Higher interest rates continue to dampen enthusiasm for commercial real estate, both CBRE and Colliers note in second-quarter reports exploring cap rates and market conditions for different asset classes and markets across Canada.
Cap rates continued to trend higher across most major asset classes, with the national average all properties yield rising 16 basis points quarter-over-quarter to 6.28 per cent in Q2, according to CBRE’s report.
While real estate spreads tightened quarter-over-quarter due to a rebound in bond yields, they’ve continued to widen and have risen 56 basis points over the past four quarters to 301 basis points, CBRE chairman Paul Morassutti wrote.
Overall Q2 commercial real estate investment activity was softer than expected.
Office, industrial and retail
Office investment remains muted due to uncertainty regarding people returning to offices and hesitancy from lenders, according to the Colliers report.
Class-AA, class-A and class-B office cap rates rose in the quarter, with downtown properties seeing a slightly larger increase than suburban product.
The cap rate spread between class-AA and class-A and class-B assets grew by a larger margin downtown than in the suburbs, where the spread held relatively steady.
While industrial leasing remains strong and it’s still a landlord’s market, the unprecedented leasing boom of the last few years — with 50 per cent-plus year-over-year rent growth in some markets — has tapered off.
Cap rates for both class-A and class-B industrial assets rose in the quarter, with class-A increasing at a higher rate.
Basic retail continues to perform extremely well despite inflationary pressures and interest rate hikes, with grocery-anchored retail attracting investors.
Retail redevelopment potential is becoming an increasingly important consideration for investors.
Intense pressure for more housing, combined with government decisions to loosen zoning in major markets, may introduce extra value for low-density assets such as suburban malls.
National retail cap rates across regional, power, neighbourhood, strip and urban street-front retail continued to rise, while strip (non-anchored) assets saw yields hold flat quarter-over-quarter.
Among the categories that saw cap rates rise, the yield expansion was relatively uniform with increases averaging 15 basis points quarter-over-quarter, according to CBRE.
Multifamily, seniors housing and hotels
Canada’s record-breaking population growth, combined with severely unaffordable home ownership, has buoyed the apartment investment market even in a high-interest-rate environment. Multifamily cap rates remain extremely low based on expectations of double-digit rent growth and strong investor demand.
Cap rates rose marginally, with yields holding steady across most markets. Relative to other asset classes, the national average cap rate for all multifamily categories rose at a much slower pace of four basis points quarter-over-quarter to 4.43 per cent, CBRE national apartment group vice-chairman David Montressor wrote.
Seniors housing investment activity in the quarter continued to be dominated by distressed assets and/or owners paired with buyers for whom the assets have strategic value. The sector continues to record meaningful rent growth that should minimize or eliminate interest rate effects on cap rates for well-positioned assets.
The lodging market is experiencing a surge, with many markets achieving new heights in average daily rates. Among the factors are the faster-than-expected return of leisure travellers and the utilization of hotels for refugees and social lodging.
Preliminary hotel investment volume in the first half of 2023 surpassed $900 million, significantly above the $550 million in the first half of 2022 and exceeding the $830 million in the first half of 2019.
Hotel cap rates held stable as upward pressure from underwriting higher debt costs is offset by hotel operating fundamentals outperforming annual budgets.
Vancouver and Victoria
Vancouver already has the lowest office vacancy rate in North America and the market is expected to improve further as more employees return to offices and the workforce continues to grow.
Vancouver’s industrial and retail sectors are performing well, with excellent fundamentals that will likely mitigate any further upward pressure on cap rates.
Industrial lease rates remain at record highs while the retail sector is experiencing average cap rates well below the national average of six to seven per cent.
Investor interest remains strong in apartment buildings, although cap rates continue to move upward on some deals.
While office investment activity in Victoria was non-existent, vacancy remained stable.
Industrial properties continue to record increases in asking rents.
Rental housing shortages, a scarcity of prime development sites and the lengthy land entitlement process are keeping investment activity strong in the new build/forward sale multifamily market despite heightened construction and financing costs.
Calgary, Edmonton and Winnipeg
Buildings that can be converted into multifamily comprised the bulk of the office transactions in Calgary’s downtown core, with the main catalyst being the city’s grant program.
Industrial and multifamily assets continue to be the most sought-after assets for investors as vacancy rates are at, or near, historically low levels.
Low industrial vacancy is driving lease rates higher while limited supply and rising construction costs contribute to a tight market for owner-user facilities.
Retail demand is mostly focused in the anchored sector, with small unanchored strip centres also seeing liquidity.
Edmonton office investment remains weak while strong tenant demand continues to fuel the industrial market.
While a healthy economy and consistent tenant demand have prevented increases to retail vacancy, there’s been little new construction.
Multifamily continues to strengthen due to strong employment and population growth. Private capital dominates the investor landscape; institutional investors are largely on the sidelines due to capital markets volatility.
Hotel investment activity has been brisk in expectation of rising net income. Financing remains difficult, however, although it continues to evolve and improve.
Momentum built in Winnipeg’s industrial market with a 10-basis points decrease in availability rates to 2.1 per cent in the quarter.
The city’s multifamily market continues to hold steady as the rental economy remains competitive.
Toronto, Kitchener-Waterloo and Ottawa
Industrial continues to be the most in-demand asset class in Toronto. Leasing remains strong, with rates supported by low vacancy. Investor and end-user demand for properties has provided good support for values.
