Real Assets Market Report - TD Bank, N.A. · 2018-05-18 · Real Assets Market Report. March 31, 2018. Table of Contents. INVESTMENT AND ECONOMIC OUTLOOK ... The national retail vacancy

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Real Assets Market ReportMarch 31, 2018

Table of ContentsINVESTMENT AND ECONOMIC OUTLOOK ................. 4

CANADIAN COMMERCIAL MORTGAGE MARKET ...... 6

CANADIAN COMMERCIAL REAL ESTATE MARKET .... 8

OFFICE ............................................................................. 8

RETAIL ............................................................................. 9

INDUSTRIAL .................................................................... 10

MULTI-UNIT RESIDENTIAL ............................................ 11

GLOBAL INFRASTRUCTURE MARKET ......................... 13

CONCLUSION ............................................................. 14

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Quarter 1, 2018 | Page 4

Consensus views that the next recession is at least one or two years away appear reasonable, given positive leading indicators and a penchant for central banks to default into accommodative postures at signs of uncertainty. We think there is also a chance that the cycle extends beyond consensus views to three years or more.

The global economy is benefitting from sustained growth in the U.S. and China, as well as a turnaround in Europe. Notable is the recovery in Japan, which recently posted eight quarters of positive economic growth for the first time in 20 years. China’s consumer is successfully taking over from fixed-asset investment and the export sector as the engine of the economy. This is a structural shift that we believe will create new opportunities for investors who can access companies exposed to the burgeoning middleclass. While perhaps mistimed, the U.S. tax cut is providing a late cycle boost to an already robust economy. Forecasting agencies are responding and continue to revise upwards their GDP growth outlooks.

The recent rise in volatility appears to us as a healthy correction and we do not believe it will derail synchronous global growth or the path of central bank normalization. We remain constructive on equities as earnings growth momentum remains strong and is supported by underlying fundamentals.

Unemployment rates in the U.S., Germany, Japan and Canada are all near pre-crisis lows, indicating capacity constraints may be looming. Central banks are also removing monetary stimulus with the U.S. Federal Reserve taking the lead. We believe that global central banks will continue to follow. There is also the chance that deglobalization and trade wars increase consumer prices and interest rates in the long run.

We are conscious of the fact that unintended disruptions often occur when the rate structure moves higher than expected. While the growth outlook is strong, we believe a continued focus on risk management is important as financial assets are exposed to shifting landscapes. The first quarter of 2018 was a reminder of financial asset volatility, with negative local currency returns across equity regions.

In the upcoming quarters, we believe investors should begin the process of fortifying their portfolios and reducing unstable longer-term risks.

Our real estate, mortgage and infrastructure views also reflect a bias for quality assets that are well suited for the later stages of an economic expansion. In our real asset and mortgage portfolios, we continue to have a strong focus on investments with sustainable cash flows and high credit quality. For real estate, we have sought acquisitions where demand is supported by robust demographic trends and stable underlying fundamentals. We recommend vigilance for real estate strategies that employ high degrees of leverage, as this tends to increase equity market correlations at times when diversification is most needed. We believe that a global lens for infrastructure continues to provide flexibility to navigate sector and geographic positioning, particularly if global protectionist sentiment continues. While prices are high across asset classes, we believe the relative value of real assets is attractive compared to stocks and bonds.

Investment and Economic Outlook

Bay Adelaide CentreOffice | Toronto, ON

Greystone.ca/Mortgages


Government of Canada (“GoC”) bond yields increased by 10 basis points (“bps”) to 1.96% for five-year terms and by five bps to 2.09% for 10-year terms. Expectations for the Bank of Canada to raise its overnight rate throughout 2018 persists; however, tempered GDP growth and uncertainty around trade policy may keep further rate rises at a moderate pace.

Figure 1: GoC Bond Yields

Q1-2017 Q4-2017 Q1-2018

5-Year 1.11 1.86 1.96

10-Year 1.62 2.04 2.09

Deal flow continues to be strong in the Canadian commercial mortgage market. Commercial mortgage origination activity reached a record level of $50 billion in 2017 (see Figure 2). This is a 4.6% increase from the prior year. Banks continue to represent the largest component of the commercial lending market at 28.8%, followed by National Housing Act insured mortgages at 16.0% and private/public investment managers at 14.5%1. We anticipate lending activity to be strong for core assets in major markets throughout 2018, whereas we expect there will be less lending capital available for non-strategic assets (i.e. power centres in secondary markets).

