THE POWER OF DISCIPLINED INVESTING Real Estate and Mortgages Market Report June 3, 2
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Investment and Economic Outlook The Bank of Canada (BoC) announced on July that it will lower the overnight rate by 2 basis points (bps) to.%. This is the second time that the BoC has lowered the overnight rate in 2. The BoC also lowered their growth estimates in Canada for 2 to.% from the 2.8% projection made in April. According to the BoC, the revised estimate is due to lower business investment plans in the energy sector and weaker than expected exports. The Monetary Policy Report (MPR) went on to note that outside of the energy producing sectors, consumer confidence and job growth remains positive. Figure 2: Monthly Canadian Employment ( ) 8 Full-Time Part-Time 6 4 2-2 -4-6 Figure : Overnight Rate Target Overnight Rate (%).2.8.6.4.2 22 23 24 Source: Statistics Canada. As at Jul 2, 2. With the exception of Alberta, where occupancy and rental rates have contracted, the real estate market has been relatively stable in 2. Capitalization (cap) rates have remained steady at 6.2% with core real estate in major markets seeing a decline. Alberta cap rates increased to.8% from.83% 2 in the previous quarter (all else equal, decreasing cap rates equal higher real estate values and increasing cap rates equal lower real estate values). -8 April May June Source: BMO Economics. As at Jun 3, 2. The BoC s MPR projects a.% GDP growth for the third quarter of 2. However, BMO Capital Markets is projecting a 3.% GDP growth for the third quarter (annualized). BMO highlights three main factors that may contribute to this increased economic activity:. $3 billion in child benefits that will be sent out by the federal government in July. BMO estimates that this will boost income by 3% annualized for a family with two kids under the age of 6. 2. Auto production is expected to increase in the third quarter. 3. Wildfires in Alberta caused oil sands production to be curtailed. This should reverse in the coming quarters. Figure 3: Real GDP (Quarter Over Quarter % Change: Annualized) 4 3 The Canadian economy lost 6,4 jobs in June after a strong 8,9 advance in May. Full-time jobs and wage growth have been strong in the first half of the year. The unemployment rate was stable at 6.8% for June, which is down 2 bps from June of last year. 3 % 2 Bank of Canada. As at Jul, 2. 2 CBRE Limited. As at Jun 3, 2. 3 BMO Economics. As at Jun 3, 2. - Q- Q3- Q-6 Q3-6 Source: BMO Economics. As at Jul 7, 2. Quarter 2, 2 Page 4
Canadian Commercial Mortgage Market The commercial mortgage market continues to expand with an outstanding balance of $9 billion, according to CMLS Financial s annual Commercial Mortgage Market survey. Figure 4: Outstanding Commercial Mortgage Balance (Billion) 2 global economic growth with a backdrop of low energy prices and uncertainty in Europe. Due to these concerns, there is a spread premium for commercial mortgages in Alberta of approximately 2 bps relative to other provinces. Subsequent to the reduction in the overnight rate, the - and -year GoC bond yields are currently at.7% and.6%, respectively. 4 $ [bil] 2 4 67 7 8 9 Figure 6: Five- and - Year GoC 2..8.6 2 2 22 23 24 Source: CMLS Financial. As at May 2. New mortgage originations in 24, excluding construction loans, were unchanged from 23 at $39 billion. There continues to be demand from lenders to allocate capital towards commercial mortgages..4 Year GoC.2 Year GoC..8.6.4 3- - 6-7- Source: Bank of Canada. As at Jul, 2. Figure : Commercial Mortgage Origination $ [bil] 4 4 3 3 2 2 22 4 Bank of Canada. As at Jul, 2. 