“Having capital is no longer an advantage. Advantage comes from being able to move quickly, deal with more complexity, and leverage strategic partners.”
As high-quality commercial property grows scarcer and prices continue to rise, some investors are beginning to look elsewhere for opportunities that could offer superior returns. As one interviewee put it, “During each economic cycle, there are opportunities to seize. You must know how to spot them.”
The industry’s search for better returns manifests itself in various ways. Major pension funds have largely acquired what the Canadian market has to offer and, consequently, are looking overseas for prime investment opportunities. These large institutional investors have also turned to developing Class A properties in Canada and around the world in response to the lack of availability, which is resulting in increased prices for institutional-grade properties and better returns. “There’s only so much institutional-quality real estate available,” one interviewee said. “So, the industry will either build more institutional-quality real estate than we need, or it will drift into non-institutional-quality real estate. Both are a concern.”
Others, especially those lacking the size and scale to go after higher-grade real estate, are getting innovative in their hunt for stronger yields in Canada. For some, this means being more creative when optimizing their portfolios. The trend of recycling capital will likely continue to improve the quality of cash flows and to redeploy capital in intensification and redevelopment opportunities. One interviewee remarked that midsize players may try to improve their portfolios by selling lower-quality properties to make room for higher-quality ones.
REITs are likely to make some strategic adjustments in the year ahead. They generally continue to focus on reducing leverage and payout ratios to more conservative levels; indeed, a number of observers suspect that REITs will have trouble generating the kind of returns needed to guarantee their distributions. This pressure may compel some to sell assets in order to generate funds, and investors are watching closely and are ready to buy when those properties are put up for sale. Others have noted that REITs are shifting away from acquisitions in favor of development and redevelopment opportunities in search of better returns.
Supply, Demand, and the Government’s Role
“Government regulations will have a meaningful impact on affordability—they just won’t solve the problems. In fact, they’ll go a long way to creating new problems.”
Industry players are skeptical that recent tax moves by the Ontario government, following last year’s move by British Columbia, to curtail foreign investment will have a long-term cooling impact on housing affordability in Toronto and Vancouver. “Growth will continue to drive needs,” one interviewee said. “No regulation will stop that.”
In August 2016, British Columbia implemented a 15 per cent foreign buyers’ tax on the Vancouver metro-area housing market. In the short term, the Canada Mortgage and Housing Corp. reported that the tax pushed monthly sales to foreign buyers from around 10 per cent of sales to 0.9 per cent, with a marked decrease in average prices. But after a year, prices rebounded to pre–foreign buyers’ tax levels and are now pushing new heights, especially in the condo market. In April 2017, Ontario announced its own 15 per cent tax on foreign buyers and expanded rent-control rules to buildings constructed after 1991. Most interviewees feel that foreign buyers’ overall influence on housing prices has been greatly overstated. The impact on some Greater Toronto Area (GTA) submarkets may have been greater, but most interviewees think that overseas buyers still see Canada as a safe haven and an attractive place to live, so they will continue to buy in the Canadian market regardless of new taxes.
For those in the industry, it is a matter of supply and demand. A common refrain from interviewees is that governments should stop trying to interfere in the market and turn their attention to other more important issues, such as the impact of regulations and processes that are limiting land supplies. This echoes findings from last year’s report, in which many stated their belief that provincial land use policies and local government approvals are factors holding back the supply of available land for development. Building on that, one interviewee stated that government policy “is the largest issue impacting real estate.”
For example, many are worried about how proposed changes to the Ontario Municipal Board will give local governments more say when it comes to development decisions. This could restrict supply if residents push back against high-density projects in their neighborhoods. And in Halifax, some believe that the government’s approach to city planning is limiting development.
A Mind-set Reset
“With more single people living in expensive markets, watch the emergence of co-living.”
While there isn’t much concern about housing affordability in most of Canada, it is driving profound change in the lives of urban Torontonians and Vancouverites—particularly millennials.
As it stands, more than one in three young adults in Canada live with at least one parent, a share that has grown since 2001 according to 2016 census data (see exhibit 5-6). Younger Canadians in centers like Toronto and Vancouver will need to rethink their living expectations. While many millennial families will move farther away from major urban cores—even to new cities—in search of affordable homes, others will choose to stay and raise their families in condo units (in some cases, larger units in family-oriented buildings). Others will simply opt out of homeownership and embrace a permanent-renter lifestyle.
