Canadian Commercial Real Estate Outlook

Transcription

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

2 OH CANADA! EXCEPTIONAL FIRST HALF GROWTH EXPECTED TO MODERATE Canada spent the first half of 217 vastly exceeding expectations. In both the first and second quarter, the country posted the best growth in GDP terms in the G7. In the second quarter, Canada hit its best quarterly growth since 211 and its best half-year growth since A strong and resilient consumer, stabilizing business investment and a more recent improvement in export activity have supported this surge in growth. Moreover, activity has broadened across provinces and the energy economy, which suffered a significant slowdown in following the collapse in oil prices, is now growing back in line with the non-energy economy. 2 Exhibit 1 - Employment, Year-over Year Growth Exhibit 2 - Retail Sales, Year-over-Year Growth Percentage (%) Aug-12 Aug-13 Aug-14 Aug-15 Aug-16 Aug-17 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Source: Statistics Canada, as of August 217. Non - Energy - Dependent Provinces Energy - Dependent Provinces Looking ahead into the second half of 217 and into 218, Canada s growth rate is expected to moderate from the high growth rates (3% -5%) it has recently enjoyed. The consumer is expected to face higher interest rates as the Bank of Canada pursues a higher interest rate policy which will gradually begin to squeeze consumption power. We have concerns that the momentum behind export activity will decelerate as the US manufacturing sector, and its ensuing demand, begins to moderate. We are also closely watching Canadian business investment in the face of heightened uncertainties, both domestic and international. Despite this moderation in growth, Canada is still likely to grow above potential and continue to absorb excess slack. We believe the country will remain far from a recession over the next 18 months, absent unforeseen shocks. Canada will also face an important shifting housing sector narrative over the coming year as federal and provincial governments along with regulatory bodies attempt to cool speculation, and the Bank of Canada continues to increase interest rates. However, we believe this is a multi-year mild-to-moderate drag on growth as opposed to a sharp shock. Understanding the multipliers to growth from Canadian housing is difficult, largely because of insufficient data, but our sense is that the part of the economy that is not leveraged to housing is substantial enough to offset the loss of housing as a growth driver. In our view, the Bank of Canada will continue to pursue higher interest rates, tracking the Federal Reserve higher over the coming years. We expect the central bank to remain data dependent and to raise rates slowly, even if inflationary pressures remain tepid. A substantial trade shock or a significant and sustained appreciation of the Canadian Dollar may cool the BoC s appetite for higher rates somewhat. However, the central bank has been clear that it no longer views base bottom interest rates as appropriate for an economy that has run this strong and a third rate hike before year-end is a very strong possibility. 1 Bloomberg: Canada s Economy Surges 4.5% on Consumer Spending, August 31, Bloomberg, as of September 29, For Institutional Use Only. Not for use with the General Public.

3 REAL ESTATE MARKET OUTLOOK, 3 Investment Markets Following a slight slowdown in investment activity entering the new year, investment momentum has steadily increased since January. This is evidenced by investment volumes which totaled CA$1. billion in Q2 217 which, when combined with the impressive Q1 217 total of just under CA$12. billion, pushed H1217 national investment volumes to CA$22. billion comprised of more than over 3,4 transactions. This momentum does not appear to have eased, as several landmark assets have traded since the start of. The most notable such transaction was the sale of a 5% interest in Scotia Plaza for over CA$68 million in August. Capitalization rates have also continued to compress in as a competitive investor landscape, extremely accessible financing and strong leasing fundamentals pushed the national average cap rate to 5.7% to end the quarter. This occurred despite impending interest rate hikes and rising Government of Canada 1-year bond yields. 3 Exhibit 3 - Transaction Volume, Canadian Commercial Real Estate Investment Volume ($B) $4 $3 $2 $1 $ H1 17 Office Industrial Retail Multifamily Land Hotel Projection # of Deals Source: CBRE Research, Realnet Canada, RealTrack Limited, Collette Plante, JLR Land Titles Solutions, Real Capital Analytics, Q k 6k 4k 2k k # of Deals Office Markets Sustained bifurcation across the country resulted in the national office vacancy rate remaining in line with last year, compressing 1 bps from Q3 216 to end at 12.8%. Downtown vacancy rates rose slightly over this period and ended the quarter at 11.1%, while suburban vacancy compressed slightly to 15.%. Overall, vacancy rates in Vancouver and Toronto remained the lowest in Canada at near five-year lows of 8.1% and 8.5%, respectively. Net absorption totaled 1.9 million sq. ft. this quarter, most of which was in Vancouver, Montreal and Calgary. Notably this was the first quarter since 214 in which Calgary s downtown market saw positive absorption. After record levels of new supply were delivered to the market in the second quarter, new supply dropped to a multi-year low of 563,667 sq. ft. in while 1.3 million sq. ft. of new office space was under construction as of quarter end. 3 Exhibit 4 - Office Vacancy Rate Vacancy Rate (%) Vancouver Toronto Ottawa Montreal Vacancy Rate Source: CBRE Research,. Edmonton Calgary National Vacancy Change Y-o-Y YoY Chnage (%) 3 Real Estate Market Outlook provided by CBRE Research. 3 For Institutional Use Only. Not for use with the General Public.

