Emerging Trends in Real Estate

American experts weigh in on why the real estate market north of the border remains immune from what’s ailing U.S.

The U.S. real estate market is heading into turbulent waters in 2008 but, unlike years past, that won’t rock the boat in Canada, according to a major real estate report. While the annual report, released late last week, warns that the U.S. real estate industry “will be walking on egg shells for a while” and anticipates “a long overdue correction,” Canada is likely to avoid both scenarios.

“Interviewees remain positive about side-stepping any serious impacts of a possible U.S. correction,” the report says. “All property sectors share positive prospects, especially industrial and retail.”

The report, titled Emerging Trends in Real Estate, was prepared by the U.S.-based Urban Land Institute and PricewaterhouseCoopers and is based on interviews with real estate executives in both countries.

A decade ago, observers suggest that when the United States real estate market developed a cold, Canada caught pneumonia; that was how mightily U.S. trends influenced Canadian markets. But now the Canadian real estate market has developed immunity from what’s ailing the U.S., observers say.

It comes down to some fundamental differences between the economies of the two countries, says Blake Hutcheson, president of CB Richard Ellis Ltd. and one of the report’s Canadian sources. He suggests that in areas where we are naturally rich, such as energy and resources, we benefit from huge global demand, which fuels both the economy and demand for all forms of real estate.

At the same time, Canada seems to have proved a better economic manager than the United States, Mr. Hutcheson says. “All those years of significant federal surpluses have given consumers confidence and that confidence shows up in spending,” he says - spending on homes, on retail goods, and on business expansion.

The downside is that in those areas where Canada is one small part of increasingly interdependent North American business activity, such as capital markets, we are already being hit with the fallout. The U.S. credit crunch is expected to make money to refinance existing projects or fund new ones either unavailable or more expensive, Mr. Hutcheson says. “In the past, it might have taken up to six months to affect us. This time we started to feel the impact in about two minutes.”

Sheila Botting, senior managing director of Canada for the capital markets group at Cushman Wakefield Lepage and another interviewee, says that, during the past 60 to 90 days, the effect of the U.S. credit crunch has been seen in secondary and tertiary Canadian markets - smaller cities, such as Winnipeg.

“In the past, properties there have traded almost on par with major centres when it came to capitalization rates,” she says. “Now, the cost of financing is starting to rise and with it cap rates. In some cases, money may just not be available for refinancing some projects or financing new ones.

“It is not serious as yet, but certainly bears watching.”

On the plus side, Canada’s economy continues to tick along; energy demand remains high and the soaring dollar brings benefits to importers and any company looking to make capital purchases, which are almost always priced in U.S. dollars, says Edward Sorbara, principal in Sorbara Group of Vaughan, Ont., a major industrial sector developer. He, too, was interviewed for the Emerging Trends report.

“One of our saving graces is that the Canadian economy is much simpler than that of the U.S.,” he says. “Also, we only have four big cities - Montreal, Toronto, Calgary and Vancouver - and almost all major real estate projects across the country are held by a small group of very professional, very well-funded pension funds, institutions and companies.”

He points out that 85 per cent of the office space in Toronto’s financial core is in the hands of five large companies and Canada’s eight major industrial developers have the resources to supply all the country’s needs for factories, warehouses and distribution centres if necessary.

“We have become much more conservative than our neighbours to the south,” he says. “We learned lessons from the meltdown of the 1990s. The result is there is no wild rush toward speculative building. We create to meet proven demand.”

In major centres, an added benefit is the money currently available to upgrade existing commercial buildings to more energy efficient standards, says Chuck Stradling, executive vice-president of BOMA Toronto, a division of the national organization Building Owners and Managers Association.

“We have $60-million available in Toronto alone,” he says. “With rents for office space rising by double-digit levels and vacancy rates extremely low, that means more and more building owners are upgrading properties. They know if they renovate, if they become ‘green’ and energy efficient, they can both fill their buildings and charge rents that provide a quick return on their investment.”

In short, Canada’s combination of natural resources and solid conservative management seems to have created a buffer against some of the problems affecting U.S. real estate, observers say.

“The strength of the markets will vary from city to city and province to province depending on the underpinnings of local and regional economies,” Mr. Hutcheson says. “but, all in all, Canada has much brighter expectations than the United States for 2008.”

Where the trends are:

All commercial property categories - office, retail, industrial and residential - in any of Canada’s high-growth energy markets, particularly Edmonton and Calgary. Demand for oil is expected to continue strong globally and that will fuel the need for almost anything with four walls and a roof.

With office vacancy rates in low single digits in all major markets, demand for office space is outstripping landlord’s ability to satisfy it. The result is certain to be rising office rents and solid sustainable returns.

Buy infill sites wherever you can. Many Canadian cities have stopped growing out and have started to grow up. Shortages of land ready for development have placed the focus for new projects, especially residential and retail, on existing infill sites. Old apartment structures are making way for new condos; brownfield sites are becoming malls or new residential communities.

Develop condominiums in Toronto, especially near subway stops. With 100,000 new immigrants every year, Toronto’s demand for residential properties will likely remain strong. But low mortgage rates will be key: It seems to be monthly carrying costs, not purchase price, that drives this market.

Invest overseas: The indisputable fact is that Canada is a limited real estate market, especially at current purchase prices. Major pension funds and development companies have already caught on to the need to look further afield for opportunities. You will now find Canadian pension funds building shopping centres in Brazil and residential projects in China.

Source: Terrence Belford