In major centres, we may continue to see a rise in multi-generational and multi-family homes as a means for people to overcome affordability challenges. Census data show that 6.3 per cent of Canada’s population lives in multi-generational households, which have grown the fastest of all household types since 2001. These affordability concerns are, in turn, creating opportunities for real estate developers in Ontario and British Columbia. One Vancouver-based developer has even launched a prize to find a paradigm-shifting technology in the construction of high-density housing.
Transit to Transform Cities
“Transit is a key link between people and where they work and play. Smart developers buy around transit nodes—and future transit nodes.”
In recent years, Canada’s federal, provincial, and municipal governments have joined forces to invest billions of dollars in transit infrastructure in cities across the country, and this is poised to shape real estate opportunities for years to come. The new transit lines will let more Canadians find homes they can afford while offering a reasonable commute to work in urban cores or intensively developed nodes along the lines.
Indeed, investors and developers in Montréal foresee the Réseau électrique métropolitain (REM) network turning Dorval and the South Shore into a sizable employment hub, with opportunities in multi-use developments. In Ottawa, city planners are championing increased density along the new light-rail transit (LRT) lines. In fact, the closer a project is to the LRT, the more favorably it’s viewed in approvals. Similarly, Edmonton’s Valley Line LRT will increase density around the corridor. In Vancouver, TransLink plans to help finance its transit network by leasing space at its rapid transit stations to retailers. Toronto is seeing much interest at key transit hubs, such as the Union-Pearson express rail, the Spadina subway extension, and the Eglinton Crosstown LRT. As one interviewee observed, transit-oriented retail and mixed-use properties offer a stable cash flow, making them strong prospects.
The link between transit infrastructure and real estate development is expected to grow stronger in the years to come. Governments and agencies are increasingly looking to emphasize transit projects that can demonstrate wider public benefit—such as creating hubs or places where people want to spend time and money, whether through work, play, or both. And as the sharing economy evolves with ride sharing and autonomous vehicles, transportation planners will need to examine “last mile” travel between transit hubs and commuters’ destinations. Transit proposals that integrate plans for further real estate development are likely to have a stronger case for funding going forward.
The Rise of Placemaking
As new transit lines prove to be a nearly irresistible magnet for real estate developers and investors, the industry is paying more attention to the idea of placemaking. In many ways, it is an evolution of the industry’s recent focus on mixed-use properties and creating communities—fusing residential, commercial, retail, and service properties. What makes placemaking different is that it’s more than a collection of different types of property. As one interviewee put it, place-based development is bigger than the sum of its parts: it’s about creating a unique experience and culture, an engaging environment that provides people with things to do throughout the day and into the night.
And now, new transit spending is creating opportunities to establish unique places along new and future lines. Large, dense, transit-centered developments in Ontario like Transit City in Vaughan or M City in Mississauga are examples of placemaking in action. They’re also attractive to investors because the appetite for new product is almost insatiable.
Reinventing Real Estate through Technology
“This is one of the first times in our history that all of these disruptive technologies will have a significant impact on where and how we live, work, and play.”
Time and again, interviewees said it’s critical that the industry embrace the use of technology and analytics in order to enhance strategies that will be supported by better, faster decisions.
With 2017 projected to have been the best year yet for global real estate tech funding, one interviewee noted, “Technology’s impact is everywhere in real estate—and we can’t ignore it.”
Harnessing the power of data and business insights is an imperative for real estate companies. It will play an essential role in helping companies improve deals and investments, mitigate risk, better understand tenants and their needs, and open up new profitable possibilities. Real estate industry leaders tell us they’re eager to be able to benchmark and run analytics on their property portfolios. They want to make decisions based on a far more detailed, nuanced understanding of what drives their business.
To achieve this, real estate companies will need to invest in modernizing their IT and data infrastructure, from new data management tools and information portals to artificial intelligence, machine learning, and automation systems. They should also make sure they hire people with the skills, knowledge, and expertise needed not only to make sense of the data, but also to make sure that companies ask the right questions. It will also be critical to make sure that data and essential business systems are protected against cyber-attack. The cost of the investment will vary depending on the approach taken, but companies should start planning for it now, if they haven’t already. One interviewee told us that they’re quadrupling their IT budget.
