A new report from Aberdeen Asset Management finds that U.S. and Canadian real estate is “broadly overpriced” with the major area of concern north of the border coming from the profusion of construction cranes looming over the downtown landscapes of Toronto and Vancouver.
“We are actually worried about the markets where you have had the big condo boom, so a little bit concerned in Toronto, mostly downtown,” should the housing market correct, said Melissa Reagen, Aberdeen’s head of Americas property research.
The Philadelphia-based analyst keeps a close eye on Canada’s housing market and expects that if the housing market dips, house prices will decline 5% to 10%. That could take a real bite out of the condo market which has been buoyed by ultra-low interest rates.
Her primary focus is on housing prices in Toronto, Vancouver and to a lesser extent, Montreal, rather than any other economic indicator. “Even more than employment, even more than GDP growth, even more than the provincial governments (spending and deficits) I am looking at what is going on with housing in those cities,” she said.
Reagen emphasizes that Canada of 2012 is not the United States of 2007. “I have this sincere belief that there is this parallel between the Canada and U.S. housing markets, with all caveats that Canada is still positioned better.”
Reagen expects any pullback in the condominium market will hit the retail property market but provide “a huge boost for apartment rentals.”
Down Is Good for Multi-Res
The Aberdeen analyst conducted a study on the fallout effects from the U.S. housing crash and believes history could repeat in over housed downtowns such as Toronto’s and Vancouver’s. “My guess will be that you see retail suffer right where those condos are and you will see a good amount of apartment demand and maybe see some of those condos actually turn into conversions. You saw that happen in places like Chicago and Miami in 2008 to 2010.”
In the U.S. market, apartment vacancies have shrunk to near record lows after suffering most of the past decade as people were lured into the housing market by subprime mortgages and the general belief that buying a home was a `can’t lose’ investment. With the housing collapse, ownership rates have shrunk from a high of about 69% to 65% today with that rate expected to drop further as more foreclosures loom and would-be first time buyers wait on the sidelines for prices to bottom.
Subprime mortgages never took off here like they did in the U.S. but home prices could end their long march upward if the economy falters, or unemployment or interest rates rise. “I won’t overplay it, you will see probably a minor correction in (Canadian) home prices,” she said.
A widespread decline in house prices could also hit outlying retail nodes, again mirroring what has happened in the U.S. “Retail properties located near overbuilt suburban housing markets in Toronto and Vancouver are likely to be the most negatively affected should a housing correction materialize,” Aberdeen stated in its May report.
The West is Best
Reagen is most positive about the Calgary commercial real estate market, particularly with respect to downtown office space. “I think Calgary’s star is rising and rising fast. It is putting its name on the map for finance, particularly in energy and I think you will see some very, very good plays in the office sector in downtown Calgary even in the next five to 10 years.”
In its estimate that the U.S. and Canadian real estate markets are generally overpriced, the Scottish asset management company sees “too much rental growth and too much optimism kind of written into the forecast” of investors.
That does not mean that there is a lack of good investment opportunities in the two countries, however. On this side of the border, Reagan likes anything to do with the energy industry, which beyond Calgary means the western provinces generally “where rents grow on a real basis and the economies are driven by the energy industry.”
Where else are there lower-risk opportunities for investors? Aberdeen likes retail, warehouses, and certain suburban apartment and office locations throughout both countries.
U.S. Getting Stronger, Canada Weaker
Canada pretty much skated through the financial crisis, but Aberdeen sees U.S. economic growth strengthening while the outlook for the Canadian economy is weakening. Weighing on growth here at home over the next three to four years will be lower federal and provincial spending, lower housing investment, and slowing consumer spending offset somewhat by natural resources exports.
The asset management firm is not predicting short-term doom and gloom, though. The low interest rate environment in both countries will ensure that investment capital will continue to flow into real estate over the rest of the year “sustaining the momentum in capital values.”