Canadian Commercial Real Estate Outlook

Transcription

1 w Real Estate Team, Manulife Asset Management Private Markets Spring 18 ManulifeAM.com

2 INTRODUCTION E-commerce is viewed as the biggest threat to traditional brick and mortar retailers, with its impact already driving change across the retail industry. However, until recently, the grocery retail sector has been relatively immune to impacts from e-commerce. Being a non-cyclical business, it remained one of the most stable and predictable segments in the industry. These qualities have led real estate investors to view grocery-anchored shopping centers as lower-risk relative to other retail investments and as such have resulted in strong investment demand. However, the pace of change in the industry intensified last year and we believe the industry will continue to evolve over the next few years. In this paper, we will review some recent grocery related e-commerce developments, provide an outlook on what we believe will be the likely outcomes of the next phase of the industry evolution, and assess potential impacts on Canadian commercial real estate. State of e-commerce in Canada Lagging Peers but Growing Rapidly Canadian consumers spend less online compared to most of their peers abroad, however the growth of Canadian online sales has been remarkable. According to estimates from KPMG s Global Online Consumer Report, only % of Canadian retail expenditures takes place online, compared to 1%, 8%, and 8%, for the UK, Germany and US respectively. 1 This variance in online sales is partly due to challenges relating to delivery logistics in Canada where consumers are relatively more dispersed compared to other countries. However, the volume of online sales in Canada is growing rapidly. Total retail sales in Canada grew 7% between 1 and 17, with online sales posting an astounding growth rate of 31% over the same period. As Canadian online retailers develop the required infrastructure and become more competitive in their offerings, we expect the online sales growth to remain strong over the next few years. In our view, this transformational phase presents a unique opportunity for the retail industry overall particularly for the grocery retail sector which to date has been the least impacted by e-commerce. Exhibit 1: Retail e-commerce Sales as % of Total Retail Sales, Select Countries, 1 Exhibit : Total e-commerce Sales in Canada, (C$, Billions) $ $1 $1 1 $1 $1 $8 +31% Growth China UK Germany US Japan Canada Australia $ $ 1 17 Source: KPMG, 17 Global Online Consumer Report, as of January 31, 17. Source: Statistics Canada, as of February 8, KPMG, 17 Global Online Consumer Report, January 31, 17. Statistics Canada, Retail E-Commerce Sales, Unadjusted, February 8, 18. For Institutional Use Only. Not for use with the General Public.

3 State of Grocery Retail in Canada Canadian groceries have historically enjoyed a uniquely stable position in the retail sector, with total sales growing at a relatively steady rate along population growth and consumers showing a strong preference to purchase groceries in-store, as opposed to online (see Exhibit 3). Further, from a real estate perspective, the Canadian grocery retail space is not over-built and studies show opportunities for new development still exist. 3 However, Amazon s acquisition of Whole Foods has pushed the pace of change into high gear, with numerous announcements in recent months relating to investments in the online grocery business including: Loblaw s agreement with Metrolinx to offer a new PC Express service in GO Transit stations; Sobeys agreement with Ocado, Britain s e-commerce giant, to develop customer fulfilment centers; and Walmart s plan to expand its home delivery services in Toronto and Vancouver. The variety of strategies pursued by these major retailers suggests the industry is going through a discovery phase and it remains to be seen which online sales model or models will satisfy Canadian consumers. Exhibit 3: Preference to Purchase In-Store vs. Online, % of Survey Respondents, Canada Grocery/food 9% Clothing/accessories 8% Appliance/tools 8% Electronics devices (computers, smartphones, etc.) 7% Entertainment (books, movies, music, video games, etc.) % Source: Angus Reid Institute, as of December 17. % % % % 8% % 3 University of Alberta School of Retailing: Grocery Stores in Canadian Urban Centres, January 1, 1. Financial Post: Loblaw Signs Deal with Metrolinx to let Customers Pick Up Online Grocery Orders at GTA GO Stations, February 8, 18. CBC News: Sobeys inks deal with Ocado to launch online grocery store by, January 31, 18. Financial Post: Walmart courts urban Vancouver customers with launch of fresh grocery delivery service, February 8, For Institutional Use Only. Not for use with the General Public.