4 Industrial Markets Robust activity across markets resulted in the national industrial availability rate compressing 112 bps year-overyear to a 16-year low of 4.3% in. Most of Canada s major markets continued to experience record tightening, including Alberta, where Calgary experienced a sharp uptick in activity this quarter in response to a strengthening market. Toronto s availability rate dropped to an all-time low of 2.3%, while Vancouver s fell to a 12-year low of 2.6% and Montreal s dropped to a 15-year low of 6.2%. Nationally, demand, as measured by positive net absorption, totaled 6.8 million sq. ft. of which 84.1% took place in Toronto, Montreal and Calgary. Construction and new supply remain well below their five-year averages totaling 11.7 million sq. ft. and 2.1 million sq. ft respectively. The national average net asking rental rate also rose in to CA$6.93 per sq. ft., reflecting growth of 7.2% over the same time last year. 3 Retail Markets CBRE s mid-year survey of select retail REIT portfolios produced an overall national vacancy rate of 3.9%, decreasing 6 bps from 4.5% at year-end 216. This was the first time since the exit of Target from the Canadian marketplace in early 215 where the national vacancy rate came in below 4.%. As a number of retail closures make headlines, and as Sears Canada continues to shed space, vacancy rates are expected to rise again in the near future. This will especially be the case as the secondary or tertiary locations of troubled or defunct retailers come to market prior to new tenants being secured. The Regional Shopping Centre category will be the most affected by these types of large exits, as seen in H2 215 when vacancies rose to 7.9% after the initial Target closures. Power Centre and other smaller formats such as Community, Neighbourhood and Strip, have and are expected to remain relatively stable over this time. 3 Exhibit 5 - Industrial Availability Rate Availability Rate (%) Toronto Vancouver Ottawa Availability Rate Source: CBRE Research,. Montreal Exhibit 6 - Retail Vacancy Rate Vacancy Rate (%) Total Regional Shopping Centre Edmonton Calgary National Availability Change Y-o-Y Power Centre H1 215 H2 215 H1 216 H2 216 H1 217 YoY Chnage (%) Community, Neighbourhood Strip Source: Select retail REIT portfolios, CBRE Research, Q1 & Q For Institutional Use Only. Not for use with the General Public.

5 Multifamily Markets The multifamily sector is one of the most stable in Canada and according to the most recent Canada Mortgage and Housing Corporation (CMHC) data the national rental vacancy rate sits at 3.3%. 4 This trend is expected to persist as the high cost of home ownership has driven many people to look to rental units as a more affordable housing alternative. Affordability in unison with urbanization and positive net immigration could even result in a further tightening of rental vacancy rates moving forward. While vacancies remain low, one key metric to track in the near term will be rental rates. The government has stated they are looking at various ways in which to curb the issue of housing affordability and while the intention is to try and keep rents low, such measures may have unexpected consequences on the market at large. One such example is the rent control measures implemented in Ontario which have already led many developers to reexamine new purpose-built development projects altogether. 3 Exhibit 7 - Home Price, Monthly Rent, & Personal Income Representative Figures (indexed as of January 2) * National Avg. Home Price National Avg. 2-Bdrm Monthly Rent Personal Income Per Capita *217 rental figure is CMHC 216 value adjusted for rental inflation. Source: CREA, CBOC, Statscan, CMHC,. 4 CMHC, as of September 3, For Institutional Use Only. Not for use with the General Public.

