Market Perspectives: Canada

James Harkness, Strategic Account Director at Juniper Square, spoke with Raj Mehta, Global Head of Private Capital and Partnerships at Starlight Investments, and Greg Speirs, Senior Vice President at Realstar, on June 23, 2020 to get their take on Canada’s commercial real estate market.

Investors are changing their allocation strategy

One of the decisions that multi-asset class investors have to make right now—whether those investors are retail or institutional—is whether to allocate to private real estate. In determining the value of continued investment in this sector, Raj Mehta provided two angles.

“From the institutional investor perspective, interest rates make it harder to find assets that generate yield. Investors have rotated assets, moving away from more traditional fixed income instruments and towards real assets or alternatives in real estate or infrastructure. From this view, it’s the best of both worlds. You still have the safety net of having real assets, and you also have the opportunity of earning equity returns on those assets. This is what we’ve seen in the marketplace. Investors have changed their allocation strategy.”

“The other point of view is the operator’s. Even though interest rates have declined significantly, the key thing is the spread between your cost of financing versus your cap rates. This spread remains quite healthy. In our opinion, the market opportunity for acquiring this level of assets has never been higher in the Canadian marketplace.”

The stability factor and industry resilience

Given the pandemic and continued low interest rates, a big challenge becomes positioning real estate returns to investors. Will those returns be positive and maybe even exceed expectations? Greg Speirs emphasized the industry’s results and performance.   

“When we talk to our investors about continuing investments in this low rate environment, one thing we keep emphasizing is the stability factor. Throughout the pandemic we’ve proven the resiliency of this sector. Look at rent collections. They’re approaching near-normal levels, which is very different from other sectors. As investors look at risk-adjusted returns, in many cases they’re able to reduce their return expectations because of the lower risk.”

Diversifying and “down-weighting”

Between 2014 and 2019, there was a significant downgrading of Canadian real estate as investors moved to other geographies. Will this continue or change given the current health crisis?

“There’s been a conscious effort on the part of larger, tier-one pension funds to expand globally. It’s not surprising that over this five-year period, portfolios in other markets became more prominent.

“That said, in terms of absolute dollars, during this period their investments in Canada actually doubled. We don’t really think this is downgrading the market at all. It’s more of an appropriate allocation, as they become more global in nature, to look at market opportunity for real estate on that basis. What you’re starting to see is investors being much more targeted, selective, and focused on what they want to go after.”

Speirs agreed and added, “I certainly think given the uncertainty ahead, a lot of those investors may be looking at a number of factors such as travel restrictions, currency risks, political-economic risks, or even tax leakage as they consider moving capital abroad.”

What’s next for office spaces

With regards to the return to offices, Speirs predicted a hybrid future.

“I’ll share an anecdote. I was working in New York shortly after the World Trade Center attacks. There was a big movement towards redundancy, the idea that you can’t concentrate your staff, your operations in any single location. So, offices moved to Florida, New Jersey, and all sorts of places. Bit by bit, that trend reversed itself.

“Now, people working from home and not wanting to come to the office may simply be temporary. But I think the movement towards creating more flexible work arrangements will be entrenched. I don’t think that’s going away. 

“As we look at residential units, how do we adapt? I think there’s going to be a movement towards having larger units with the ability to have some form of home office.”

Mehta saw the workforce still wanting an in-person experience.

“People may opt to work from home. But to see that with a large portion of the staff permanently—I think it’s difficult to envision. For example, people may end up coming to the office three times a week and work from home twice a week. We still need to accommodate them when they come to the office. 

“One of the real secrets of the office, which you just can’t replicate in the two-dimensional world through Zoom calls, is the ability to collaborate, to work with people, to learn from each other. Unless you’re in an environment that facilitates that, professional development will stagnate. The office of the future will evolve.”

The impact of immigration

Although it’s common knowledge within Canada, the country also has an international reputation as having one of the most progressive immigration policies, one that’s been in place for decades. Through a points-based system, anywhere between 300,000 to 350,000 new Canadians a year are coming into the country. 

Mehta thinks it’s only natural that these newcomers go to cities and markets where jobs exist. 

“With an influx of new Canadians that come in, you have a new residential issue—where are people going to live? The data suggests that two thirds of new Canadians rent first. That’s one reason a lot of strain is being put on the larger cities themselves with respect to vacancy rates. For example, if you look at the vacancy rates in Toronto and Vancouver, you’re close to 1% within those marketplaces, because immigration is a significant demand driver.

“Going forward, with the travel restrictions we have in place and everything else we’re seeing with COVID-19, there’s certainly an expectation of a dip in 2020.”

A bumpy but promising road

Over the next few years, Mehta expects demand to grow for commercial real estate in general, and multifamily assets specifically. 

Speirs added, “We’ve got a bumpy road ahead, probably for the next couple of months and maybe through the end of this year. But it doesn’t change our fundamental outlook on a sector, which is strong. Maybe there’ll be some permanent changes we need to make. But long-term, people need good, quality housing and we’ll be there to provide that for them.”

Click here to watch the full conversation