Figure 2: Commercial Mortgage Origination Activity

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Source: CMLS Financial. As at Dec 31, 2017.

The high level of lending capital in the mortgage market and strong overall real estate fundamentals resulted in spreads compressing over the quarter by five basis points for five-year and 10-year term mortgages. However, the resulting increase in bond yields negated the spread compression, which led to a stable absolute yield.

1 CMLS Financial. As at Dec 31, 2017.

Figure 3: Five-year Mortgage Spread Range

125

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Mar17

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Source: CMLS Financial. As at Dec 31, 2017.

Lenders continue to remain disciplined in their underwriting process. Given the capitalization rate compression in some major markets, the underlying property’s cash flow generation (i.e. debt service coverage) and stability of the tenant roster are important considerations when determining the appropriate loan to value (“LTV”) ratio. As a result, we anticipate that some lenders in major markets, such as Vancouver, British Columbia, may underwrite to lower LTV ratios.

Canadian Commercial Mortgage Market

One YorkOffice | Toronto, ON

FCC TowerOffice | Regina, SK

Greystone.ca/RealEstate


Office

The national office vacancy rate was 12.5% as of Q1-2018. This is a decrease of 47 bps from the previous quarter. Excluding Alberta, the national vacancy rate is 9.8% (see Figure 4).

Figure 4: National Vacancy

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%

National National (Excluding Alberta)

Source: CBRE Limited. As at Mar 31, 2018.

2017 had 6.3 million square feet of positive absorption (leasing activity), which reflects the highest level of demand for office space since 2011. This trend continued in the first quarter of 2018 with office leasing activity reaching 2.1 million square feet, more than double the amount in Q1-2017 (see Figure 5). In fact, Calgary saw positive absorption for the first time since 2014.

Figure 5: Leasing Activity

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On average, there is 6.3 million square feet of completions each year. The yearly completions forecast over the next five years are below that of the long-term average. The majority of new construction projects are focused on the downtown Toronto market.

Technology and business service tenants are expected to drive demand with some co-working service providers also entering the market, including WeWork.2

At a national level, approximately 13.1 million square feet of construction activity is underway (see Figure 6), most of which is occurring in Toronto and Vancouver. Despite active construction, RBC Capital Markets predicts vacancy could still trend lower due to limited near-term supply and strong demand in the downtown Toronto and Vancouver markets.3

Figure 6: Construction Activity

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2 CRESA Oct 20, 2017.3 RBC Capital Markets Jan 12, 2018.

Canadian Commercial Real Estate Market

320 Bay StreetOffice | Toronto, ON


The national retail vacancy rate is 6.2% as at H2-2017 (see Figure 7). This is a 181 bps increase from H1-2017, primarily as a result of increased vacancies from Sears’ closures that materialized over the second half of 2017. Although Target had a similar amount of square feet upon liquidation in 2015, the closure did not materially impact the vacancy figures shown below due to two primary reasons. First, approximately 33% of the space was bought by other major retailers prior to store closures. Second, the scheduling of the vacancy survey done by CBRE Limited provided landlords adequate time to lease up space prior to when the survey was completed.

Figure 7: Retail Vacancy

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Q4-05 Q4-07 Q4-09 Q4-11 Q4-13 Q4-15 Q4-17

%

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Source: CBRE Limited. As at Dec 31, 2017.

Annual Canadian core retail sales (excluding automobiles, parts and gasoline) were up 4.7% in 2017 equating to an 11-year high (see Figure 8).

Figure 8: Retail Sales Annual Growth

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Source: Statistics Canada 2017.

National mall sales productivity increased in 2017 to $770 per square foot from $761 per square foot in 2016. British Columbia, Ontario and Alberta lead all provinces (see Figure 9).

Figure 9: Canadian Mall Sales Productivity

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Source: ICSC 2017.

Landlords will continue to focus on a diverse tenant mix and unique product offerings as a result of shifting consumer behaviour. Over Q1-2018, luxury goods and discount retailers experienced growth. Brands such as Nordstrom Rack entered Canada for the first time and Winners/HomeSense unveiled its 62,000 square foot store in Edmonton, making it their largest location. Plans by these retailers to expand across Canada in 2018 present landlords with opportunities to reposition vacant space formerly occupied by Sears and Target.4

4 Retail Insider. Mar 29, 2018.


Retail

Deerfoot CityRetail | Calgary, AB


National availability rates reached a 15-year low of 4.0% in Q1-2018 (see Figure 10).

