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THE POWER OF DISCIPLINED INVESTING®
Real Estate Market Report
December 31, 2014
There continues to be domestic and global capital available for well-located, core real estate in Canada. CBRE Limited has revised their projections of cumulative investment volume for 2014 to $26.5 billion compared to $26.8 billion in 2013.1 With the drop in the Government of Canada (GoC) yield in 2014 and the corresponding drop in the overnight rate in 2015, bond yields have been volatile. However, capitalization rates have remained relatively unchanged and core real estate continues to be competitively priced.
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1 CBRE Limited.
333 Seymour StreetOffice, Vancouver, BC
Quarter 4, 2014 | Page 4
Oil prices declined from over US$100 per barrel in June 2014 to around US$53 per barrel as at December 31, 2014. RBC Economics is projecting a negligible impact on national real Gross Domestic Product (GDP).2 The weakness in the energy sector should have a divergent impact at the provincial level.
Figure 1: Oil Prices
0
20
40
60
80
100
120
2013 2014
Oil
Pri
ce P
er B
arre
l ($
)
WTIBrent
Source: Bloomberg. As at Dec 31, 2014.
The Canadian economy is forecasted to grow 2.5% in 2014 and 2.7% in 2015; non-energy producers (i.e. manufacturers and exporters) should help counter some of the negative effects of lower energy prices.3 The lower energy prices can also act as a stimulus for consumers due to increased disposable income. However, the negative direct impact of lower oil prices on the economy will be more immediate than the offsetting positive impacts of higher exports, increased manufacturing and higher consumer spending.
Figure 2: Exports & Consumer Spending Growth Forecast in Canada
0
1
2
3
4
5
6
7
2012 2013 2014F 2015F 2016F
YO
Y %
Ch
ang
e
Exports
Consumer Spending
Source: RBC Economics. As at December 2014.
Job gains increased in the second half of the year and, correspondingly, the unemployment rate declined to 6.6% in November. This is a level that economists consider full employment in Canada.4 However, wage growth has not kept up in recent years and low energy prices will likely present headwinds for Canadian job growth in 2015.
Figure 3: GDP & Inflation Growth Forecast in Canada
0
0.5
1
1.5
2
2.5
0
0.5
1
1.5
2
2.5
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3.5
Q4-14F Q4-15F Q4-16F
YoY
% C
han
ge:
Hea
dlin
e In
flat
ion
QoQ
An
nu
aliz
ed %
Ch
ang
e: R
eal
GD
P
Real GDP [LHS] Inflation [RHS]
Source: RBC Economics. As at December 2014.
As growth and inflation pick up in the United States, the U.S. Federal Reserve may consider raising the overnight rate. This would put upward pressure on GoC yields. The decline in interest rates through 2014 emphasizes that there is volatility associated with the expected increase in yields.
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2 Bloomberg.3 RBC Economics. December 2014.4 Statistics Canada.
Investment Market
Whirlpool Distribution CentreIndustrial, Milton, ON
Quarter 4, 2014 | Page 5
Figure 4: Comparison of 10-year GoC Yields and 10-year U.S. Treasury Yields
0
1
2
3
4
5
2010 2011 2012 2013 2014 2014
Yie
ld (
%)
10 Yr. GoC Yield
10 Yr. U.S. Treasury Yield
Source: Bloomberg. As at Dec 31, 2014.
During 2014, bond yields trended downwards and the 10-year GoC yields ended the year at 1.79% (Figure 4), almost 100 basis points (bps) lower than the end of 2013. Subsequent to year-end, 10-year bond yields declined even further to 1.26% as at January 30, 2015 due to Bank of Canada’s unexpected rate cut. Commercial mortgage rates have followed overall interest rate levels; but to a lesser extent due to an increase in mortgage spreads. Lenders have also started implementing floor rates.
The supply of mortgage capital in the market is expected to remain prevalent into 2015. Lenders are focused on securing shorter terms to reduce interest rate risk, given the low yield environment. Likewise, borrowers are aiming to lock in long-term debt. This supply and demand imbalance, due to the availability of mortgage capital, has created more opportunities for borrowers.
Figure 5: Comparison of 5-year GoC and Mortgage Rates
5.9%
1.7%1.6%
14.3%
10.3%
8.3%6.2%
3.2%
0
5
10
15
1987 1990 1993 1996 1999 2002 2005 2008 2011 2014
%
5-Year GoC
5-Year Commercial Mortgage
Source: RBC Capital Markets. As at Dec 31, 2014.
77 Bloor Street WestOffice, Toronto, ON
Quarter 4, 2014 | Page 6
Figure 7: Calgary Downtown vs. Suburban Market Vacancy
0
4
8
12
16
20
2006 2008 2010 2012 2014
%
Suburban
Downtown
Source: CBRE Limited. As at Dec 31, 2014.