6 WHERE TO INVEST IN A VOLATILE WORLD? A CASE FOR CANADIAN COMMERCIAL REAL ESTATE Canadian commercial real estate has delivered strong returns, with low volatility relative to other markets, over the past decade. We believe Canadian economic growth, strong governance and diversified investment markets provide a good environment for consistent, stable commercial real estate returns now and in the future. Strong Stable Economic Growth The performance of commercial real estate is highly correlated with the long-term performance of the overall economy and Canadian economic growth is forecast to be a top performer among G7 countries over the next three years (see Exhibit 8). More importantly, Canada s economy faces smaller downside risk for growth compared to other G7 economies, particularly Eurozone countries that are challenged by political uncertainty both at a domestic and EU level. In addition, Canada s government has the strongest balance sheet among the G7 countries, with considerably lower net debt as a percentage of GDP, which can provide further support for the economy as economic challenges arise. This economic outlook is supportive of healthy commercial real estate returns. Exhibit 8 - GDP Consensus Growth Forecast, G7 Countries Canada United States Germany France United Kingdom Italy Japan Source: Bloomberg, as of September Strong Governance Canadian commercial real estate has demonstrated resilience to the economic episodes that have swept across the globe over the past decade (see Exhibit 9) in large part due to strong governance in both the economy and the commercial real estate markets. Canada ranked ahead of all G7 countries based on a combined score of all factors (see Exhibit 1) in a survey of governance indicators published by World Bank, that includes factors such as Political Stability, Regulatory Quality, Rule of Law, Voice and Accountability, Government Effectiveness and Control of Corruption. 5 A culture of strong governance pervades the commercial real estate market which is dominated by large, respected institutions including well capitalized pension funds, life insurance companies, public corporations and investment trusts. These entities operate in a disciplined (rather than speculative) manner, encouraged by stakeholder and government policies that value thoughtful community development and urban planning. 5 World Bank: Worldwide Governance Indicators, September 29, For Institutional Use Only. Not for use with the General Public.

7 Exhibit 9 Commercial Real Estate, Cumulative Total Return Index, (25 = 1) Exhibit 1 The Worldwide Governance Indicators, G7 Countries, Ranked Based On Average Percentile Great Financial Crisis, '8 Canada Germany UK 18 Japan US 13 France Italy Voice and Accountability Political Stability Government Effectiveness Regulatory Quality Global Canada Europe ex. UK UK USA Rule of Law Control of Corruption Source: MSCI/IPD, Manulife Asset Management, as of Dec 216. Source: World Bank, Manulife Asset Management, as of September 216. Diversified Investment Markets Canada s economy is driven by many different industries and each major market in Canada has its own unique economic characteristics and is impacted by different market drivers. This dynamic became particularly evident after the recent collapse of oil prices and the economic downturn in energy-dependent markets. Over the same period, Ontario, British Columbia, and Quebec enjoyed an upturn in the manufacturing, technology and services sectors which helped stabilize overall economic growth. 6 This diversity benefits the Canadian economy, and by extension, Canadian commercial real estate. Investing in a Canadian commercial real estate portfolio that is diversified across different markets can offer a counterbalancing effect while one market may be depressed, another may be growing. Outlook The effects of the 28 global financial crisis linger in global economies. Canada endured the crisis better than most countries whose steep declines resulted in superior investment opportunities in other markets, most notably in the USA. Following recent years of strong growth and an indication of synchronized growth occurring globally, Canada is poised to continue delivering reliable growth. Canada s stable growth, strong governance and diversified markets suggest we can expect Canadian commercial real estate to deliver more years of risk-adjusted outperformance. 6 More information on Canada s energy and non-energy markets can be found in our Canada Playbook For Institutional Use Only. Not for use with the General Public.

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