Canada has exceeded pre-credit-crisis investment dollar volumes and pricing for most asset categories, while improving property market fundamentals continue to fuel investment activity in the U.S. There is no evidence that the recent rise in interest rates slowed activity on either side of the border in the first half of 2013. However, it will be interesting to watch the appetite of the biggest buyer group — interest-rate-sensitive REITs, and whether they will be taking a break from their insatiable buying spree.
These are some of the key trends noted in Avison Young’s Fall 2013 Canada, U.S. Commercial Real Estate Investment Review. The report covers commercial real estate investment conditions in 24 regions: Calgary, Edmonton, Montreal, Ottawa, Toronto, Vancouver, Atlanta, Boston, Chicago, Dallas, Denver, Houston, Las Vegas, Los Angeles, New Jersey, New York, Orange County, Pittsburgh, Raleigh-Durham, San Diego County, San Francisco, San Mateo, South Florida and Washington, DC.
“Canada and the U.S. are on track to meet or exceed 2012’s volume of sales as Canadian REITs and pension funds continue to target strategic U.S. markets,” comments Mark E. Rose, Chair and CEO of Avison Young. “Robust demand and available capital for quality assets is evident on both sides of the border. Whereas Canada continues to be stable, if not at peak pricing, the U.S. seeks to improve if the politics of sequestration, government shutdowns and debt-ceiling limits do not prolong the recovery. Interest rates will remain the wild card as U.S. tapering of bond purchases and the inevitability of inflation will impact both countries.”
“Canada’s stable economic environment and enviable commercial real estate market saw strong investments in the first half of 2013 across all asset types – in comparison with the first half of 2012 when office sales dominated. Look for Canadian REITs to be more discriminating in their acquisition choices in Canada in response to interest rates. Nevertheless, pension funds, life insurance companies and private equity players are poised to fill the void, should REITs take a step back,” he says.
“In the U.S., expect the economy to continue its modest growth through the balance of 2013, as constraints on construction overall and an uptick in occupier demand have led to improved market conditions in many metro areas. Rising interest rates have failed to halt investor appetites for stabilized core properties, and office and multi-residential sales comprised 80 per cent of the volume thus far,” adds Rose.
According to the report, healthy market fundamentals continue to drive investment activity in Canada. Slightly more than $14.4 billion (CAD) worth of commercial real estate assets (office, industrial, retail, multi-residential and land, greater than $1 million) changed hands in the first half of 2013 – up $1 billion, or 8 per cent, compared with the first half of 2012. Four of the six major Canadian markets saw an increase in commercial sales volume in the range of 4 per cent to 46 per cent, while two markets witnessed a decrease of between 20 per cent and 29 per cent.
“Though transactions are being consummated across the country and the full brunt of the initial interest rate hike earlier this year has not shown up in the first-half figures, the full effect may very well reveal itself in the year-end tally,” notes Bill Argeropoulos, Vice-President and Director of Research (Canada) for Avison Young. “However, there are indications that one of the most active buyers since the downturn, the REITs, have tempered their appetite for commercial real estate over the past year. This is clearly evident in two of Canada’s biggest investment markets – Toronto and Calgary. Year-over-year REIT investment volumes are off by 34 per cent and 60 per cent in Toronto and Calgary, respectively.”
Argeropoulos continues: “The second half of 2013 should prove to be interesting. A year ago, we expected Vancouver, Calgary, Toronto and Ottawa to either match or exceed their previous annual investment totals. We were pleasantly surprised that every market, with the exception of Edmonton (by a narrow margin), surpassed their 2011 results. Given the first-half 2013 performance, only Toronto and Edmonton are on pace to match or exceed their 2012 tally. Perhaps, we will be pleasantly surprised one year from now.”
Nationally, industrial properties were the most actively traded asset class in the first half of 2013, outpacing the office sector with 24 per cent of total first-half investment dollar volume. In all, $3.5 billion worth of industrial product sold – the greatest year-over-year increase at 92 per cent. Industrial sales increased in every market. While Ottawa saw the most notable improvement (+351 per cent), Toronto recorded the largest industrial dollar volume – $1.9 billion (53 per cent of the national total). Highlights in this sector included REIT portfolio acquisitions in Toronto, where GE Canada Real Estate Equity (GE) sold $341 million worth of industrial buildings to PIRET; and Montreal, where Tecton Industries sold a portfolio of buildings to Cominar REIT for $151 million.