Having a diversified tenant base, lease terms, property types, locations and risk strategies are key risk reduction measures in commercial real estate. For example, given the current oil prices, a lower Canadian dollar and a growing U.S. economy, Ontario and Quebec may be beneficiaries, which can help to smooth out risk from oil dependent markets. In addition, having non-energy dependent tenants, such as government tenants, would do the same.
The fourth quarter vacancy rate was 10.7%.5 This was an increase of 40 bps from the previous quarter and a 100 bps increase from the start of the year. With new supply coming to the market in the next two years, we may see some pressure on rents, vacancy, and increased subleasing activity in energy dependent markets such as Calgary and Edmonton. However, direct real estate tends to lag the overall market (due to the length of lease terms) and there would need to be an extended period of low energy prices to impact underlying real estate fundamentals.6 In addition, due to a shortage of highly skilled workers, energy firms are reluctant to lay off engineers and geologists.7
Figure 6: Calgary Net Rent and Vacancy History
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30
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40
0
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18
2006 2008 2010 2012 2014
Net
Ren
t P
SF (
$)
Vacan
cy (
%)
Net Rent
Vacancy
Average Vacancy
Source: CBRE Limited. As at Dec 31, 2014.
Larger markets tend to have more productivity advantages with access to an extensive workforce, knowledge and ideas. These cities tend to recover faster during major shocks relative to tertiary markets. After the 2008–09 financial crisis (when capital markets froze and oil prices dropped), Calgary rents and vacancy rates started to recover within a few quarters after reaching the peak for vacancy and trough for net rents (Figure 6). We are anticipating more of a “U” shaped (longer) recovery versus what has historically been a “V” shaped recovery for oil.
Office
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5 CBRE Limited. 6 BMO Capital Markets. 7 CBRE Limited.
11 King Street WestOffice, Toronto, ON
Quarter 4, 2014 | Page 7
There is 19.5 million square feet of industrial space under construction, which represents 1.1% of total inventory.8 Demand continues to be robust for logistics and distribution tenants that typically require newer generation facilities. Availability rates continue to be stable at 5.5%.9
Figure 8: Construction as a % of Inventory
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
Q1-06 Q1-08 Q1-10 Q1-12 Q1-14
%
Construction as a % of Inventory
Source: CBRE Limited. As at Dec 31, 2014.
Figure 9: Development by City
0
1
2
3
4
5
6
7
8
Vancouver Calgary Edmonton Winnipeg Toronto Ottawa Montreal Halifax
Sq
uare
Feet
[Millio
ns]
Source: CBRE Limited. As at Dec 31, 2014.
With the drop in energy prices and the lower Canadian dollar, increasing net exports and e-commerce should help support the industrial property type.
Canada should see positive benefits by being the United States’ largest trading partner. The U.S. economy is projected to grow at the fastest rate in a decade and lead the global economy due to U.S. unemployment falling to pre-recession levels, increased consumer spending and business investment. The lower Canadian dollar should support Canadian exports and bolster demand for industrial space.
Online sales are projected to grow from $15.2 billion in 2010 to $34 billion by 2018.10 Industrial properties should see additional demand due to this growth.
Figure 10: Industrial Q4-2014 Availability Rates
National Vacancy Rate 5.5%
0
1
2
3
4
5
6
7
8
9
Vancouver Calgary Edmonton Winnipeg Toronto Ottawa Montreal Halifax
%
Q4-14
Q4-13
Source: CBRE Limited. As at Dec 31, 2014.
Industrial
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8 CBRE Limited. December 2014.9 Ibid.10 Statistics Canada, Forrester Research, CBRE Limited.
3400 Rue Raymond-Lasnier (Adidas Distribution Centre)Industrial, Montreal, QC
Quarter 4, 2014 | Page 8
With online sales forecasted to grow at a healthy rate in Canada, we anticipate that there is going to be stiff competition between the discount department stores and online competitors.11 Retailers that are well located and able to create an omni-channel presence are likely to withstand these changes. CBRE Limited notes that luxury and discount sectors are likely to be the beneficiary over mid-market retailers in the coming year. The retail occupancy rate is forecasted to be 95.5% by year-end.12
Target’s announcement that it is closing its Canadian operations will likely create both opportunities and challenges for landlords. The 15 million square feet of retail space coming back to the market will likely increase vacancy rates and create opportunities for redevelopment. Destination type shopping centres should be able to quickly fill the space.13
As at October 2014, retail sales were up 4.9% from the previous year.14 The forecast for 2015 and 2016 are 4% and 3.8% respectively.15
Canadians used 42.9 billion liters of fuel in 201316 and this is forecasted to be higher in 2014. It is estimated that households would save approximately $12 billion in 2015 if current gas prices hold.17 CIBC indicates that the savings gained from the pumps is likely to be spent in the stores. As noted previously, lower oil prices are likely to have a divergent impact across the provinces. Consumer confidence will likely be negatively impacted by the drop in oil prices for energy dependent markets and consumers could scale back spending. Shoppers in Ontario and Quebec, on the other hand, are more likely to spend the extra savings. The current economic environment (especially the lower Canadian dollar and growing U.S. economy) could also attract U.S. consumers to Canada.
