The Canadian commercial real estate market will be hit by shockwaves emanating from the economic crisis in the United States next year, according to a report by the Urban Land Institute and PricewaterhouseCoopers LLP.
However in 2009 the Canadian market is more likely to be in for a tough slog rather than the full-blown disaster unfolding in the U.S., according to the report, which included feedback from more than 700 industry members.
“Overall, Canada may get sideswiped, but should avoid the more serious problems suffered south of its border,” the report said.
Foreclosures, delinquencies, plunging property values and the flagging economy will cause the U.S. commercial real estate market to hit bottom next year, it said.
A tepid recovery is expected to begin in 2010, led by already hard-hit real estate investment trusts.
Private equity investment returns in the U.S. commercial real estate sector are expected to turn negative for the first time in nearly two decades.
U.S. problems including the credit crisis, weak dollar, falling demand for Canadian products, and the overall economy, caused interview respondents from Canada to turn more cautious, uncertain and pessimistic, the report said.
This more bearish outlook is contributing to a decrease in transactions. Commercial real estate deal volumes have dropped in 2008 from the previous three years; also the result of banks limiting their exposure to the sector.
The demise of the market for commercial mortgage-backed securities has put another crimp on deal-making, limiting debt flow in the industry. 57 per cent of Canadian survey respondents forecast the debt capital markets for real estate would be substantially or moderately undersupplied next year.
The drought of liquidity could create opportunities to buy undercapitalized asset owners and smaller REITs, particularly for all-cash buyers, participants in the report said.
Investors should also conserve cash for emerging opportunities, survey respondents said.
A drop in development is also on the horizon as higher financing, materials and labour costs come at the same time demand for space is ebbing.
Many landowners are well capitalized following the real estate boom, however, meaning prices are more likely to moderate than plunge, the report said.
Tougher lending requirements including higher pre-leasing targets, combined with more controlled development activity, should help protect Canada from the problems in the U.S. They should also buffer Canada from the dramatic plunge in values in the real estate bust of the early 1990s, the report said.
Best bets for investors are to buy or hold apartments, and hold investments in city centres. These niches are likely to benefit from an upswing in renters, inflow of immigrants and growing demand from people who want to live in urban core areas, the report said.
At a “stronghold,” Vancouver was rated the best Canadian market for commercial real estate investment and development. The ratings declined from West to East in the following order: Calgary, Edmonton, Toronto, Ottawa, Montreal and Halifax.
In Calgary, positive views about the wealth generated by the energy industry were tempered by worries about the building boom. Developers are building 7 million square feet of new office space in a market with a total of 38 million square feet, at a time the market is becoming riskier, the report said.
In Edmonton values appear to have gone too high, with office rents surging near the $50 per square foot level from the single digits not too long ago, the report noted. The market there is a “pure energy wager,” the report said.
In Toronto a surge of office construction will add five per cent to the city's inventory, cause for concern for owners of lower quality buildings in less desirable areas. Condo sales are also expected to soften along with the value of suburban real estate. Those surveyed said investors are most likely to benefit over the long term in the apartment and industrial sectors.
With its exposure to government, Ottawa is seen as a slow and stable market where investors can find safety in a slumping economy.
Montreal offers “bond-like returns,” with its relatively cheap cost of living and strong flow of immigrants firming up demand for apartments.
Halifax was seen as a stable market lacking growth potential, where locals could do well, “but institutional investors find slim pickings,” the report said.
Survey respondents included the chief executive officers for a number of large Canadian real estate investment trusts, along with members of Canadian investment, brokerage and development companies.
© The Globe and Mail