Office, 2012’s most actively traded asset class, saw sales of $3.2 billion (22 per cent share) – down 37 per cent from an
impressive $5.1 billion in the first half of 2012 – falling everywhere except Montreal (+77 per cent) and most sharply in Vancouver (-70 per cent). Toronto was the most active office market, as sales reached $1.8 billion, but even this figure represented a decrease from the 2012 first-half performance of nearly $2.7 billion. Notable office transactions across the country included the sale of a $542-million Toronto portfolio by GE to Greystone Managed Investments and Slate Properties; Canada Pension Plan Investment Board (CPPIB)’s purchase of 1 Queen Street East and 20 Richmond Street East in Toronto’s financial core for $220 million from Ontario Pension Board; and Calgary’s sale of the Jacobs Engineering building from KanAm Group to Epic Realty Partners for $171 million.
Land was in demand (especially in Western Canada) with first-half 2013 sales of $3.1 billion, comprising a 22 per cent share – up $925 million (42 per cent) compared with the same period in 2012. Calgary was the hottest land market as sales jumped 249 per cent to $902 million, 30 per cent of the Canadian total. Of the top five transactions in terms of dollar value, two – including the top-ranking deal – were land sales amounting to 44 per cent of the total land sales activity in Calgary. Runners-up were Edmonton, at $460 million, and Vancouver, at $456 million, while in the eastern markets (Toronto, Ottawa and Montreal) land sales accounted for $861 million, only 10 per cent of total investment dollar volume in those markets.
The flow of foreign retailers continuing to establish a presence on the Canadian landscape, along with a steady consumer appetite, pumped more investment dollars into the retail sector. Retail transactions across Canada increased a modest 3 per cent above 2012 to $2.3 billion (16 per cent share). The eastern markets (Toronto, Ottawa and Montreal) were busiest, combining for $1.6 billion worth of retail trades – two-thirds of the national total. Toronto garnered $1.3 billion (55 per cent of national total) – matching the sales volume for all of 2012. REITs and pension funds continued to swap assets and were involved in a number of sizable deals at both ends of the country. In the Greater Toronto Area, RioCan REIT purchased Oakville Place from Primaris Retail REIT (Primaris) for $259 million; Oxford Properties Group sold a 50 per cent interest in Upper Canada Mall to CPPIB for almost $252 million; while in the Edmonton area, H&R REIT sold a 50 per cent interest in Sherwood Park Mall to Primaris for $180 million – the largest asset sale in Edmonton in the first half of 2013.
rounded out the five sectors. Low vacancy rates, steady incomes and favourable mortgage rates lifted sales of multi-residential property 12 per cent compared with 2012 to $2.2 billion (16 per cent share). While Edmonton and Montreal witnessed annual sales growth of 184 per cent and 124 per cent, respectively, Toronto led all markets in total dollar volume with $986 million (44 per cent of national total). Though it did not make the top five sales list, the sale of Maple Leaf Quay for nearly $151 million ($300,000 per door) at the heart of Toronto’s waterfront is evidence of investors’ strong interest in multi-residential assets.
Although capitalization rates (cap rates) are lower on average than one year ago, further interest rate hikes may moderate or even signal the end of cap-rate compression for some property types. Cap rates are lowest for multi-residential investments, and once again, Vancouver yields the lowest cap rates in every asset category except retail (tied with Toronto). Financing acquisitions on a go-forward basis, however, will be tricky.
“Canadian debt markets were very active in the first half of 2013, despite a couple of the larger institutional participants withdrawing as a result of meeting their allocations. The second half of the year will be tempered by the U.S. Federal Reserve’s actions on reducing market stimulus. Expect higher ‘all-in’ interest rates driven by deteriorating bond prices in anticipation of the Fed’s reduction of market stimulus. Lenders will be very conscious of funding deadlines in what we see as a potentially rising interest-rate environment,” explains Avison Young’s Norman Arychuk, Mortgage Broker, Capital Markets Group, in Toronto.
Toronto, Canada’s largest city and commercial real estate market, remains the investment market of choice, recording $6.5 billion in sales (a 45 per cent share of the national total) up 15 per cent compared with the first half of 2012, and beating the 8 per cent national year-over-year growth in sales. Office and industrial were top of mind capturing 56 per cent of the total investment volume, while first-half sales of retail properties already equal the sales volume for all of 2012.