How Will Emerging Technologies Shape the Market?
Autonomous vehicles (AVs) may not be a regular sight on roads yet, but technology and automotive giants are racing to get AVs on streets and highways—and it’s a change that could radically transform cities and future developments. With AVs comes the need for fewer personal cars and surface parking spaces. What does it mean when residential, commercial, and retail properties and projects no longer need the parking spots they once did?
It’s likely that many companies will capitalize on their existing assets and redevelop excess space into new properties, generating new value and increasing urban density along the way. What’s more, Canada is looking to take the wheel when it comes to AV development. Edmonton has expressed that it would like to be at the forefront of AV research in Canada, exploring setting up a test track at the University of Alberta. And a major auto manufacturer is establishing a research and development center in Ottawa to work on developing AVs and connected vehicles.
It’s not just autonomous vehicles that are making waves in real estate. Drones are slowly but steadily gaining in prominence within real estate and changing how companies work. They’re being deployed by developers and owners to inspect construction progress, assess potential damage, and help produce visuals for marketing materials. And with the rise of faster e-commerce delivery efforts across North America, they are another variable in the retail landscape. Virtual reality also lets real estate professionals showcase properties to clients through 3-D virtual tours, preventing potentially costly missteps on the construction site and allowing home purchasers and tenants to see spaces in 3-D rather than just plans on paper. And the evolution of block-chain is expected to have a significant impact on real estate transactions and the whole industry.
Tenant Expectations Continue to Evolve
Technology has swiftly reshaped what employees expect of their employers and workplaces. In last year’s report, interviewees said a “smart,” connected building that was energy efficient and constructed using sustainable materials was seen as a unique project. Today, that same building is a necessity because tenants and their employees will settle for nothing less. Builders have responded, building the highly connected, green-as-possible offices their tenants want. And they’ve been rewarded: Class A new builds are quickly leased, while older buildings empty out and stand in desperate need of retrofitting and refurbishment. To stay relevant, real estate players must anticipate and meet the needs and expectations of these influential companies and their equally demanding employees.
Expected Best Bets for 2018
This year’s Canadian real estate trends are about creating possibility. So, where should developers and investors look for these possibilities in 2018? Our conversations and survey suggest that the following areas may offer the best potential for the coming year.
With an increasing focus on a work/play/live lifestyle, appetite for placemaking remains. And while it’s a major focus in rapidly intensifying cities like Toronto and Vancouver, other regions also have big plans. Edmonton’s ICE District, for example, has brought new energy to the downtown core and is drawing interest from buyers and investors. Developers have moved away from viewing projects as one-offs in favor of planning complete neighbourhoods that include wellness, retail, entertainment, office, and more. Observers say the real estate market also needs to look at providing lifestyle services, including better integrating health and wellness services into the cities’ urban fabric.
Fulfillment and Warehousing
With online commerce showing no signs of stopping, the demand for warehouses and distribution centers continues to grow. Rents are good, and they’re rising after a long period of flat rates—which is good news, as industrial land prices will continue to rise, especially around major transportation hubs. Large bays with room for plenty of trucks, high ceilings, and computerized rack systems are what are in demand to facilitate logistics, distribution, and fulfillment.
An aging population means rising demand for senior housing and high-quality senior living facilities. More than half of all survey interviewees recommended buying into the “age-restricted housing” subsector. The main challenge with this sector is that it typically involves a mix of private and public investment—and a tricky business model. So, developers that can get the right talent with enough experience to navigate the upfront regulatory hurdles and identify strategic locations could put themselves at the forefront of an area poised for growth.
With land becoming scarcer in major urban centers, industry players see opportunity in redeveloping existing, underused space for new mixed-use real estate developments. Multifamily residential in major cities is seen as a promising opportunity, since demand is projected to stay strong thanks to immigration and affordability concerns about single-family housing.
Toronto’s office development boom shows no sign of stopping, and new supply can’t reach the market quickly enough. Toronto’s downtown vacancy rate is the lowest among major Canadian cities—and the rate masks the fact that half of that space is awaiting occupancy. According to some interviewees, demand will exceed supply for the next 24 to 36 months.
Andrew Warren serves as the Director of Real Estate Research for PwC.
The preceding is an excerpt from The Emerging Trends in Real Estate 2018, a joint publication between Urban Land Institute and PwC.