The appetite for Canadian commercial real estate assets steadily increased in 2018 and it appears that mentality is not going to change much in 2019, according to a report by Morguard Corporation (MRC-T).
The company’s 2019 Canadian Economic Outlook and Market Fundamentals Report indicates Canadian commercial real estate remains an attractive asset class.
“Over the past 18 months, investors placed capital into the market with confidence, resulting in record-high sales volume,” said Keith Reading, director of research for Morguard, a major North American real estate company which owns and manages a $21.6-billion portfolio of assets. “The market shows no signs of slowing, as investors continue to show interest in core and core-plus quality properties with strong tenant profiles in Canada’s major urban centres – while site intensification and repositioning opportunities continue to shape the Canadian real estate landscape.”
The Morguard report says the Canadian commercial property investment market over the past 12 to 18 months was largely bullish.
Pension funds, either directly or through their advisors, joined private capital groups, real estate investment trusts, real estate operating companies and various other investment structures seeking core opportunities across the country, it says. Investors exhibited a willingness to accept prevailing property yields, even though they ranged at or near all-time lows for prime assets.
Record-high CRE investment rates
“The rate at which capital was invested in the Canadian commercial investment property market over the past year reached a record high. During the first six months of 2018 a total of $26.8 billion in transaction closing volume was reported, following a record annual high of $43.1 billion in 2017,” says the report.
“Investors continued to target the Greater Toronto and Greater Vancouver areas. Investors looked to capitalize on their stable and healthy economic outlooks and strong leasing market fundamentals.
“The Greater Toronto Area was the most active of regions over the past 18 months, with $15.7 billion in property sales completed in 2017, followed by a further $9.6 billion in the first half of 2018. The Greater Vancouver Area and Greater Montreal Area were also highly active regions during the same 18-month period, with $17.4 billion and $8.2 billion in transaction volume recorded, respectively.”
Reading said both the office and industrial markets have rising rents and low vacancy rates and investors love that dynamic: “They’re looking for growth and that’s what they’ve been chasing.”
If there is a global trade war, he added, trade will slow. That will impact the business environment in general and, in turn, could affect the real estate market.
Here’s a closer look at the different asset classes, accompanied by Reading’s analysis:
Multi-unit residential rental
Investment capital flowed into this asset class with a record $6.3 billion of investment property sold during 2017, followed by another $3.6 billion in the first six months of 2018. The record-setting pace was indicative of the sector’s buoyant demand backdrop and broad-based investor confidence, Morguard’s report says.
In 2018, the national vacancy rate was forecast to fall a further 20 basis points from the cycle-low of 3.2 per cent in 2017. At these levels, most landlords were able to achieve full occupancy or close to it. In situations where units were vacated, landlords commanded higher rents.
The exceptions were in Calgary and Edmonton, where vacancy levels remained near 25-year highs. The tightest conditions were in the Greater Vancouver, Greater Toronto and Greater Montreal areas.
“Outside of Edmonton and Calgary, you’ve got vacancy rates sort of under three per cent and in some markets like Vancouver and Toronto, you’ve got one per cent vacancy or less. For people looking for apartments, that means you’re faced with rising rents and very little choice,” said Reading.
“That has benefited people who have bought condos and put them up for rent. They have rented out fairly briskly as well. Because there hasn’t been a lot of development in multi-family, at least on the rental side, if you want a nice new rental unit you’ve got to go to the condo market because most of our inventory is old.
“So to some extent that’s also propped up the condo market.”
Canadian office properties have sold at close to record levels over the past 18 months with $10.2 billion in transaction volume for 2017, and $5.8 billion for the first six months of 2018.
“We’ve had one of the strongest runs in office leasing and the office investment market that I can remember,” said Reading. “We’ve got record low vacancy in markets like Vancouver and Toronto. Similarly Montreal. Winnipeg is stable and healthy.
“The big issue has been a lack of space in most of those markets. Demand has been strong. That’s pushed rents steadily higher. Vancouver and Toronto are the big stars, there’s no doubt. A lot of that is growth in tech and also this influx of shared workspace companies, too.