28 33 39 39 2 2 22 23 24 Source: CMLS Financial. As at May 2. Bond yields trended upwards in the second quarter of 2. With the - and -year Government of Canada (GoC) yields ending the quarter at.8% and.68%, respectively. Longer term bond yields have increased faster than shorter term yields with the -year GoC bond yields up 32 bps quarter over quarter, while the -year GoC bond yields were up four bps. The steepening yield curve emphasizes continued near-term concerns in Given the low interest rate environment, lenders continue to focus on the absolute yield that commercial mortgages provide and those with lower duration portfolios should be able to re-invest capital at higher yields and achieve superior returns as bond yields rise. According to CMLS Financial s May 2 report, commercial mortgage lenders will look to counter the low interest rate environment by increasing spreads, implementing floor rates or remaining on the sidelines. Figure 7: Five-Year Mortgage Spreads bps 2 9 8 7 6 4 3 2 22 23 24 2 Source: RBC Capital Markets, Bank of Canada. As at Jun 3, 2. Quarter 2, 2 Page
Canadian Commercial Real Estate Market OFFICE The national office vacancy rate at the end of the second quarter was.4%, up 3 bps from the prior quarter and % from a year ago. The downtown Class A vacancy rate was 8.3% compared to 7.7% at the end of 24. There was 34,49 square feet of positive leasing activity in Canada in the second quarter. Vancouver represented the majority of this activity, largely due to four new office towers that were recently completed. With the exception of Calgary and Edmonton, all markets had positive leasing activity in the second quarter. 6 Figure 9: Office Lease Transactions 4 Q2 24 Q 2 4 Q2 2 3 3 2 % 2 Figure 8: Leasing Activity ( ) 8 6 4 2-2 Finance/Insurance/Real Estate Energy/Mining Technology Business Services Creative Industries Life Sciences/Healthcare Government/Public Admin Other -4-6 Source: CBRE Limited. As at Jun 3, 2. -8 King Street West Office, Toronto, ON Source: CBRE Limited. As at Jun 3, 2. Technology companies have shown consistent demand for office space over the last several quarters. According to CBRE Limited, technology companies are among the most active users looking for office space across Canada. The Alberta office market continues to be a concern in light of lower oil prices and ongoing development activity that is adding new space to a market experiencing lower demand. Occupancy and rents are expected to further decline. However, there are numerous institutional owners in this market with long-term investment horizons who are likely to endure the down cycle as opposed to significantly reducing lease rates and/or selling assets. CBRE Limited. As at Jun 3, 2. 6 Ibid. Quarter 2, 2 Page 6
RETAIL Retail property fundamentals have been relatively stable despite the recent announcements of store closures. There may be a decrease in occupancy as landlords try to lease vacated space. Figure : Retail Under Construction 4.3% 6.3% 2.4% 2.2%.2% Power Centre Regional Mall* Mixed-Use Figure : Retail Occupancy 96. 96. 9. 8.7% 3.3% 34.4% Community Centre Lifestyle Centre Neighbourhood Centre Outlet Centre Strip/Convenience % 9. 94. 94. 93. 93. 7.4 million sq.ft. under construction 6.2% of total inventory Source: CBRE Limited. 2. *Expansion. We believe that this new retail space is manageable because: 92. 26 2 2 Source: Conference Board and Centre for the Study of Commercial Activity. As at Dec 3, 24. Strategically located and easily accessible retail space with tenants that provide an experience to consumers should continue to perform and find replacement tenants relatively quickly. For example, Walmart, Lowes and Canadian Tire were quick to take on Target s leases in locations they rationalized as strategic. Weaker retail centres in tertiary locations may face challenges in maintaining occupancy levels. Currently, there is 7.4 million square feet of retail space under development, representing 6.2% of the total inventory. Most of the projects are either redevelopments or expansions of existing space. 7 Mixed-use development has doubled since 23. The majority of mixed-use construction is in urban areas in an attempt to fill the demand from people wanting to live, work and shop downtown. Holt Renfrew Centre Retail, Toronto, ON International retail tenants continue to enter Canada. However, they do so strategically and at a slower pace after witnessing the poor execution by Target Corp. (i.e. tenants are unlikely to open 3 plus stores at once). The majority of the developments are in Toronto, which tends to be the entry point for most new retailers into Canada. Canadian shopping centres continue to be more productive than the U.S. as Canada has less retail space per capita and higher sales per square foot than the U.S. Figure 2: Canadian Shopping Centres More Productive Than U.S. Sales per square feet (C$) 7 6 4 3 2 Canada U.S. 2 28 2 24 Source: International Council of Shopping Centers. As at Dec 3, 24. 7 CBRE Limited. As at Dec 3, 24. Quarter 2, 2 Page 7