Office continues to be the most challenging asset class, with less financing availability and limited investor interest.
Investor demand for multifamily remains strong, with limited new supply and rental growth driving performance in existing buildings.
Underlying office market fundamentals are strong in certain areas of Waterloo Region and weak in others, leaving more questions than answers for potential investors.
Several office buildings have been sold for conversion purposes.
While there’s demand for industrial space and the fundamentals remain strong, significant pricing gaps remain.
The retail market has been showing more signs of activity.
Sales volume is up in multifamily. Institutional buyers still aren’t active, however, as private purchasers drive the market.
The Ottawa office market continues to evolve in the face of increasing vacancy and downward trending rental rates.
Adaptive reuse strategies for obsolete federal government buildings that will be deemed surplus are expected to continue. Several residential conversion projects have been delivered.
Investors continue to seek out opportunities in the multifamily market to capitalize on increasing rental rates.
While retail rental rates in prime locations continue to rise, the downtown core is struggling with upwards of 35 per cent of all retail space currently vacant.
Montreal, Quebec City and Halifax
Investors continue to gravitate toward short-term leased industrial properties in Montreal, with increasing activity from private capital. Net rents have normalized with moderate growth versus the historic increases over the past two to three years.
Limited availability of debt capital continues to hamper office investment; active office buyers have predominantly been value-add investors and users. Rents have begun to soften, due mostly to the sub-lease market.
Demand for necessity-based retail assets continues to be strong, with interest from both institutional and private capital. Small strip centres are starting to trade, as are community and grocery-anchored investments.
Multifamily assets remain attractive, as a lack of supply exerts upward pressure on rents. Most deals are being done by private investors.
Developers, however, are putting multifamily projects on hold due to inflation and higher borrowing and labour costs.
In Quebec City, industrial rents are rising fast and vacancy rates remain low.
Although rents remain stable, office vacancy rates are increasing in many sectors. Suburban offices and anchored retail are garnering interest from private local investors.
Low vacancy and little availability are keeping upward pressure on multifamily rental rates.
Multifamily and land transactions made up the bulk of investment trade dollar volumes in Halifax for the first half of 2023. Both sectors continue to be in demand, especially newly constructed apartments.
Multifamily construction continues despite ongoing cost pressures, as demand outpaces supply and record-setting rents are being achieved.
The industrial market remains the strongest sector, with low vacancy rates and continued upward pressure on rental rates. Industrial trade activity is being driven by owner-occupiers.
While office vacancy rates remain challenging, there are some positive indications of absorption and market rents.
Retail investment remains muted, although vacancy is trending downwards and rents are rising.
Regency Centers Corp. on Friday completed its acquisition of Urstadt Biddle Properties in a $1.4B all-stock transaction.
The previously announced deal will merge the two REITs’ portfolios of shopping centers, which are largely grocery-anchored. The combined company has a pro forma market capitalization of more than $11B and a total enterprise value of $16B, according to Jacksonville, Florida-based Regency Centers.
Greenwich, Connecticut-based Urstadt Biddle had 75 properties as of March, primarily in the New York metropolitan area. That represents a small yet significant portion of the 56M SF and 480 properties Regency says it now owns.
The acquisition of Urstadt Biddle will help Regency grow its footprint of “high-quality, grocery-anchored shopping centers in premier suburban trade areas,” Regency said in a news release.
Urstadt Biddle’s properties are attractive to retailers given their affluent suburban locations, Dane Bowler, chief investment officer with 2nd Market Capital Advisory Corp., said in a March analysis on Seeking Alpha.
Regency’s shopping venues serve markets with a median household income of more than $125K across its portfolio, according to its website.
“The portfolio that Urstadt Biddle has carefully assembled over the more than 50 years offers a highly aligned demographic and merchandising profile to Regency,” Regency Centers CEO Lisa Palmer said in a statement.
Urstadt Biddle was founded in 1969 as an affiliate of Merrill Lynch then called Hubbard Real Estate Investments, CoStar reported. Charles J. Urstadt joined the company as a director in 1975 and became its CEO in 1989, eventually narrowing the REIT’s focus to grocery-anchored shopping centers in affluent New York neighborhoods, according to the article.
Regency operates open-air and neighborhood grocery-anchored centers across the U.S. coasts and its midsection. The REIT cited an increase in tenant demand for its spaces during a May earnings call, even as some retailers like Bed Bath & Beyond fell into bankruptcy and shuttered stores.
REIT mergers have been sparse this year compared to the $83B in REIT merger transactions last year, CoStar reported using data from REIT trade group Nareit.
Deals this year include affiliates of Centerbridge Partners and Singapore’s GIC Real Estate acquiring industrial REIT Indus Realty Trust in an $868M deal, as well as operational expense-focused REITs Global Net Lease and Necessity Retail REIT merging in a $4B all-stock transaction, per CoStar.
Even though high interest rates and economic uncertainty have slowed the flow of mergers and acquisitions, investors view grocery-anchored shopping centers as a safe bet, CoStar reported, citing more frequent visits and higher foot traffic for necessities like food than other types of shopping centers.
The largest mall in London, Ont., could undergo a transformation over the next few years after being acquired by local company Westdell Development Corporation in an off-market deal with BentallGreenOak.
