Despite the almost daily barrage of bad economic news concerning Europe, China, the U.S. and even more recently Canada, the commercial real estate sector continues chugging ahead.
That’s the assessment of two separate quarterly reports, one gathered from industry professionals and the other from the glass canyon of Bay St.
Altus InSite’s recently released second-quarter Investment Trends Survey declared the current bull cycle in the Canadian commercial property market “has yet to cool off.”
Altus Group, which surveys more than 300 investors, managers, owners, lenders, analysts and others quarterly to get their opinion on value trends and perspectives, found that yields have not compressed to the point of causing investor discomfort and the market has seen several notable transactions in this quarter.
“Every quarter we think it we have reached the bottom [of yield compression] and it seems that it continues to decrease,” said Marie-France Benoit, Director of Development with Altus InSite.
Extremely low interest rates are driving more investors into real estate, keeping momentum going, she noted. Yes, overall capitalization rates (OCR) are down to just 4.4% for high-quality suburban multi-residential property in Vancouver, “but it is still higher than your average 10-year bond now at 1.7%. A lot of investors are using Canada bond rates as a kind of benchmark to determine if a mortgage loan or a direct real estate investment provides them with an attractive return.”
The firm's survey of investor sentiment found that nearly 40% expect values to continue to increase and 57% expect no change in values. Just 4% expect real estate values to decrease. “The perspective is optimistic but cautiously optimistic.”
Altus does note though that projected growth assumptions in terms of rental rates and values seem to have scaled down from prior quarters.
The research firm found yield compression for 11 of the 32 benchmark products/locations it tracks while practically all other asset classes were stable compared with the previous quarter. Altus noted that for a number of products and locations, overall capitalization rates (OCR) are now lower than those reported in the Q2 2007 market peak, “a clear signal that the current market cycle has yet to bottom out and that yields continue to compress, primarily due to the historically low interest rate environment.”
By sector, Altus found the strength in office is showing signs of slowing. Its forecast of office vacancy trends find weaker results for all locations except for downtown and suburban Calgary, still booming due to the energy sector. At the other end of the spectrum, Ottawa, downtown and suburban office vacancy is projected to increase over the next three months. Vacancy is also expected to increase in suburban class B office in Vancouver and Halifax. For most locations and office classes, the three-month outlook is still for a decline of vacancy.
Take Me to the Mall
Altus also found that investors are moving back to retail properties, perhaps because they are less optimistic about alternatives such as industrial and office. Tier I regional mall and food anchored retail strip products, considered ‘safer’ assets given the consumer-oriented and slowdown-resistant nature of their tenants, are the two most preferred asset classes in the quarter.
Industrial properties continue to remain strong overall, Altus found, but overall the firm found a “slow down from earlier frenzy for industrial products.”
Multi-Res Still Home Sweet Home
Multi residential continues to be one of the most stable property investment types and typically produces the lowest yield rates in the Altus survey. The reported yield in terms of OCRs for suburban multi-residential ranges from a low of 4.4% in Vancouver to a high of 6.0% in Halifax. This asset class remains coveted as vacancy has been constantly declining nationwide.
Altus concluded that nationally, commercial real estate continues to benefit “from low interest rates, a shortage of supply in certain sectors and an imposed discipline in the commercial development sector.” Yields continue to compress although more modestly than in the prior quarter. An increase in interest rates remains an overall market threat.
The Sunny View From Bay Street
RBC Dominion Securities' recent third-quarter forecast declared that REITs “keep delivering” evidenced by the REIT Index’s second-quarter return of 5.8% compared with the -5.7% total return of the S&P/TSX. As well, RBC sees that earnings are accelerating from last year. The investment firm expects 2012 earnings growth of 8% before a slowing of earnings growth in 2013 to a figure that still could be a little better than the long-term annual average of 3%-4%.
RBC found that three of the four property sectors among Canadian REIT posted gains in the second quarter: commercial property (+9.1%), apartments (+7.3%) and lodging (+1.9%). Only the seniors housing sector posted no gain, a (0.0%) return for the quarter.
REITs Keep Running
TSX-listed REITs ended the second quarter with a market capitalization of approximately $48 billion compared with $44 billion three months early. The aggregate market cap for the TSX-listed REITs has grown for 13 consecutive quarters, RBC noted, rising $35 billion from the market bottom in the first quarter of 2009.
Of the 29 TSX-listed REITs, 24 had their market caps increase in the past quarter while just three declined. At the end of the quarter, 16 REITs had equity market caps in excess of $1 billion and 10 REITs had market caps greater than $2 billion.
Based on its coverage of 30 REITs and real estate companies, RBC gives its “outperform” to just over one third: Brookfield Asset Management, Calloway REIT, CREIT, Dundee REIT, Extendicare Inc., First Capital Realty Inc., Granite Real Estate Inc., H&R REIT, Huntingdon Capital Corp., Killam Properties Inc., Morguard Corporation and Morguard REIT.