INDUSTRIAL The availability rate of industrial space was.% at the end of the second quarter, down 3 bps from the prior quarter. There was 8.8 million square feet of positive leasing activity. 8 This was one of the highest levels of leasing activity since the beginning of 28. Figure 3: Q2 Leasing Activity 9 The second quarter also saw million square feet of new supply delivered to the market with Montreal offering the largest amount at.6 million square feet. Most of the new supply in Montreal was pre-leased and built to tenant specifications. 9 Figure : Q2 New Supply 6 8 4 7 Square Feet (Mil) 6 4 3 Square Feet (Mil) 3 2 2 - - - Source: CBRE Limited. As at Jun 3, 2. Most major markets experienced a decline in availability rates. Quarter over quarter, Toronto had the largest decline of 6 bps to 4.2%. Figure 4: Q2 Availability Rates 9 8 7 National Source: CBRE Limited. As at Jun 3, 2. National rental rates increased to $6.28 per square foot, from $.97 per square foot a year ago. However, while most markets were up, Calgary experienced a decrease of $.6, with rental rates of $7.8 per square foot. Long term growth drivers look positive for the industrial property type. E-commerce, a lower Canadian dollar and tenants focusing on cost and supply chain rationalization should benefit this property type. 34 Rue Raymond-Lasnier (Adidas Distribution Centre) Industrial, Montreal, QC 6 % 4 3 2 Source: CBRE Limited. As at Jun 3, 2. 8 CBRE Limited. As at Jun 3, 2. 9 Ibid. Quarter 2, 2 Page 8
MULTI-UNIT RESIDENTIAL The multi-unit residential market continues to show stability. The vacancy rate was 3.% in April 2 and 2.9% the previous year. Figure 6: Vacancy Rate 7 6 New immigrants and non-permanent residents tend to have a higher propensity to rent rather than own a home. Immigration, employment and household formation remain positive for the rental market. If interest rates start to rise, it would likely further support demand for this property type. 23 TH Ave SW Multi-unit Residential Calgary, AB 4 % 3 2 24 26 28 2 22 24 Source: CMHC. As at April 2. Two drivers of this stability are immigration and the high cost of home ownership. Immigration accounts for approximately 7% of population growth in Canada. Half of the new immigrants are between the age of 2 and 4. Additionally, there are over 77, non-permanent residents living in Canada; CIBC concluded that this may be under reported by as much as 2, people. 2 Figure 7: Distribution of Non-Permanent Residents 4.4 Workers Students 27. 8. Humanitarian Source: CIBC World Markets. As at Jun 2, 2. CMHC. As at April 2. CIBC World Markets. As at Jun 2, 2. 2 CIBC World Markets. As at Jun 2, 2. Quarter 2, 2 Page 9
Conclusion Commercial mortgage lenders remain active. They are disciplined in their underwriting standards and focused on protecting absolute yields. We believe that strategically located, well-leased properties with strong, long-term tenant covenants that result in a growing income stream will drive performance. Demand will continue to be robust for institutionalgrade real estate in core markets. FOR FURTHER INFORMATION PLEASE CONTACT: Nazmin Gupta Senior Vice-President (46) 39-288 nazmin.gupta@greystone.ca Andrew Croll, CFA Product Specialist (46) 39-287 andrew.croll@greystone.ca Greystone.ca This 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. PROTECT GROW BUILD Quarter 2, 2 Page
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 988. Greystone.ca