super regional malls and downtown Class A office towers. The one except is industrial properties, which is currently catching up and was one of the most prized asset classes among investors in the Q1 survey. “What it tells me is the industrial is seen as a type of asset that has a lot of upside,” she said. “It was so beaten in the recession it is recovering. Especially in Toronto and Montreal which were really affected by the recession, we see leasing activity picking up and it seems like the worst days are over.” Retail, which was a very popular asset in 2011, has moved down the preference list among investors.
Multi-Tenant and Single Tenant Industrial replaced retail options among prospective buyers, with 9.0 and 6.5 buyers for every seller respectively. Tier 1 Regional Mall (5.0 buyers for every seller) and Food Anchored Retail Strip (4.4 buyers for every seller) have slipped to third and fourth positions respectively, while Downtown Class “AA” Office has moved down to seventh position from number three.
Interestingly, Downtown Office Land maintained a top ten position, underscoring a new office construction cycle in many locations. The largest upward move from the last survey was Multi Tenant Industrial, which moved into number one position from tenth position. The other noteworthy product is Hotels, which moved into positive territory at 1.3 buyers per seller for the first time since the economic crash. Only two asset classes, Suburban Office Land and Suburban Class “B” Office, remain in negative position with more sellers than buyers.
“The respondents expect values to continue to increase, rents are firming up, so revenues are improving and there is no oversupply,” said Benoit. “So for the most popular asset classes there is no oversupply. All the projects that were built in Calgary and Toronto, downtown office towers are well leased, they are filling up well. All the signs are positive, there are not a lot of clouds on the horizon.”
The low interest rate environment has not only made real estate investments more affordable, it has also made them more attractive as an asset class as investors are finding it difficult to stay ahead of inflation with fixed income investments,” the Altus InSite director noted.
Deal activity is also on the rise as more sellers have stepped forward to meet that increased demand for property. “Products were really rare and now quantity of product available for sale has improved in the last six months,” she said. “We have had more investment activity than we had a year ago.”