Figure 10: National Availability Rates

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Currently at $7.10 per square foot, the average net rent in Canada continues to trend upwards due to exceptionally strong demand. Vancouver and Toronto lead in year-over-year net rent growth at 25.6% and 11.2%, respectively (see Figure 11). The growth of e-commerce has had an impact on the demand in the industrial market as companies within this space require distribution and warehouse facilities closer to their consumers. CBRE Limited estimates that for every $1.0 billion of e-commerce sales, an additional 1.25 million square feet of distribution space is required.

Figure 11: National Average Net Rent

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The national construction pipeline remains modest at 13.1 million square feet relative to its five-year average of 14.7 million square feet, further increasing the need for industrial space. In Vancouver, construction as a percentage of its market inventory is only 2.4% due to significant land constraints (see Figure 12). While new industrial space is expected in Toronto and Vancouver, JLL forecasts vacancy to decline and asking rents to rise.

Figure 12: Construction Activity

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GTAA LandsIndustrial | Mississauga, ON


Industrial


It is predicted that Canada’s population grew to 36.7 million in 2017, representing over a 4.4% increase from 2016.5 International immigration, which drives the majority of population growth, is most significant in Ontario and Québec where it receives the largest share of immigrants at a provincial level (Figure 13). Additionally, the Government of Canada will raise its immigrant intake to 340,000 annually by 2020, which should continue to drive population growth. Immigrants generally have a higher propensity to rent, which is and will continue to be one of the main contributors to rental demand.

Figure 13: Share of International Immigrants Received by Province

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2013 2014 2015 2016 2017

%

British Columbia Alberta Prairies Ontario Québec Atlantic Canada

Source: Statistics Canada. As at December 2017.

A slowdown in purpose-built residential supply was experienced in 2017 and CBRE Limited forecasts that new supply in the next two years will continue to decrease (see Figure 14).

Figure 14: Multi-unit Residential Units New Supply

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Source: Canada Mortgage and Housing Corporation and CBRE Limited. As at December 2017.

The lack of supply and strong demand for purpose built rentals has led to low vacancy rates, particularly in Toronto and Vancouver. While Calgary and Edmonton have experienced increasing vacancy rates in the past four years, both cities saw a decrease in 2017. (see Figure 15).

5 Statistics Canada. As at December 2017.

Figure 15: Vacancy Rate

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%

Overall Vacancy Year-Over-Year Change

Source: CMHC. As at October 2017.

Looking forward, the supply and demand imbalance in the multi-unit residential market will likely lead to further rental growth.

8515-8532 Jasper AvenueMulti-unit Residential | Edmonton, AB


Multi-unit Residential

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Social Circle Solar FarmGeorgia, USA

Greystone.ca/Infrastructure


1,547 transactions totaling US$437.1 billion closed globally in 2017 with power, renewables and transportation sectors accounting for 34%, 27%, and 25% of deal value, respectively. Investment in Brownfield projects accounted for US$177.1 billion in deal value, up from US$171.3 billion in 2016 and represents an increase of more than 77% from US$100.3 billion in 2014. This highlights a continued demand for Brownfield infrastructure assets among fund managers.6

Figure 16: Sector Activity by Value

4%

25%

28%

37%

3%

1%

2%4%

27%

25%

34%

3%3% 4%

Social Infrastructure

Renewables

Transport

Power

Environment

Other

Telecoms

2016

2017

Source: Inframation Deals FY17 Project Finance League Table and Trend Report, Infra-Deals, 2017.

Unlisted infrastructure funds raised a total of US$53.6 billion in 2017, US$2.2 billion shy of the US$55.8 billion secured in 2016. With an unprecedented volume of capital available, competition for assets remains high, compelling investment managers to seek alternative strategies to deliver risk-adjusted returns, such as moving away from traditional infrastructure assets and seeking assets with infrastructure-like characteristics. This includes energy metering, telecommunications towers, and data centres.7

Figure 17: Global Unlisted Infrastructure Fundraising 2006-2017

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Source: Fundraising Round-Up 4Q17: Another Strong Year, But 2018 May Falter, Infra-Deals, 2017.

North AmericaAlberta has become the focus of renewable investment in Canada, having made significant strides towards greater renewable procurement. Alberta’s Renewable Electricity

6 Inframation Deals FY17 Project Finance League Table and Trend Report, Infra-Deals, 2017.7 Fundraising Round-Up 4Q17: Another Strong Year, But 2018 May Falter, Infra-Deals, 2017.