4 Implications for Commercial Real Estate Investors The evolution of e-commerce on the grocery retail sector over the next few years will have wide ranging impacts. Commercial real estate investors should monitor this evolution to manage risks and capitalize on opportunities which may arise over time. As the industry navigates its way through the discovery phase, we expect different sales channels will emerge to fit the unique requirements of each market segment based on differences in demographics, location, population density, etc. While it is impossible to forecast all outcomes from this discovery phase, we expect the following: Physical grocery stores are here to stay: Although the size and format of grocery stores are likely to change, we believe physical stores will remain an integral part of the grocery supply chain for several reasons. First, the experience of other retail sectors that are further ahead in the discovery phase suggests that maintaining a physical store is critical to brand recognition and customer engagement. In addition, as sales of basic grocery items shift to online channels, we expect retailers to use physical stores to provide value-add services such as ready-to-eat meals or meal-kit subscriptions. 7 This could be a way for retailers to differentiate themselves 8 and maintain customer loyalty. Finally, the provision of Click-and- Collect services, which requires an accessible physical location, is likely to emerge as one of the strongest strategy alternatives. 9 Interestingly, these services could potentially allow retailers to: leverage their existing supply chain infrastructure at the retail level; reduce costs and; help to sidestep logistical challenges associated with home delivery. Opportunities for redevelopment and repositioning of underperforming assets could emerge: An increase in online sales may give rise to opportunities for the repositioning or redevelopment of some grocery anchored centers. Examining how ex-target stores were repositioned and released after their exit from the Canadian market in early 1 provides interesting insights. For instance, a study published by Ryerson University s Centre for the Study of Commercial Activity concluded that redeveloped centers in the post-target era brought a new tenant mix to the space and created the opportunity to generate greater revenue (albeit at varying levels of upfront capital investment). Demand for modern industrial space to remain strong: As the grocery retail model, which is currently centered on in-store sales, evolves into an omni-channel model, efficient warehousing and logistics facilities that can fulfil requirements of different sales channels will become a more critical component of the supply chain. Accordingly, we expect increased investment in specialized warehouses with high clear height, as well as advanced cooling and refrigeration facilities. 7 Meal-kit subscriptions offer packages of the exact ingredients needed to make a given recipe. 8 Financial Post: The rise of the grocerant : Grocery stores are stealing restaurant s best ideas with ready-to-eat meals, March, ICSC: Click-and-Collect Seanlessly Merges Physical, Digital Consumer Channels, September 1, 17. CSCA: The Absorption of Target s Former Store Portfolio in Canada, October 31, 1. For Institutional Use Only. Not for use with the General Public.

5 Q1 REVIEW: THE CANADIAN ECONOMY Canadian economic data has been varied this quarter with more signs of softness than strength. Recent regulatory changes to mortgage lending have had the predictable impact on the residential real estate market, with activity down about % since the end of 17 and approximately 7% from last summer, when restrictions were announced (see Exhibit ). 11 Retail and wholesale sales have also slowed at the margin, while inflation has continued to inch higher. The labor market remains a bright spot, with national unemployment at multi-decade lows and regional figures all continuing to show signs of improvement. 1 At this time, we expect the Bank of Canada to raise rates at a gradual pace (one or two additional hikes in 18) while trying to strike a delicate balance between slightly higher inflation and consumer/homeowner sensitivity to higher interest rates. Looking forward, our five-year forecast for Canada is consistent with the rest of the developed world, calling for modest growth and well contained inflation. We do, however, expect growth to decelerate to below % in 18, with the caveat that if growth in the United States accelerates, Canada should be a beneficiary of such increased activity (Exhibit illustrates the strong relationship between Canadian and US manufacturing). We also believe that as the Bank of Canada increases its policy rate the Canadian Dollar should appreciate modestly against the US Dollar. There are several sources of uncertainty that could affect Canada in 18, including central bank policy. After a year punctuated by shifting stances, increased uncertainty and a more modest growth profile could converge to skew the policy stance back to being more measured/dovish in nature. Geopolitics continues to warrant monitoring as NAFTA negotiations remain a key sensitivity for the year ahead. The residential real estate market is also an area of focus, with concerns of overheating local markets being compounded by tighter mortgage requirements that came into effect at the beginning of 18. So far, the more restrictive environment has had the predicted impact on home sales activity, with the hope being that the national rules follow recent provincial restrictions by lowering activity without materially hindering the broader economy. Exhibit : Canadian Home Sales 8,, Exhibit : Canadian Durable Goods Shipments A Function of US Industrial Production 8,,, 38, 3, - - 3, Canada: Durable Goods Shipments (Y/Y% chg.) Home Sales United States: Industrial Production (Y/Y% chg. RHS) Source: Canadian Real Estate Association (CREA), as of April, 18. Source: Bloomberg, as of December 31, 17. Percentage (%) 1 Percentage (%) 11 Canadian Real Estate Association (CREA), as of April 13, Statistics Canada, as of March 31, 18. For Institutional Use Only. Not for use with the General Public.

