Commercial real estate owners are getting a Christmas present from Colliers Canada in the form of a rosy forecast for next year.
“There doesn’t seem to be much negative on the horizon,” says Craig Hennigar, director of market intelligence for Canada at Colliers in Vancouver. “Generally it’s a positive story everywhere.”
He was discussing Colliers’ recently released Top 6 markets forecast report for Q3 in which 220 company advisors from 15 markets across Canada weighed in with their sentiments on the prospects for the six markets in the country with a population of more than one million.
Colliers started doing the quarterly survey this year. The survey asks advisors to provide their scores for value drivers (potential for rental income growth, increases in tenant demand and cap rate decreases) and income drivers (factors such as demand and supply that may influence property income growth) using a negative to positive rating from -1 to +1.
“Overall it seems like we’re in this bull market environment and there’s an expectation that this is going to continue in pretty much all markets,” Hennigar says.
Better news in Edmonton, Calgary
The report finds Ottawa shows the most positive value and income driver levels for Class A office properties and that Alberta’s two major cities, which were in the commercial real estate doldrums, are picking up. Edmonton has moved from having very negative to almost neutral ratings from Colliers advisors. The horizon is now positive for Calgary.
As is typical for a market that is coming off the bottom, Hennigar says, there is a flight to quality in Calgary in which tenants abandon Class B and C buildings and move to Class A and Class AA buildings at almost the same cost or lower cost. The result is a potential for increases in net rents for higher-quality assets.
He adds suburban markets across Canada, which had been out of favour for a couple of years, are starting to see some positive pickups in most major cities. The absorption of suburban space now generally equals, or exceeds, that of the downtown cores.
Montreal acts as somewhat of an exception, with more demand for the midtown and downtown markets. Major public transit and highway projects underway in Montreal, such as the upcoming REM (Réseau électrique métropolitain) light-rail train and construction of a new Turcot Interchange, should alleviate at least some of the city’s well-documented traffic woes. This could be resulting in “a new interest in getting downtown when you can actually get downtown.”
Economic growth expected to continue
Hennigar says there is a broad-based expectation for continued economic growth as well as higher rental rates and increased tenant demand in Canada’s major markets.
While the spectre of a NAFTA failure exists, “I think one of the biggest challenges we’re probably going to face is labour shortage,” he says. “A lot of companies want to grow but in some markets we’re getting to very low unemployment rates. That could be the fly in the ointment.”
Although there is significant potential for growth, the task of filling vacant positions with qualified people could pose difficulties.
In addition, companies such as tech firms that are moving into downtown Toronto, Vancouver and Montreal are leasing more space than they require. This makes it unclear how many years of employment growth they have already factored into their space strategies, he says.
“Are they going to run out of space in a year and have to expand, or have we already seen the benefit of next year’s employment growth already reflected in last year’s absorption? This is the only thing out there, short of major economic catastrophe, that might have some significant impact.”
Interest rate risk minimal
Hennigar does not believe the possibility of higher interest rates will have much impact unless rates rise dramatically. Rising interest rates do not seem to be translating into rising cap rates, he says.
“Real estate tends to be inflation-indexed,” so an increase in interest rates might not be reflected in an increase in cap rates “because there’s a lot of capital looking for places to go and real estate does rise with inflation.
“Some of the risk in rising inflation might be mitigated by the nature of real estate investment.”
Interest rates, Hennigar said, are so low even moderate changes will not lead to massive increases in mortgage payments. The reason, he says, is that most of the mortgage payments are tied to principal, not interest, given that rates remain low.