JLL’s Nick Macoritto and Matthew Smith approached Westdell and brokered the transaction involving the 50-year-old, 700,000-square-foot White Oaks Mall. Financial details haven’t been disclosed.
The enclosed shopping centre sits on about 46 acres at 1105 Wellington Rd. near Highway 401 and offers nearly 180 stores and services and 3,350 parking spaces.
It’s anchored by several major retailers, including Walmart and The Bay.
“We’re hoping that we can add multiple uses to it and bring in office, retail and residential under some form,” Westdell president Iyman Meddoui told RENX.
White Oaks will become a transit hub
White Oaks will also become a transit hub for the local bus rapid transit system now under construction.
“Being a transit node, we think there’s a strong opportunity to take an already good and viable asset and make it better,” Meddoui said.
While plans for the White Oaks intensification are still in the early stages, Meddoui said Westdell likes to move quickly on such projects.
He also noted London and the other municipalities it has worked with have generally enabled the company to do that when it comes to development applications.
“We would anticipate that within 18 to 24 months we would have our first whatever-it’s-going-to-be and whatever-it’s-going-to-look-like approved and potentially in the ground.”
Westdell’s other activity
Westdell was formed in London as a residential developer in the 1990s and then quickly moved into commercial real estate.
It owns more than 30 properties and is most active in southwestern Ontario, with London and Windsor being its two primary markets.
Westdell also owns the 135,000-square-foot Arnprior Shopping Centre in the town of the same name northwest of Ottawa.
“We’re a multi-faceted corporation,” Meddoui said. “We have our own development team, acquisition team, leasing team and property management services.”
Westdell recently redeveloped London’s Wellington Gate Centre and is welcoming new tenants in addition to recent arrivals Wendy’s and Tahini’s at a location already occupied by Staples and Tim Hortons.
Westdell is actively seeking new opportunities in markets and neighbourhoods in need of commercial or mixed-use development as well as existing commercial properties with intensification potential, such as White Oaks.
A 142-unit apartment building called Aria is under construction at 420 Fanshawe Park Rd. E. in London, not far from the 185,000-square-foot Hyland Centre where Westdell is based along with several retailers, commercial and office tenants.
The company is seeking site plan approval to add 269 residential units to Hyland Centre.
Westdell owns a 20-acre, fully zoned development site at 1370 Fanshawe Park Rd. E. and a greenfield site at 952 Southdale Rd. where it’s proposing to build more than 130,000 square feet of retail and residential space.
There are plans to build three high-rise residential buildings with almost 500 units at 689 Oxford St. W. near Wonderland Road. The site is currently occupied by the 32,220-square-foot Oxford Capulete Centre retail plaza.
There are plans for an 18-storey, 188-unit apartment building called Oxbury Place on the 11-acre site of Oxbury Centre, a 170,000-square-foot retail plaza at 1299 Oxford St. E.
Westdell recently received approval to move forward with a 100-unit residential project in downtown London.
Meddoui is hoping some of these projects will move forward in 2024.
Westdell is also looking to intensify some of its Windsor retail properties that have land for additional development.
It will add 640 rental residences and 10,397 square feet of commercial retail space to a 9.53-acre property at 2700 Huron Church Rd. at the intersection of Tecumseh Road West.
More retail intensification proposed for London
Other London retail property owners are also looking to intensify their sites, according to Meddoui, who said it’s becoming “more and more common.”
These intensification projects include:
Cadillac Fairview’s CF Masonville Place, a 627,267-square-foot mall with more than 150 stores at 1680 Richmond St., where several residential buildings are proposed;
and KingSett Capital and Corpfin Capital Inc.’s Westmount Commons, a 530,000-square-foot-plus mall with 3,000 parking stalls occupying a 31-acre site at 785 Wonderland Rd. S., where the addition of six residential buildings with 898 units, as well as office and more retail space, has been proposed.
Meddoui said London has one of the lowest residential vacancy rates in the country and demand remains very strong, while there’s also a lot of activity in the condominium market.
Activity in the Greater Golden Horseshoe’s industrial sector has decelerated amid economic headwinds, but St. Thomas isn’t just bucking the trend, it’s on the cusp of a boom.
Since Volkswagen’s announcement in late April that St. Thomas will play host to its electrical vehicle “gigafactory” battery plant, which will create an estimated 3,000 direct jobs as well as thousands of more indirect jobs, players in the industrial sector have flocked to the municipality.
Demand for raw farmland is particularly high, said Diana Hoang, founder of Toronto-based Spear Realty, which is working with a couple of groups looking to establish a presence in St. Thomas.
“Looking at (land) trades from last year to this year, they’ve gone up significantly, and talking to vendors, their expectation is a lot higher when it comes to raw land,” Hoang told RENX.
“Everybody is anticipating land to be converted from actual farm lands to higher uses like industrial or residential to meet the demands of the new plant.”
Development land at a premium
Hoang said the Volkswagen announcement has been seismic.
The price per acre was $150,000 last year, but today it’s north of $400,000. Land already zoned for industrial is even scarcer and commands even higher per-acre prices. With the plant scheduled to open in 2027, there’s much more room for growth, she added.
“Pricing will still continue to grow because of the interest rates and the demand needed from all the smaller submarkets and smaller industries to accommodate a bigger automotive plant,” Hoang said. “It will definitely go up because you’ll see more users and more demand and it’s all about supply and demand.”
