Based on its recently-released 2014 Canadian Economic Outlook and Market Fundamentals Research Report, Morguard Corporation is predicting a third consecutive year of strong performance for the Canadian commercial real estate market. The forecast rise in Canadian economic growth for 2014 bodes well for the nation’s rental market performance. As a result, the nation’s commercial property market will continue to provide investors with stable and positive income and attractive returns in helping them meet their investment objectives.
“The Canadian real estate market will remain a stable and attractive source for investment yield and cash flow over the near term, while generating above-average activity levels in the sector over the next 12 months,” said Keith Reading, director of research at Morguard. “Canadian property values will remain close to the peak, with the relatively low cost of debt and equity funds supporting this trend.”
A range of investor groups are expected to be active in Canada’s commercial property investment market, including pension funds, REITs, private capital, and institutions. Therefore, the combination of the availability of capital and increasing allocations to Canada’s property market will result in above-average transaction volume. Annual investment capital flow into the Canadian real estate sector is predicted to fall slightly short of the 2013 level, but still beat the long-term annual average of almost CDN$20 billion.
2014 Real Estate Investment Trends to Watch in Canada
- Solid fundamentals will continue to characterize Canada’s real estate market, buoyed by what is anticipated to be a period of moderately stronger economic expansion.
- Property values will continue to range close to the peak, supported by robust investment demand and low interest rates.
- Income performance will remain positive over the near term as rental markets in all sectors post solid occupancy levels, positive demand trends, and stable or modest increases on 2013 rental rate averages.
- Capital flows into Canada’s property investment sector will remain robust over the near term, boosted by the eventual return of capital market buyers (i.e. REITs and Real Estate Operating Companies).
- Construction activity will rise significantly over the next few years in the industrial and office sectors, with developers hoping a stronger economy will see these properties leased quickly. The ongoing delivery of new supply in the nation’s major downtown office nodes could lead to increased vacancy and downward pressure on rents, if demand fails to keep pace over the next few years.
- The arrival of U.S. retailer Target will continue to impact the retail sector, as the discounting sector adjusts to new competition. The broader retail sector will continue to adjust to changing shopping channels, formats and consumer preferences.
- The multi-family residential real estate sector will continue to stabilize, as rental buildings remain largely full. However, competition from the rental condominium market will be monitored closely by landlords in the purpose-built market segment.
Real Estate Investment Overview
The Canadian real estate investment market will see a continuation of positive performance in 2014, given a more robust economic forecast. The Canadian economy is expected to gain momentum in the coming year, boosted by a strengthening of the U.S. recovery. In 2014, demand for Canadian exports is forecast to rise, helping to drive economic output higher by between 2 per cent and 2.5 per cent on an annualized basis. While there is continued concern related to the European economic recovery, trade activity between Canada and its largest trading partners is expected to pick-up. Canadian businesses are expected to pick up the economic baton and invest in their existing operations to meet this demand.
Business cycle dependent sectors, like office and industrial, will experience moderately positive demand due to the increase in trade-related activity. The office sector will see the ongoing delivery of new supply, with the hope that tenant expansion will offset the addition of this new vacant space. The industrial sector is set to capitalize on increased economic activity. The rise in speculative industrial development will be met with equally healthy interest from tenants in the warehouse and distribution sectors. The broadly positive outlook for Canada’s commercial property market will drive investment capital to the sector. Yields will therefore, remain at levels required to justify the allocation of funds, with income stability and growth adding to the overall rationale.
Holders of Canadian commercial real estate assets will be the beneficiaries of stable market fundamentals in 2014. Core property values, on the rise for much of the past few years, will hold at the peak. Higher up the risk spectrum, property values will stabilize, having slipped slightly in 2013. Demand for investment-grade property will continue to outpace supply. However, capital flows will remain above the long-term average. Returns will continue to attract investment into the property sector, likely finishing somewhat lower than those of the previous year. The private investment market should see the generation of returns between the high single and low double digits. In short, Canada’s commercial real estate owners can expect another run of solid results in 2014, barring an unforeseen shift in market fundamentals.
The Canadian office sector is poised for continued health in 2014, although it will include some challenges. Returns are expected to remain positive, though slightly lower than the 2013 results. In the leasing sector, occupancy levels will rise, given relatively modest demand both in the public and private sectors. The ongoing delivery of new supply in Calgary, Toronto, and Vancouver will present a challenge, particularly for the downtown sub-market. The combined effect of increased supply and modest demand will limit rental growth. However, if demand surprises to the positive, then growth may be more buoyant. For the most part, trends in Canada’s office markets will remain relatively healthy, despite the onset of headwinds over the next couple of years.
The industrial sector is expected to build on the healthy momentum of 2013 in the coming months. Export-driven markets will lead the charge. Eastern cities will benefit from a stronger economic recovery expected south of the border. U.S. demand for Canadian products will boost export-driven companies in the manufacturing dominated markets like: Montreal and Toronto. In the west, Alberta and British Columbia will see continued growth in light of improved demand for oil and gas and lumber across the globe. At the same time, a the rise in the rate of economic expansion in Canada will boost distribution and warehousing activity, due to increased domestic demand. The recent surge in speculative development in markets like Calgary, Edmonton, and Toronto will be met with solid interest from a variety of tenants. As a result, construction volume will continue to rise, boosted by U.S. retailers who will continue to develop and perfect their distribution networks.
The investment sector will also see continued momentum, resulting in attractive returns, healthy demand, and values that will hover close to the cycle peak. Investors will look to the sector increasingly in the coming year, with the view that the sector still has upside in terms of growth. In summary, Canada’s industrial heartlands will see continued health and stability in 2014, adding to what was a solid 2013.
Canada’s retail environment will continue to evolve in the coming year, with new ways to shop, new and changing bricks and mortar fo
rmats, and an increasingly sophisticated consumer. On balance, the retail property sector will more than likely enjoy another year of prosperity and growth. In 2014, rental market trends are forecast to mirror those that have been in place for much of the current cycle, including healthy occupancy patterns and demand. U.S. groups looking to expand into Canadian cities will continue to support this occupancy and demand-strength. Competition for limited vacancy will ensure rents hold at the peak, with the potential for further increases in prime centres and high streets. An improved job market and economy will provide a foundation for spending activity, which is forecast to better the modest increase of 2013 in the coming year. The strength of the leasing backdrop will help buoy investment fundamentals over the near term.
Investment fundamentals are expected to continue to unfold over the next year, a period that will be characterized by positive trends. Attractive returns will once again be generated, boosted by healthy income and capital trends. Property values will hold at the peak, although the growth cycle of the past few years appears to have reached a plateau. However, demand for investment-grade retail property will remain strong, indicating there may be some addition inflation achieved. In short, Canada’s retail market will generate largely strong leasing and investment fundamentals through 2014, in keeping with the current phase of the cycle.
The 2014 multi-family residential property sector performance will be characterized by persistent stability and broad health. Steady growth in property values over the past few years will continue to ease, in keeping with the 2013 trend. However values will continue to range at the peak for the cycle. The strength of the sector’s demand drivers and constrained supply will once again produce rental market health and stability in 2014. Occupancy should rest above the 95 per cent mark in most cities, as vacancy units remain in relatively short supply. Rents will, as a result, continue to rise, with the limitation of rental control legislation in a number of provinces. Competition for tenants from rental condominiums will continue to be a factor, given the slack in the ownership market. As 2014 progresses however, excess capacity will decline, benefitting the purpose-built market. Investment-grade assets will remain popular and in short supply, thereby supporting values. Indeed, the health of the investment market will mirror that of the rental market in most markets across the country in 2014.