6 REAL ESTATE MARKET: Q1 REVIEW & OUTLOOK 13 Investment Markets The investment markets were off to an encouraging start this year thanks to a deep buyer pool and continued access to capital. The national average capitalization rate compressed for the 8 th consecutive quarter in Q1 18, dropping by two basis points (bps) and ending the period at.7%. The underlying trend across the nation continues to be premium pricing for core or top-of-class assets in primary and urban submarkets while pricing for other assets continues to lag slightly. Notable transactions in Q1 18 include the sale of a % stake in the Bay Adelaide Centre to Dadco Investments for C$8 million, and the purchase of the Pure Industrial REIT portfolio by Blackstone for C$. billion. Exhibit : National Cap Rate vs. GOC -Year Bond Yield 199 Q1 18 Yield (%) bps 1 Q1 18 -yr GoC Bond Yield Source: CBRE Research, Q1 18. National Average Cap Rate Office Markets Building on a record-breaking year, market fundamentals for the Canadian office sector remained strong in Q1 18. The national office vacancy rate compressed by bps to 1.%, the highest quarterly compression recorded since 11. Overall, the Canadian office market saw.1 million Square Foot (SF) of positive net absorption in the quarter. Demand remains strong, specifically among gateway markets, with 977,39 SF and 73,78 SF of net absorption recorded in Toronto and Vancouver, respectively. Sustained tenant demand has bolstered market confidence and the development pipeline has responded in kind with construction activity growing by 17.3% quarter-over-quarter to 13.1 million SF as of Q1 18. Toronto, followed by Vancouver and Montreal, has the largest inventory of offices under construction in Canada (as measured by SF). Tightening market conditions are expected to persist as new product is not expected to be delivered in the near-term, leaving new entrants and expanding occupiers with limited options. Exhibit 7: Offices Under Construction by Market Q1 18 Under Construction (MSF) Toronto Vancouver Montreal Edmonton Calgary Downtown % of Stock Source: CBRE Research, Q1 18. Winnipeg Waterloo Halifax Suburban London Ottawa % of Stock 13 Real Estate Market Outlook provided by CBRE Research. For Institutional Use Only. Not for use with the General Public.

7 Industrial Markets The national industrial availability rate declined bps to.% in Q1 18, the 7th consecutive quarter of compression resulting in the lowest national availability rate since 1. Seven major markets experienced tightening with London, Montreal and Halifax each reporting decreases in excess of bps. Availability in Toronto and Vancouver during the quarter remained at record low levels ranking amongst the lowest in North America. The strength of the market shows no signs of abating as demand continues to outpace new supply with.1 million SF of net absorption and only.9 million SF of new industrial inventory delivered during the quarter. Toronto added.1 million SF of inventory during the quarter. However, even that provided little relief as positive net absorption hit. million SF. As national supply continues to lag below the fiveyear average of 3.8 million SF per annum, the development pipeline has started to ramp up with 13.1 million SF reported under construction during Q1, 18, an increase of 1.% from Q1 17. Currently, 83.% of this product is expected to come online by year-end. Exhibit 8: National Industrial Market Fundamentals Q1 1 to Q1 18 Absorption & New Supply (MSF) Q1 1 Q 1 Q3 1 Q 1 Q1 1 Q 1 Q3 1 Q 1 Net Absorption New Supply Source: CBRE Research, Q 17. Q1 17 Q 17 Q3 17 Q 17 Q Availability Rate -1 - Availability Rate (%) Retail Markets After two months of decline, the Consumer Confidence Index rose 9. points in March to a reading of 11.. Despite a more positive sentiment from respondents in Alberta, Canadians have become less optimistic about future job prospects. This comes on the heels of a banner year in which improved labor markets helped sales reach 19-year high growth of.7% and the consumer confidence rise to decade-high level of 18. in December. Overall, the country s unemployment rate dropped to.8%, and stayed relatively stable through to March 18. In the year ahead, it is likely that high levels of household debt and a risk of correction in housing markets may put a damper on continued growth. Exhibit 9: Consumer Confidence & Unemployment Rate Q1 1 to Q1 18 Consumer Confidence (1 = ) Mar 1 Jun 1 Sept 1 Dec 1 Mar 1 Jun 1 Sept 1 Dec 1 Mar 17 Jun 17 Sept 17 Dec 17 Mar Unemployment Rate (%) Consumer Confidence Unemployment Rate Source: Statistics Canada, Conference Board of Canada, March For Institutional Use Only. Not for use with the General Public.

8 Multifamily Markets In response to continued vacancy rate compression, the Canadian multifamily rental market has started to see an increase in development starts. Year-to-date starts as of February 18, totaled 1,378, a 1.% increase over the same time period in 17. Toronto experienced the largest year-over-year increase in starts, growing from 3,89 to 7,18 units. Toronto needs the increased supply as the 17 vacancy rate of 1.% has left renters with very limited housing options. Vancouver has the lowest vacancy rate in Canada at.9%. The market has responded with development starts of,98 year-to-date, which represents.7% of Vancouver s market inventory and the highest proportion of inventory under construction across Canada s major markets. Canada needs to maintain this development momentum to meet future demand as immigration increases and people continue to move into major urban areas. Exhibit : National Multifamily Starts by Market YTD 18 Multifamily Starts (YTD 18) 8, 7,,,, 3,, 1, Toronto Vancouver Montreal Starts Waterloo Calgary % of Market Source: Canada Mortgage and Housing Corporation, February 18. Edmonton Ottawa Halifax Winnipeg London % of Market 8 For Institutional Use Only. Not for use with the General Public.

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