However, all things considered, the cost of land in St. Thomas is much cheaper than in the GTA, or even London where it’s over $1 million per acre.
Industrial prices determined by farmers
Brokers, representing clients in the industrial, residential and hospitality sectors, are approaching farmers to buy their land, and when successful, it’s costing a pretty penny.
One reason farmers are reticent to sell is their operating expenses, especially as they pertain to farming equipment, are so exorbitant that they will only sell for an astronomical price, Hoang said.
“For farmers, their problem is where do they go after this, because they need a lot of land,” she said, noting there are a myriad of other financial considerations for farm businesses including equipment and buildings, and access to other suitable property. “The cost to buy land does not outweigh (these) costs.”
However, a couple of residential subdivisions by Mapleton Homes and Palumbo Homes are already underway, and as St. Thomas grows in the years ahead, development economics across all asset types are expected to justify the rising land prices.
“Any kind of recycling companies, or any group that needs storage, any steel for massive buildings, will have to be stored somewhere,” Hoang said. “We’ll even see little users like welding or mechanical engineering companies, even HVAC; we’ll definitely see a little more in that area because they have to service the bigger industries.”
St. Thomas is open for business
London-based Dancor Construction had been looking to enter the St. Thomas industrial market in 2019, well before the Volkswagen EV battery plant announcement. One of the reasons is that the city’s planning department has a reputation for being easy to work with.
Sean Ford, general partner at Dancor, said the firm put in offers on properties in 2020 and 2021 which weren’t successful. However, it remains on the hunt.
“For the approval process part of it, St. Thomas is fantastic and that’s what generated our interest in looking at lands to develop there,” Ford said. “We got a sense we needed to hang on because something was going to happen and obviously it has.
“Now the focus is developing in and around the plant, and at some point developing on EV plant lands as well, because a lot of suppliers will want to go there.”
Along with Nexus REIT, Dancor is the largest landlord for new industrial buildings in London – which is about 15 kilometres from St. Thomas.
Ford maintains that, even without Volkswagen’s EV battery plant, St. Thomas’ industrial sector was poised to grow.
“We’re looking at St. Thomas and London as being one and the same,” he said. “In terms of a regional approach, when companies are looking to go there, they’re going to be looking for workforce — this is the most important part of everything — and proximity to the highway, and both St. Thomas and London are perfect on both those scores.”
Vicano building near VW property
In addition to developing industrial facilities, Vicano Developments Limited is a general contractor that had done some work for the City of St. Thomas. That’s when, according to vice-president Paul Vicano, Vicano began familiarizing itself with the local marketplace.
Today, Vicano owns five lots spanning 14 acres across the street from the VW plant on Dennis Road between Burwell Road and Highbury Avenue. Two of the lots already have industrial buildings on them.
Two more lots are slated for development before the end of the year.
“The price was attractive and we were hearing about the demand out in St Thomas for smaller-bay industrial,” Vicano said.
The VW plant is an added boon and not just for St. Thomas.
“There’s no doubt a large announcement like VW will bring with it ancillary-type industrial to the area, whether in London, south London or even eastward to Woodstock,” Vicano observed. “We’re from Brantford and when Ferrero Rocher came, many smaller users came to service Ferrero and I see the same thing happening in St Thomas.
“It will bring industry to the area that will need industrial real estate to call their home.”
Fiera Real Estate and Berkshire Axis Development have completed their 10th partnership deal with the acquisition of 19 acres of industrial land in the Greater Toronto Area (GTA) city of Brampton.
The partners acquired the development land from DG Group for $53 million on July 4.
The site, which was marketed by Lennard Commercial Realty and subject to a bidding process, is bordered by Inspire Boulevard to the north, Dixie Road to the east, Tasker Road to the south and Ace Drive to the west.
The site is close to a new industrial corridor that’s been created in recent years as well as major 400-series highways. It’s a 20-minute drive from Toronto Pearson Airport and a CN intermodal rail yard.
Adding to the partners’ economy of scale, it is less than a kilometre from Fiera and Berkshire Axis’ approximately 750,000-square-foot Heart Lake Business Park project that broke ground in the late spring of 2022.
The conceptual site plan for the latest Brampton project calls for a development of approximately 336,000 square feet of industrial condominium space in six buildings ranging in size from 43,900 to 73,400 square feet.
There would be 94 units ranging from 3,290 to 5,006 square feet, four truck courts and 401 parking spaces.
The goal is to start construction by late spring or early summer of next year, with the summer of 2025 being targeted for completion.
Strong demand for industrial condos
“Pent-up demand for high-quality industrial condo units largely led us in that direction,” Berkshire Axis vice-president and partner Craig Wagner told RENX.
“We’ve had a very strong year across the platform for condo sales, whether that’s some of our conversions on existing buildings or our pure new-build industrial condominiums.
“I think both lines have exceeded our sales forecasts throughout the first part of this year and we’re definitely excited for the remainder of this year and certainly heading into next year.”
Heart Lake Industrial Condominiums was launched by Fiera Real Estate and Axis Berkshire while interest rates were escalating rapidly last year.
It offers 26 industrial condo units in two buildings of 61,000 and 46,000 square feet with 28-foot clear heights and truck-level loading. All of the units sold ahead of schedule.
Fiera Real Estate and Berkshire Axis are partners on Addison Hall Business Park, which features three industrial condo buildings ranging in size from 37,661 to 50,339 square feet at 115-155 Addison Hall Circle in Aurora, just north of the GTA.
