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'Optimistic' earnings outlook for Canada's REITs

2023 a tough year, but several factors point to a better 2024: BMO's Kate MacDonald during RealCapital panel

RealCapital 2024 commercial real estate panelists, from left, Amadeo Prete of BentallGreenOak, BMO Global Asset Management's Kate MacDonald, Collliers' Adam Jacobs, Fengate Asset Management's Colin Catherwood, and moderator Gaurav Mathur. (Steve McLean RENX)
RealCapital commercial real estate panelists, from left, Amadeo Prete of BentallGreenOak, BMO Global Asset Management's Kate MacDonald,  Collliers' Adam Jacobs, Fengate Asset Management's Colin Catherwood, and moderator Gaurav Mathur.

The commercial real estate market continues to face challenges due to high interest rates, costs and scarcity of capital -- but a sense of optimism is growing according to at least one industry monitor.

A panel of industry experts provided multi-sector insights on the issues, as well as exploring emerging growth opportunities, during a discussion moderated by former REIT analyst Gaurav Mathur at the RealCapital conference at Toronto’s Metro Toronto Convention Centre on Feb. 27.

“We've just come through a very difficult year in 2023, but it seems like there are tailwinds which would be much more supportive for real estate as we enter into 2024," BMO Global Asset Management vice-president and global real estate portfolio manager Kate MacDonald said.

“I would say that we are optimistic with respect to REITs, and specifically Canadian REITs, for the coming year. We certainly see underpinnings of strong or healthy supply and demand dynamics across most property types — with office being a notable exception. 

“We see earnings growth for the REITs in 2024 and we also see a very marked disconnect between where the listed REITs are priced vis-a-vis where we're seeing assets clear in the private market.”

Opportunities are there, but deals aren't

Fengate Asset Management managing director of investments Colin Catherwood is seeing lots of acquisition opportunities, but bid-ask spreads remain wide and not many transactions are occurring.

“There are deals to be done, but you have to be creative and you have to structure,” Catherwood said. “I think 2024 is going to be much the same. 

“It's going to be a slower pace and things will take a little bit longer, but I see the green shoots coming and I’m very, very optimistic going forward.”

Colliers head of research Adam Jacobs said the industry has been waiting for a wave of distress sales since the height of the COVID-19 pandemic and it still hasn’t materialized. He thinks the worst is over pertaining to interest rate hikes and, while he’s optimistic, he’s not seeing that sentiment shared on a wide-scale basis.

Valuations are coming down

BentallGreenOak principal and head of valuations and investment analytics Amedeo Prete said his company is always canvassing for deals but has generally been sitting on the sidelines when it comes to closing on them. Prete is seeing downward pressure on valuations but he’s not yet sure if enough has been taken off.

The office asset class has become risky and Jacobs doesn’t think the hybrid work model of people staying at home at least one day a week -- which many believe is here to stay -- has been fully factored into office building valuations.

Catherwood said land values are down significantly and he expects to see distress sales from owners that aren’t capitalized well enough to carry costs.

However, Catherwood is very bullish on the multifamily market. He believes apartment building valuations will increase and cited net operating income growth, rising rents, very low vacancy rates, high demand and expectations of little new supply over the next three to five years as the reasons.

There’s still lots of Canadian industrial real estate demand, much of it coming from foreign investors that are creating liquidity for the market, according to Catherwood. Leasing is taking longer, though, and he expects industrial valuations to be relatively flat this year.

“Retail is a covered land play all day long and there are lots of opportunities to either re-densify, repurpose or just run the cash flow out,” Catherwood said.

Institutional investors are largely on the sidelines

Although there were some success stories and MacDonald said there’s still an appetite for commercial real estate, raising capital was difficult in 2023.

After decades of growing allocations to real estate, MacDonald said targeted allocations by large institutions, pension funds and endowments have essentially flatlined at 10.8 per cent of total capital over the last few years.

“The disappearance of the institutional buyer is, in my mind, the biggest story in the investment market post-COVID,” Jacobs observed, adding that having private buyers dominate the market has also made lending more complicated.

Office market remains risky

Jacobs believes there’s a possibility lenders could turn off the tap and walk away from office properties, preferring to just focus on more desirable asset classes.

Considering that major office developments started in the past five years will soon be completed and no new large-scale projects are planned, Jacobs thinks population growth will help the office market and bring vacancy numbers down over the next few years.

“The No. 1 fastest growing area of employment since COVID is professional services, such as accounting, law, engineering and consulting,” said Jacobs. “Those are office-occupying industries.”

MacDonald is encouraged by a recent report that showed Toronto, at 60 per cent, has now surpassed the United States in terms of the number of people returning to occupy offices. Office tour activity is also up and she’s waiting for these positive indicators to translate into more leasing.

The BMO Global REIT Fund was launched last spring and MacDonald said it has received a continuing flow of funds despite not having a track record to show investors. She acknowledged, however, that many advisors are steering clients to money market funds and guaranteed investment certificates instead of REITs.

Good investment options

MacDonald said BMO Global Asset Management is comfortable with industrial, multifamily and grocery-anchored retail and that it has limited and highly selective office exposure.

Prete expects the industrial asset class to continue to be a solid performer and he also likes related alternative assets, including cold-storage facilities and data centres.

Jacobs is still “rah rah” for industrial, as there’s strong demand and he believes there’s room for rents to continue to grow.

In addition to traditional apartment buildings, Catherwood is big on student and seniors housing. While the condominium market is tough right now, he believes it will come back and thrive. 

“I really like the seniors market in particular for the simple fact that it's got the mega demographic trends in terms of aging baby boomers,” Catherwood noted. “That aging baby boomer is close to 70 right now, so this is when services are required for them to go into a retirement home or a long-term care home.”  

There’s also interest from a range of different types of investors in grocery-anchored retail plazas priced from $20 million to $50 million in primary and secondary markets, according to Catherwood.

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