Program is intended to encourage the development and interconnection of 5,000 MW of renewable electricity generation capacity by 2030. After awarding 595 MW of wind generation in December 2017, the Alberta Electric System Operator (“AESO"), responsible for implementing and administering the program, expects to procure up to 300 MW of renewable energy projects in round two. AESO is prioritizing indigenous group involvement by requiring bidders to include 15-20% equity ownership from indigenous groups.8

Australian highway developer Transurban Group has agreed to buy the A25 toll road and bridge in Montréal, Canada from Macquarie Infrastructure Partners for US$650 million. The purchase price represents a high9 EBITDA multiple of 26x for the highway. The road has demonstrated exceptional traffic numbers over the last seven years and will receive income from availability payments, guaranteed minimum payment and tolls. As a critical link in a heavily congested urban area, owning the motorway presents opportunities to drive value through operational efficiencies, upgrades to customer products and network enhancements.10

EuropeThe European Commission estimates that €180 billion must be invested annually in green and sustainable projects for the European Union to meet its 2030 climate and energy target. To achieve this target, the Commission adopted a new action plan for sustainable finance, with plans to introduce a regulatory incentive to boost lending for renewables and other green assets. The Commission will explore the feasibility of a proposal that would ease capital requirements for lending to green projects, allowing banks to lower the amount of shareholder capital required to be held against the asset being lent to.

In the U.K., the volume and value of Greenfield transactions by U.K.-based investors slowed in 2017 due to a limited project pipeline and lack of government initiatives. However, investments in Brownfield assets by U.K.-based investors in the first half of 2017 exceeded the total value of Brownfield transactions in 2016 as investors looked to Brownfield assets for established revenue streams and the absence of construction risks.11

8 Details Emerge on Alberta’s Follow-on 700 MW Renewable Tender, Infra-News, 2017.9 The Infrastructure Opportunity-Listed versus Unlisted, Rare Infrastructure, 2016.10 Transurban Wins A25 Toll Road, Infra-News, 2017.11 Strong Foundations for growth: How U.K. investors view the infrastructure landscape, Infra-News, 2017.

Global Infrastructure Market


Greystone claims compliance with the Global Investment Performance Standards (GIPS®). A GIPS® compliant presentation is available upon request. Greystone has been independently verified for the period January 1, 2000 to December 31, 2016. The verification report(s) is/are available upon request. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS® standards on a firm-wide basis and (2) the firm’s policies and procedures are designed to calculate and present performance in compliance with the GIPS® standards. Verification does not ensure the accuracy of any specific composite.

This report is confidential and no part of this material may be duplicated by any means for distribution to any person who is not an employee, officer, director or authorized agent of the recipient without Greystone’s prior written consent.

This report is for informational purposes only. It is not meant as investment advice and is not an offer, solicitation or recommendation to purchase or sell any security. There is no assurance that any predictions or projections will actually occur. Past performance is not necessarily indicative of future results. Commentary reflects the opinions of Greystone Managed Investments Inc. as of the date of the document. This document was developed from sources believed to be reliable, but is not guaranteed to be accurate or complete.

Greystone is a registered portfolio manager, exempt market dealer and investment fund manager.

* An eligible employee is defined as contributing one or more years of service to Greystone.

© Greystone Managed Investments Inc. All rights reserved.

The Canadian commercial real estate and mortgage markets continue to be active in Q1-2018. Office demand remains strong in Toronto and Vancouver. Retail properties, particularly super regional centres, offer opportunities for repositioning. The need for industrial space is still evident as availability rates continue to decline. Population growth in Canada will contribute to the demand and supply imbalance for purpose-built rentals.

2017 was characterized by strong fundraising from unlisted infrastructure funds and robust deal flow in the renewable energy and transportation sectors, accounting for 52% of total transaction value.12 In the U.K., headwinds such as political uncertainty around Brexit and continuing foreign exchange volatility pushed investors to look further afield in search of returns.13

12 Inframation Deals FY17 Project Finance League Table and Trend Report, Infra-Deals, 2017.13 Strong Foundations for growth: How U.K. investors view the infrastructure landscape, Infra- news, 2017.

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Real Assets Market Report - TD Bank, N.A. · 2018-05-18 · Real Assets Market Report. March 31, 2018. Table of Contents. INVESTMENT AND ECONOMIC OUTLOOK ... The national retail vacancy