Sales launched a year ago and 32 of its 39 units, ranging in size from approximately 2,700 to 5,000 square feet, have been sold. Construction completion is slated for November.
“There’s a big need for continuing to support small- to mid-size businesses,” Fiera Real Estate senior VP of development, core and opportunistic strategies Kathy Black told RENX.
She noted it’s difficult to find smaller sites that are appropriately sized for building industrial condos.
Plans for new Brampton site could change
Plans for Fiera Real Estate and Berkshire Axis’ latest Brampton site to be broken down into small industrial condo units could change due to market conditions and tenant interest.
“If somebody came by and wanted to have a big design-build and wanted to buy everything, we’re not closed off to that,” Black explained.
“We’re so fresh in the development cycle with all of these conversations, but it’s zoned for all of those uses so the flexibility is there.”
Black said industrial rents in the GTA increased by 25 per cent from 2020 to 2021 and by almost 40 per cent from 2021 to 2022.
While rents have stabilized this year, they’ve done so at more than $20 per square foot to create a benchmark, she noted.
Fiera Real Estate and Berkshire Axis’ partnership
Toronto-headquartered Fiera Real Estate is wholly owned by Fiera Capital Corporation, a multi-product investment management firm that had approximately $164.2 billion of assets under management as of June 30.
Fiera Real Estate is an investment management company with offices in North America and Europe and more than 80 employees.
It globally managed more than $7 billion of commercial real estate through a range of investment funds and accounts as of June 30.
Fiera Real Estate purchased 156 acres of industrial land in Acheson, Alta., near Edmonton, and is also active in industrial condo projects (known as strata developments) in British Columbia.
Toronto-based Berkshire Axis has more than 25 years of experience in delivering industrial and residential projects across the GTA. It has completed more than 30 industrial developments over the past 10 years.
Four Fiera Real Estate funds have been used in the partnership with Berkshire Axis, which is now responsible for more than two million square feet of industrial space in the GTA.
Three of Heart Lake Business Park’s five for-lease industrial buildings have firm leases in place and Wagner said there are deep conversations happening regarding leasing of the fourth building.
Construction of the development will be winding down through the remainder of the year, according to Wagner.
There’s more apparently to come, according to Black and Wagner, but they can’t yet reveal any details.
While Black said she would like to see the partnership continue long-term, it depends on what opportunities arise.
Commercial real estate investors and lenders are slowly confronting an ugly question – if people never again shop in malls or work in offices the way they did before the pandemic, how safe are the fortunes they piled into bricks and mortar?
Rising interest rates, stubborn inflation and squally economic conditions are familiar foes to seasoned commercial property buyers, who typically ride out storms waiting for rental demand to rally and the cost of borrowing to fall.
Cyclical downturns rarely prompt fire sales, so long as lenders are confident the investor can repay their loan and the value of the asset remains above the debt lent against it.
This time though, analysts, academics and investors interviewed by Reuters warn things could be different.
With remote working now routine for many office-based firms and consumers habitually shopping online, cities like London, Los Angeles and New York are bloated with buildings local populations no longer want or need.
That means values of city-centre skyscrapers and sprawling malls may take much longer to rebound. And if tenants can’t be found, landlords and lenders risk losses more painful than in previous cycles.
“Employers are beginning to appreciate that building giant facilities to warehouse their people is no longer necessary,” Richard Murphy, political economist and professor of accounting practice at the UK’s Sheffield University, told Reuters.
“Commercial landlords should be worried. Investors in them would be wise to quit now,” he added.
WALL OF DEBT
Global banks hold about half of the $6 trillion outstanding commercial real estate debt, Moody’s Investors Service said in June, with the largest share maturing in 2023-2026.
U.S. banks revealed spiralling losses from property in their first half figures and warned of more to come.
Global lenders to U.S. industrial and office real estate investment trusts (REITs), who supplied credit risk assessments to data provider Credit Benchmark in July, said firms in the sector were now 17.9% more likely to default on debt than they estimated six months ago. Borrowers in the UK real estate holding & development category were 4% more likely to default.
Jeffrey Sherman, deputy chief investment officer at $92 billion U.S. investment house DoubleLine, said some U.S. banks were wary of tying up precious liquidity in commercial property refinancings due in the next two years.
“Deposit flight can happen any day,” he said, pointing to the migration of customer deposits from banks to higher-yielding ‘risk-free’ money market funds and Treasury bonds.
“As long as the Fed keeps rates high, it’s a ticking time bomb,” he said.
Some global policymakers, however, remain confident that the post-pandemic shift in the notion of what it means ‘to go to work’ will not herald a 2008-9 style credit crisis.
Demand for loans from euro zone companies tumbled to the lowest on record last quarter, while annual U.S. Federal Reserve ‘stress tests’ found banks on average would suffer a lower projected loan loss rate in 2023 than 2022 under an ‘extreme’ scenario of a 40% drop in commercial real estate values.
Average UK commercial property values have already fallen by around 20% from their peak without triggering major loan impairments, with one senior regulatory source noting that UK banks have far smaller property exposure as a proportion of overall lending than 15 years ago.
But Charles-Henry Monchau, Chief Investment Officer at Bank Syz likened the impact of aggressive rate tightening to dynamite fishing.
“Usually the small fishes come to the surface first, then the big ones – the whales – come last,” he said.