Figure 12: Retail Q4-2014 Availability Rates
National Vacancy Rate 5.0%
0
1
2
3
4
5
6
7
Vancouver Calgary Edmonton Winnipeg Toronto Ottawa Montreal Halifax
%
Q2-14
Q2-13
Source: RBC Economics. As at Jun 30, 2014.
Figure 11: Canadian Fuel Use
40.0
40.5
41.0
41.5
42.0
42.5
43.0
43.5
2009 2010 2011 2012 2013
Gaso
lin
e a
nd
Oth
er
Petr
ole
um
Fu
el
So
ld (
$ B
illio
n)
Source: Statistics Canada. As at Dec 31, 2013.
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11 CBRE Limited.12 Conference Board & Centre for Study of Commercial Activity.13 Triovest.14 Statistics Canada.15 RBC Economics.16 Statistics Canada.17 Globe and Mail. Canadians could save $12-billion at the pumps if oil stays low in 2015. Jan 2, 2015.
Retail
Holt Renfrew CentreRetail, Toronto, ON
Quarter 4, 2014 | Page 9
Figure 13: Multi-unit Residential Vacancy Rate
0
3
5
8
10
2007 2009 2011 2013
%
National Average Vacancy
Source: Canada Mortgage & Housing Corporation. As at October 2014.
Figure 14: Immigration to Canada
0
50
100
150
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300
1973 1983 1993 2003 2013
Th
ou
san
ds
Immigrants
Source: Statistics Canada (From Jul 1 to Jun 30). As at July 2014.
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18 Canada Mortgage and Housing Corporation. 19 Ibid.20 CBRE Limited.21 Toronto Star. Jan 27, 2015.22 Toronto Star and Urbanation. 23 Canada Mortgage and Housing Corporation.24 Statistics Canada. July 2014.
There continues to be investment demand for the multi-unit residential property type. The stable demand and a lack of supply have kept the vacancy rate at 2.9%. Vacancy rates have remained below 3% over the last four years.18
Oil prices and in-migration are highly correlated in Alberta. Therefore, the strong growth in population, and corresponding low vacancy, that was witnessed over the last few years may decline in 2015. In 2014, Alberta had the highest average rental rate ($1,103), the highest average rental growth (8.1%) and the lowest vacancy rate (1.8%).19
Uncertainty in the energy dependent markets may also hold off potential homebuyers and keep them in the rental market.
There continues to be a limited number of purpose built, multi-unit residential construction projects underway. Vancouver had the largest amount of construction starts underway in the first half of 2014 accounting for 1.2% of total inventory (which is approximately 1,200 units).20 In Toronto, there was a recent announcement of a condo complex being converted to rental apartments; this is likely due to growing interest in the rental market.21 An Urbanation study found that people were willing to pay a premium for professionally managed rentals for the long-term security it provides.22
We should continue to see demand for multi-unit residential properties across Canada; expected immigration flows continue to support rental demand for multi-unit residential properties. Occupancy rates were up or stable for 24 of the 35 markets covered by CMHC. The average national occupancy rate is 97% and the two-bedroom apartment rents are up 2.4% from last year to $915.23
Multi-unit Residential
The Canadian government has set a target of 285,000 new immigrants in 2015, which is an increase of about 20,000 people from the target set in 2014.24 This is the largest increase in recent history and should continue to support housing demand into 2015.
345 Rue de la GauchetiereMulti-unit Residential, Montreal, QC
Quarter 4, 2014 | Page 10
Greystone.caThis document 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 Managed Investments Inc. All rights reserved.
We are closely monitoring the health of the office markets in key oil dependent provinces, such as Alberta. In particular, we are monitoring development activity in cities such as Edmonton and Calgary. If oil prices remain depressed, this could reduce demand for office tenants linked to the oil industry.
Well-leased properties with strong, long-term covenants that help support a steady income stream will drive performance. With the spread between capitalization rates and bond yields widening in January to record levels, we believe that demand will continue to be robust for institutional-grade assets in core markets.
FOR FURTHER INFORMATION
PLEASE CONTACT:
Nazmin GuptaVice-President, Product Specialist
(416) 309-2188
Andrew Croll, CFA
Product Specialist
(416) 309-2587
Conclusion
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Greystone.ca
(02/2015)
Headquartered in Regina, with additional offices in Winnipeg, Toronto and Hong Kong, Greystone Managed Investments Inc. is one of Canada’s largest asset managers, providing investment management services to its broad client base since 1988.