“Though we haven’t had a blockbuster deal along the lines of Scotia Plaza this year, 2013 has been a busy year thus far. Notwithstanding the uncertainty surrounding interest rates, some REITs will continue to look for assets; however, they will be more discerning as to the quality of the assets they will pursue. Even though we are seeing a shift from the REIT community, this has been more than compensated for by others, including pension funds and their advisors, life companies and private investors. As such, we envisage pricing to remain relatively stable,” observes Robin White, Avison Young Principal and Executive Vice-President, Capital Markets Group, in Toronto.
Demand for commercial real estate in Vancouver attained near-record levels in the first half of 2013 with almost $2 billion invested. While dollar volume tapered off compared with the same period in 2012 (a record-setting $2.4 billion), deal velocity was one of the strongest recorded in the past decade.
Avison Young Principal Michael Gill in Vancouver notes: “Despite the fact that the largesse of the REITs is currently absent from the BC commercial property market, there remains plenty of capital in the hands of the pension funds and life insurance companies seeking investment properties with strong fundamentals. Those investors who decide to wait to buy on the premise that capitalization rates may rise due to the absence of the REITs will be sadly mistaken, as capitalization rates are expected to remain stable. What the market really needs are more sellers who recognize that it is still a very opportune time to sell due to the large pool of available capital and very low mortgage rates.”
Calgary’s commercial real estate investment market once again witnessed significant investment activity in the first half of 2013. Total dollar volume increased by 4 per cent compared with first-half 2012 levels, amounting to almost $2.2 billion (15 per cent share). Though the growth in sales was modest, the key driver was land sales, which totalled $902 million (+249 per cent).
“The conditions present in today’s marketplace make for an ideal and opportune time for buyers to be active on the acquisition front. Cap rates continue to show resistance to threats of increase for best-in-class assets across all property types, and interest rates remain favourable. With some of the world’s largest companies located here, and rental rates expected to stay strong for the foreseeable future, Calgary is a great place to invest in,” adds Avison Young Principal Todd Throndson in Calgary.
Investment volume in Edmonton for the first half of 2013 was up almost $350 million compared with the first half of 2012, reaching $1.6 billion (11 per cent share). These numbers are indicative of the cyclical trend that has gripped the market during the last three years, with larger investment totals occurring in the first and fourth quarters and dropping off during the second and third.
“As the year continues, we feel that investment volume will remain moderate with product in tight supply. Pricing will remain strong, particularly in class A assets, as pent-up demand and strong balance sheets from pension funds and life insurance companies continue to drive capitalization rates further down. With the temporary downward turn in the capital markets, we anticipate less REIT activity, resulting in likely price declines in class B and C product – also compounded by today’s more expensive debt climate,” explains John Ross, Managing Director of the Edmonton office.
Montreal had an exceptional first half with sales volume of nearly $1.6 billion (11 per cent share), representing an increase of nearly $497 million (+46 per cent) compared with the same period in 2012 – led by the multi-residential and industrial sectors, capturing 62 per cent of the total investment volume.
“This is the second-largest first-half dollar volume experienced during the last five years. With previously announced and ongoing transactions in the second half of the year, it is more than likely that 2013 total sales volume will surpass the 2012 mark – and may very well exceed the record volume of $3.5 billion seen in 2008,” notes Avison Young Principal Tom Godber in Montreal.
The nation’s capital, Ottawa, continues to be a safe haven for pension fund advisors, REITs, financial institutions and other institutional investors looking for stable long-term yields. Investors’ assets of choice continue to be office buildings – although the industrial market is ahead of 2012 levels as it remains popular with institutional and private local investors. Ottawa was the only market not to crack the $1-billion-dollar mark in the first half of 2013 as sales declined 29 per cent to $618 million (4 per cent share).
According to Avison Young Principal Michael Church in Ottawa: “A slowing office market has not tempered enthusiasm for well-positioned assets with covenant leases in place, despite lower investment volumes compared with one year ago. Retail development continues to be strong. Interest rates continue to drive the Ottawa investment market, with multiple bids on the very limited product that does come to market – a trend expected to continue through to the end of 2013.”