“Was Credit Suisse the whale? Was SVB the whale? We’ll only know afterwards. But the whale could be commercial real estate in the U.S.”.
CUTTING SPACE
Global property services firm Jones Lang LaSalle (JLL.N) – which in May pointed to a 18% annual drop in first quarter global leasing volumes – published data this month showing prime office rental growth in New York, Beijing, San Francisco, Tokyo and Washington D.C. turned negative over the same period.
In Shanghai, China’s leading financial hub, office vacancy rates rose 1.2 percentage points year-on-year in Q2 to 16%, rival Savills (SVS.L) said, suggesting a recovery would depend on nationwide stimulus policies succeeding.
Businesses are also under pressure to slash their carbon footprint, with HSBC (HSBA.L) among those cutting the amount of space they rent and terminating leases at offices no longer considered ‘green’ enough.
More than 1 billion square meters of office space globally will need to be retrofitted by 2050, with a tripling of current rates to at least 3%-3.5% of stock annually to meet net-zero targets, JLL said.
Australia’s largest pension fund, the A$300 billion AustralianSuper, is among those on the sidelines, saying in May it would suspend new investment in unlisted office and retail assets due to poor returns.
Meanwhile, short-sellers continue to circle listed property landlords the world over, betting that their stock prices will sink.
The volume of real estate stocks lent by institutional investors to support shorting activity has grown by 30% in EMEA and 93% in North America over the 15 months to July, according to data provider Hazeltree.
According to Capital Economics, global property returns of around 4% a year are forecast this decade, compared with a pre-pandemic average of 8%, with only a slight improvement expected in the 2030s.
“Investors must be willing to accept a lower property risk premium,” Capital Economics said. “Property will look overvalued by the standards of the past.”
Suburban office markets are continuing to show lower vacancy rates than downtown areas, Colliers says
Suburban office markets are continuing to show lower vacancy rates than downtown areas, where a substantial increase in new office supply has been pushing vacancies higher.
According to Colliers Canada’s latest National Market Snapshot, 93 per cent of new office supply this year through the end of the second quarter has been concentrated in downtown areas. Suburban office vacancy rates stood at 11.7 per cent compared to its downtown counterpart at 15 per cent.
As demand for office space declines, developers are repurposing planned construction projects and to cater to the life sciences sector.
As demand for office space dwindles, some developers are deviating on planned projects and instead opting to cater construction to the life sciences sector.
The emerging trend is detailed in Avison Young’s Greater Toronto Office Market Report for Q2 2023, which relays that vacancy and availability rates have continued to inch upwards, with both rising 30 basis points (bps) on a quarterly basis.
The jump brought the overall office vacancy rate in the GTA to 12%, and the overall availability rate to 18.1% — 219 buildings in the GTA had more than 50,000 sq. ft of office space available in Q2.
Avison Young
The office vacancy rate in downtown Toronto also stood at 12% in Q2, a 40-bps increase from Q1, while the availability rate fell 30 bps to 17.5%. Although this marked the first quarterly decline since the onset of the pandemic, availability was still up 340 bps annually. Similarly, available sublet space dipped 50,000 sq. ft. on a quarterly basis, to 4.5M sq. ft., but was still up 1.8M sq. ft. year over year.
Across the GTA, 8.9M sq. ft of sublet space was available in Q2, a 42% annual increase. In suburban markets, sublet space as a proportion of total available space hit 19%. In downtown Toronto, it was 31%.
Despite this, seven new office buildings, totalling 480,000 sq. ft, were completed in the region in Q2, and another 6.2M sq. ft of space is under construction, equal to 3% of existing inventory.
Avison Young
With demand expected to continue on its downward trajectory, Avison Young reports that some developers have begun to repurpose new office construction projects for the life sciences sector.
It is decidedly difficult to convert existing offices into lab space, as most buildings lack the ceiling height, separate loading areas, and infrastructure required to do so. The challenges present a unique opportunity for developers to make the switch before, or even during, the construction process.
An example of this trend can be seen at 77 Wade Avenue in Toronto’s Junction neighbourhood. The 155,000-sq.-ft space was originally slated for office use until AIMCo partnered with Canadian Life Science Property Group, Avison Young said.
Another instance is the four-storey, 187,000-sq.-ft addition KingSett Capital is adding to 700 University Avenue in the Discovery District, which will now be used solely for life sciences and research space, rather than its initial mixed-use designation.
Also previously eyed for office use, The CORE at 2395 Speakman Drive in Mississauga will be the first purpose-built life science campus in the GTA, offering 400,000 sq. ft of lab and research and development space.
Avison Young expects both office vacancy and availability to continue rising across the GTA in the short term as companies continue to adjust to their new realities.
With existing options for lab space slim, particularly so in Downtown Toronto, repurposing office developments may prove to be a viable solution to promoting the region’s life science’s sector.
Despite recession predictions, retail continues its strong post-pandemic growth into 2023, says a new report by commercial real estate firm Colliers.
The consumer appears resilient, with higher savings rates than pre-pandemic, and a huge demand for travel, hospitality, and entertainment. Favourable demographics, particularly strong population growth compared to other developed countries, continues to act as a tailwind for retail sales. Overall sales rose in every province but one, despite shortages in areas such as automotive, said the 2023 Retail Outlook.