“We’re short on space, particularly downtown, so landlords have enjoyed some rising rents and close-to-full, or full buildings.”
Morguard sees a modest strengthening of leasing fundamentals in Canada’s office sector, although oversupply remains an issue in Calgary and Edmonton.
“Office leasing demand outdistanced supply in most of the country’s major urban areas over the past year. In several markets, technology-related businesses were the main demand-drivers and leased a significant volume of vacant space. The professional services, education and health care business sectors also continued to expand,” says the Morguard report.
The national average downtown vacancy rate fell to 10.7 per cent by the end of Q2 2018, down from 11.4 per cent a year earlier. In downtown Toronto and Vancouver conditions were markedly tighter, with vacancies of 2.9 per cent and 4.7 per cent, respectively.
Almost $8 billion of industrial investment sales were reported for the first half of 2018, surpassing the previous annual high of $7.4 billion set in 2017. Reading said the industrial market is a similar story to what’s happening in the office sector.
“In markets like Toronto, you’re really hard-pressed to find space, particularly if you’re in the logistics field or you’re in a field where you’re trying to deliver consumer goods. There just isn’t enough space, particularly for larger buildings,” said Reading, noting “just-in-time delivery groups” are driving much of the demand.
“The interesting thing this time around is even in some of the older areas of Toronto, Montreal, places like that, we’ve got vacancy rates of five per cent or less in industrial, which is quite different.
“We haven’t seen that in previous cycles. We’ve always had this sort of overhang of old space but even that’s leased up this time.”
The national vacancy rate stood at 3.9 per cent at end of June, having fallen 70 bps year-over-year. Functional space was hard to find in Vancouver and Toronto, where record-low vacancies of three per cent and 2.5 per cent were reported, respectively.
“The near-term performance outlook for Canada’s industrial sector is stable and healthy. Leasing fundamentals will continue to improve, although supply constraints in some cities will hamper progress.
“Economic growth rates forecast across much of the country are expected to translate into leasing demand stability. However, the supply of functional space will continue to fall short of this demand in the nation’s three largest inventories, Toronto, Montreal and Vancouver,” says the report.
The sale of retail investment properties surged to a record level despite heightened sector risk. A total of $5.5 billion in retail property was sold across the country during the first six months of 2018. This mirrored the pace of 2017 with its record of $9.2 billion in transactions.
“Retail is really interesting because there’s a lot of talk about online shopping and what it’s doing to bricks and mortar, and it absolutely has had an impact. There’s no denying it. But there’s a couple of other things going on in retail as well,” said Reading. “The big driver in the last decade or so is we’ve seen unprecedented growth in the retail sector. It’s been a hot growth cycle for a pretty prolonged period.
“Now we’re seeing not just the influence of online shopping but we’re also seeing just a correction in the cycle. As we know with cycles, you can’t see growth indefinitely. There’s got to be a correction.
“I think also you’ve seen saturation in certain segments of the market; clothing, shoes being prime examples. That’s always been the case in retail. You’ve had this turnover in brands and we’re seeing that . . . not to mention the whole demographic shift. That’s also a driver.
“You hear talk about a perfect storm, but it truly is. There’s a massive amount of change going on in retail. Now the backdrop from a real estate standpoint is you’re starting to see some increased vacancy. We lost Target and then we lost Sears.”
But he said retail remains an exciting asset class going through a self-reinvention, and bricks and mortar is clearly not dead.
Morguard said the record pace of the past 18 months was fuelled by positive demand fundamentals. The national vacancy rate was 6.8 per cent at the end of Q2, up 240 bps year-over-year.
“The probability of material change in retail sector trends over the near term is quite low. Retail sales growth will continue to moderate through the balance of 2018 and much of 2019.
“However, spending patterns will support retailer expansions. The luxury and discount market segments will lead the way in terms of expansion activity. Therefore, vacancy patterns will mirror those of the recent past,” the report predicts.