“We're stepping gingerly into a recovery.” That was the message from MSCI head of real estate economics Jim Costello as he opened Tuesday's Global Property Market conference  in Toronto.

“We've gone through a tremendous down period in returns, investment volume and activity, so where we get to on the other side of this is still a little bit unknown," he told the audience at the Metro Toronto Convention Centre. 

Global deal volume has had a major pullback compared to the period between 2015 and 2019 and, while it was up four per cent in Q3 compared to a year earlier, it was still 35 per cent lower than the average third quarter before the COVID-19 pandemic.

Costello noted, however, these double-digit declines are coming off an “excess high” period when global interest rates were below one per cent and real estate was a very attractive investment.

Americas lag Europe and Asia-Pacific

Deal activity for income-producing properties is down one per cent from a year ago in the Americas, but up three per cent in Europe and the Asia-Pacific regions.

Costello said non-office assets have turned a corner and are gradually coming out of the doldrums experienced from 2022 to earlier this year.

“But even in the Americas, where return to office is harder than other parts of the world, we saw some growth in office investment,” Costello said. “It was a lot of smaller buildings — $100-million to $200-million buildings.”

While office still lags the other major asset classes, Costello said some private capital is showing a willingness to take risks and some value investors are purchasing assets. Institutions need to produce returns, however, and they’ll likely remain hesitant to re-enter the market to any large degree until this can be achieved.

Valuations have been affected

“We've made some cuts in prices that have started to have an impact on valuations, so the reckoning has been happening and now there are some signs of recovery in place,” Costello said. “Recovering returns is what you need to get deal volume growing again.”

While global valuations by appraisers for properties in the $10-million to $50-million range have been pretty close, there’s been a disconnect with larger and smaller properties.

“With the littlest stuff, appraisers have been more conservative and sale prices were actually much higher,” Costello observed. “With the biggest stuff, they've been missing because the sale prices end up being much lower.”

Countries experiencing the biggest valuation misses have been the United States and Sweden, though Canada is a close third, according to Costello. He noted lots of errors have been made with central business district office buildings due to the uncertainty brought about by high vacancy rates.

“You're not just going to get paid double-digit returns for showing up to the real estate market any more,” Costello said. “There's going to be a lower level of return and it's going to take a lot more work to deliver something.”

If returns don’t bounce back to the lofty levels of the not-too-distant past, there will be less liquidity in the market. This could change investors’ attitudes toward real estate, where they come to see it as more of a stability play than a big growth opportunity.

Where Canadian foreign investment is going

Canadian foreign investment capital has gone, as always, mainly to the U.S. this year. But while the average has historically been 58 per cent, Costello said it’s now 67 per cent.

Canadian investors have also been more active over the past 12 months in Germany, Japan and France and less active in the United Kingdom, Australia, India and Brazil. Germany and Japan are expensive markets where you don’t invest for tremendous growth but for a nice yield and stability, according to Costello.

Thirty-two per cent of Canadian capital invested in foreign real estate traditionally went to the office sector, but Costello said it’s only been eight per cent over the past year. More money has been allocated to purpose-built apartments and industrial assets because they have lower capital expenditures relative to net operating income and are more predictable.

“We had two generations of commercial real estate investors that made money simply by watching cap ex fall,” Costello said. “We don't have as much of an opportunity there these days.

“It’s going to be more about building up income. It's about managing properties effectively, and that's just a slower growth type.”

The U.K. and the U.S.

The U.K. had an earlier and much sharper decline in returns compared to Canada but, because that market took its hits early, returns are also starting to turn positive sooner. That’s caused institutional investors there to become net buyers again.

“If we're lucky, we're going to have returns follow that same pattern, and that should lead to more deal volume in North America in the coming year,” Costello said.

American real estate price growth has traditionally been about four per cent whether a Democrat or Republican president is in power because Costello said “everybody had kind of a common view of the global economy and the role of government in the economy in the Western world.”  

There’s more uncertainty with Donald Trump’s incoming administration, however, so there could be challenges ahead since the market generally doesn’t like that.

“Investors don't like putting money to work in areas where they're not sure what happens next,” Costello said.

There’s been an increase in U.S. distress sales, but it hasn’t grown quickly; Q3 saw the slowest pace of distress sales growth since the end of 2022.

Costello dismissed the notion of loan maturities in the U.S. causing problems for real estate owners and possible bank failures. He said many loans originated before interest rates dropped so low, so there shouldn’t be a huge shock when they come up for renewal.