“Retail rents reached all-time highs as renewed leasing demand and a lack of new developments funnelled demand to existing centres. Vacancy rates dropped nationwide, as the nadir of retail leasing in 2021 has turned around. Despite high-profile closures of US retailers such as Bed Bath and Beyond and Nordstrom, the vacant space has been rapidly absorbed in most markets,” said Colliers.
Shuttered Nordstrom at Yorkdale Shopping Centre (Image: Craig Patterson)
“Retail investment continues to be dominated by private investors, as larger institutions and REITs continue to be net sellers. Larger players have also focused on the redevelopment aspect of retail, turning suburban assets into mixed-use developments or land assembly plays.
“Throughout the pandemic, grocery, pharmacy, discount stores, and quick-service restaurants – performed very well. These sectors have continued to attract both customers and investors into 2023, even as restrictions have disappeared . . . The retail industry of Canada has seen a focus on sustainability, partly manifested in the growth of second-hand and vintage apparel, providing an unexpected growth area going forward.”
Madeleine Nicholls, Senior Managing Director Brokerage | Vancouver, for Colliers, said the key message from the report is that Canada overall compared to other countries is outperforming many nations in both economic growth and retail sales.
Even with the various interest rate hikes, Canadians have remained resilient when it comes to retail spending, added Nicholls.
DUER on Ossington Avenue in Toronto (Image: Dustin Fuhs)
The departures of American-based retailers recently have garnered much media attention and headline news but the Canadian retail market has also seen, at the same time, expansion of existing brands and new brands entering the market.
“That’s an indicator of the low vacancy rate that we’re seeing across the country in all segments. When great locations become available, they’re very desirable,” said Nicholls.
She said a few things have fuelled retail spending in Canada including strong employment, population growth and the wealth effect that even during this environment of higher prices from homes to vehicles, people have higher savings than they did pre-pandemic.
Nicholls added that certain retail categories showing year-over-year sales growth is promising, including shoes, clothes, and food and beverage which have been solid and healthy.
“All the provinces are performing really well but what really jumps out is the spending in Alberta and Newfoundland which is extremely high. That’s perhaps driven by the fact that there has been movement to those provinces,” said Nicholls. “And in Alberta’s case, different than the oil boom, people are moving to Alberta now because of the demographic shift of young people moving there in search of affordability for the same reason that people have moved to Newfoundland as well.”
The Colliers report said retail spending dipped in the first quarter of 2023, as the unprecedented interest rate hikes of the prior year took effect. While experts forecast a mild pullback in consumer spending, it is expected to be similar to prior declines, returning to trend within two years. Rate increases of +4.25 per cent in 2022 were intended to address runaway inflation in Canada, a problem shared with much of the rest of the world.
“While inflation nominally helps retail sales numbers, it hurts it overall when we look at spending in real dollars. Clearly there has been some pullback since 2022, where spending peaked in Q2 just as interest rate increases were taking effect. Higher costs of housing, gas, cars and food have squeezed spending elsewhere,” said the report.
“Interest rate hikes have a number of benefits for retail long-term, as the goal of reducing inflation and increased housing costs will hopefully return more spending power to the household. Additionally, higher rates incentivize saving over borrowing, which can create a “wealth effect” where households spend more as they see their assets grow.”
Colliers Retail Outlook Report 2023
Colliers said the extreme drop during COVID lockdowns led to years of “pent up” demand for everything from international flights to cars to live sports to music events, and the economy is only just now adjusting to these new levels of demand for “experiential” retail.
“Overall retail spending is maintaining a consistent trend, reflecting Canada’s strong population growth and robust labour market. Favourable “fundamentals” are the driver for consistent growth in the retail sector until at least 2025,” added the report.
“Prior to the pandemic, the Canadian consumer was strained, with household savings rates reaching zero or even negative levels. Despite lower inflation, rising costs in several areas combined with weak wage growth was clearly straining households.
“However, one unintended side effect of lockdowns was a drastic improvement for some in household finances. Between mortgage deferrals, income supports, business loans and the reduced costs of working from home, households suddenly experienced savings rates in excess of 20 per cent. There was nothing to spend on (no travel, shortages of many products due to shipping issues caused by lockdown) and households socked away unprecedented savings. This led to a boomerang with the “pent up demand” spending upon reopening, and the subsequent inflation that is only just now subsiding.”
Columbus Cafe Construction Hoarding in Toronto (Image: Dustin Fuhs)Future Columbus Cafe in Toronto (Image: Dustin Fuhs)
While the closure of a few large occupiers such as Nordstrom garners wide coverage, there has also been a surge of new retail occupiers across Canada, explained Colliers.
“Quick-service restaurants have been thriving for years, with a highly scalable business model that was ideally suited for small urban spaces. Large expansions are planned for a number of occupiers like US stalwarts Taco Bell and Burger King, homegrown brands such as Harvey’s and Mary Brown’s Chicken, and new chains like Egg Club (Ontario) and Columbus Café (Quebec),” said the company.
“In Q1 2023, Goodwill announced a large expansion, planning to open 40 new stores in more affordable markets. Across Canada and the world, second-hand shopping has surged in popularity, to economize in an inflationary environment, support local stores, and for the “thrill of the find” as opposed to the standardized and searchable environment of ecommerce.
Amid a fire season that has seen a record number of blazes, wildfires and poor air quality are top-of-mind concerns for commercial property developers, industry insiders say.
The fires have burned an unprecedented amount of land from coast to coast in Canada, entering communities not typically in harm’s way, such as the outskirts of Halifax, and triggering air quality warnings as far away as Europe.
“It’s been a major point of discussion for some time now and landlords have taken measures such as putting in a number of air exchanges and upgrading to more advanced air filtration systems,” says Samantha Sannella, managing director, consulting services, Canada at Cushman & Wakefield. “It’s something occupiers ask for.”
Ms. Sannella says the growing fire threats are forcing innovation in design and development that could include the use of fire-resistant building materials and Internet of Things technology to oversee sensors and fire suppression systems.
Business disruption
Glenn McGillivray, managing director of the Institute for Catastrophic Loss Reduction (ICLR), a disaster-prevention research centre established by Canada’s insurance industry, says with the wildfire trend moving in the wrong direction as urban boundaries expand, it’s more than likely wildfires will reach urban areas.
“The more fire we see, the more it’s going to get into communities and the more businesses are going to be affected. We’re going to see businesses directly hit by wildfires and operations interrupted,” he says.
Against this backdrop, “there is a huge regulatory gap that needs to be addressed,” Mr. McGillivray says, adding that there are no specific provisions in residential or commercial building codes relating to wildfires.
“There isn’t even any guidance on how small businesses can reduce the risk of wildfires,” he says, though the building code does require that engineers attest that a building designed by an engineer or architect conforms to design standards, and that all potential hazards, such as tornadoes, floods or fires, have been considered.
In Ontario, municipal bylaws and the site-control process that examines design and technical aspects of a proposed development can address wildfire threats at the planning stage of construction, says Victoria Podbielski, press secretary for Ontario Municipal Affairs and Housing Minister Steve Clark.
Municipalities in the province are required to conduct a community risk assessment every five years to identify threats to fire safety, including from wildfires, she says.
“If any new provisions are brought into the National Building Code to address wildfire management, including additional requirements for indoor air quality controls, Ontario would consider the same for analysis and potential inclusion in its building and fire codes,” she says.
FireSmart Canada, a national program that aims to help neighbourhoods increase wildfire resistance, offers resilience guidance for the oil and gas industry that could be adapted to other commercial sectors, Mr. McGillivray says.
Wildland-urban interface
ICLR executive director Paul Kovacs says oil sands operators prepared well for the wildfires that ravaged the Northern Alberta community of Fort McMurray in 2016, relying on firebreaks and other protective measures. The flames came very close to their installations but ultimately caused no major damage or injuries.
Mr. Kovacs says industries operating in the so-called wildland-urban interface have a business case for investing in wildfire mitigation.
B.C.-based fire ecologist and consultant Robert Gray says most of the land in the interface in the province is owned by the Crown, limiting private developments in fire-prone areas.
The more fire we see the more it’s going to get into communities and the more businesses are going to be affected.
— Glenn McGillivray, managing director of the Institute for Catastrophic Loss Reduction
The wildfire in the Wood Buffalo region that includes Fort McMurray remains the most damaging in Canadian history, with property and casualty insurance claims of more than $3.6-billion to date. Public Safety Canada estimates that more than 2,400 homes and businesses burned down in the region in 2016, with another 530 structures damaged.
The event skews data published by Catastrophe Indices and Quantification (CatIQ), which show that Canada’s insurance companies reported 82,692 wildfire damage claims totalling $4.1-billion for the 10 years through 2022.
This included 50,000 residential damage claims worth $2.4-billion; 7,000 small business claims of $500-million; and 474 claims from large companies for $1.1-billion. Residential and small business damage account for $2.9-billion or almost three-quarters of the total.
The 2022 total insured catastrophic loss of $3.1-billion lands the year in the top three loss years for the country.
According to a June, 2023, report by DBRS Morningstar, Canadian property and casualty insurance companies bear the weight of an above-average wildfire season.
Fire occurrence ‘off the charts’
Marcos Alvarez, global head of insurance at DBRS Morningstar, says while financial results are likely to come under pressure this year, “we expect those insured losses will remain manageable for most companies.”
He added in an e-mail that insurance companies “usually pause underwriting new policies in areas affected by wildfire.” An existing policy for a property in those areas “would need to be revised to make these protections a requirement, (probably at its annual renewal process),” he said.
Michael Norton, director general of the Canadian Forest Service’s Northern Forestry Centre, said in a wildfire update posted on YouTube in early July that the total area burned in 2023 exceeds any year on record in Canada, with the 150,000 people displaced the highest in the four decades of record-keeping.
“The occurrence from coast to coast is unprecedented,” Mr. Norton said, calling the total of hectares burned versus the 10-year average of 805,196 hectares “literally off the charts.”
The Canadian Interagency Forest Fire Centre reported on July 19 that more than 11 million hectares have been consumed to date, with most of the wildfires burning in B.C. According to Natural Resources Canada data, 2023 is already the worst fire season in Canada’s history, topping the previous record of 7.6 million hectares burned in 1989 and with several weeks of fire season still to go.
Cheryl Evans, director of flood and wildfire resilience at the Intact Centre on Climate Adaptation at the University of Waterloo, says small businesses and homeowners can do simple and inexpensive things to mitigate against fire risk such as clearing debris from properties and changing furnace filters.
At the same time, she says, they can “nudge local, provincial and federal government to start moving things further along to provide wider protection.”
