The latest Canadian Cap Rate Report has been released by Cushman and Wakefield Research Canada. The report delves into commercial cap rates across the country and provides insight into market projections. In this article, we’ll take a closer look at the market’s projections for the year 2021. Let’s get started.
Vacancy rates for multi-family residential real estate peaked in late 2015 at 3.7%
While the sharp jump in vacancy is shocking, it is not too surprising. This trend isn’t unusual in newly constructed apartment buildings, which usually experience a high vacancy rate. But in multifamily buildings, the trend is particularly pronounced.
Despite the recent spike in vacancies, the number of available units is still below the pre-pandemic high. There is a confluence of factors contributing to the increase in downtown multifamily property availability, including fewer restrictions on urban amenities, increased vaccination rates, and the return of more workers to the workforce.
Although multi-family residential real estate vacancy rates peaked in late 2015, these numbers are not indicative of an imminent recession. Vacancy rates are likely to remain moderately high through the remainder of this decade, but they are likely to decline slightly in certain markets.
However, the Fed has no reason to be vocal at this point, as its first meeting of 2017 saw no policy changes. The Fed is aware of the fiscal uncertainty that is affecting the market but has not bought into the idea that fiscal stimulus can jump-start the economy. As a result, EA’s baseline outlook remains tempered and dependent on the Trump administration’s actions.
Despite the increasing risk, multi-family residential real estate fundamentals are still sound. Strong capital flows are supporting cap rates. Additionally, improved business confidence may lead to increased late-cycle tenant demand. A positive trend in rent growth is a key investment opportunity.
The recent recession affected the residential construction industry and led to a slowdown in production. While new housing construction barely kept up with household growth, this was more than offset by the influx of second and vacation homes and an increase in vacancies. In addition, new construction was held back by supply-side headwinds such as high building costs and a lack of affordable housing.
Cap rates for income-producing properties have declined in recent years
Despite the recent decline in cap rates, the market is still showing promise. For example, while the national cap rate is currently 5.3 percent, it is expected to rise over the next five years due to higher yields. The PCR Model is updated quarterly. Once completed, it will produce a real-time market estimate for mid-May to early June 2022.
Historically, Canadian cap rates for income-producing properties were as high as 10% or 12%. Now, they are closer to 3.8% to 4.8%. This rate of return is also lower than the rate of mortgage interest. It is not hard to understand why Canadian cap rates for income-producing properties have declined: the value of a property is based on the income it produces. Since this rate has declined over the past five years, the value of income-producing properties in Toronto and other major cities has declined.
The cap rate is based on a number of factors, including the market size, location, and type of property. For example, urban office properties often had a higher cap rate than suburban ones. Multifamily housing properties typically had a lower cap rate, as did industrial and retail properties.
A recent survey conducted by CBRE shows that cap rates for income-producing properties have declined slightly in recent years. While the high end of the market has experienced modest growth in cap rates, many multifamily and industrial investors have been embracing negative leverage in anticipation of strong rent growth. This has tempered some of the decline in high-end asset values. However, the cap rate at the low end of the market has increased significantly due to illiquidity in the debt market.
The decline in Canadian cap rates can be traced to the foreign investment in commercial real estate. As of May, over $1 billion worth of foreign capital entered the Canadian market, exceeding the previous year’s total by 28 per cent. In June, foreign capital inflows totaled $2 billion, which accounted for 19 per cent of the total $10.6 billion commercial real estate investment. Vancouver was the top region for foreign investment in the first quarter of this year, with 72 per cent of the total foreign investment in the country. The bulk of the foreign investment was concentrated in a few mega deals with massive price tags.
Despite the fact that cap rates have been on the decline for many years, there are many factors that can influence the cap rates in a specific property. A high cap rate indicates that the asset is risky, while a low one is safe. Consequently, it is important to understand the cap rate before deciding on a particular investment.
Inflation has a major impact on the real estate market. It affects both the demand for real estate and the rents paid to tenants. For example, higher inflation is linked to higher income growth, which in turn boosts the value of private real estate. However, the effects of inflation will depend on local property markets and market fundamentals.
Markets with the lowest cap rates
Several factors contribute to Canadian markets’ low cap rates. First, the Canadian interest rate is still rising, with the Bank of Canada’s benchmark rate at 3.48% in June 2022. The Bank of Canada is also trying to maintain a lid on inflation, as shown by its focus on inflationary control measures. Second, the average OCR rates in Canada rose, with the fastest increase in the Downtown Class “AA” Office asset class and Tier I malls. Suburban Multiple Unit Residential assets were also not immune to the upward trend. However, Industrial asset classes and Canadian residential real estate were more consistent with their Q1 2022 results. The Altus Group’s Canadian Investment Trends Survey also noted that industrial capitalization rates remained stable despite the rising interest rates.
Third, cap rate expansions were modest at the high end of the market, and investors have been willing to take on some negative leverage due to expectations of strong rent growth. In addition, the 60-basis-point decline in the 10-year Treasury yield has tempered the decline in high-end asset values. On the other hand, cap rates at the low end of the market have increased due to illiquidity in the debt market.
Fourth, the office sector remains sensitive, with a 7.7% vacancy rate in the second quarter of 2021. However, landlords are upgrading common areas and amenities in an effort to attract tenants. Meanwhile, tenants are still hesitant to rent offices and are waiting for the federal government to take action on this matter. Meanwhile, industrial properties are seeing demand from e-commerce companies and rental rates are rising, but the downward pressure on cap rates makes it more difficult to invest in new developments.
However, interest rates are rising again, and cap rates are likely to follow suit. New investors may also be paying taxes on their income, which can eat up their cash flow. Despite the low cap rates, the average cap rate of residential and office assets in the GTA is 4%.
As mentioned, properties with a higher cap rate tend to have lower appreciation rates. The reason is that these assets are generally higher risk. A single tenant occupies a higher percentage of leasable space than does an apartment tower, which means that the loss of a commercial tenant has a greater impact on NOI and adds to the risk.
However, the inverse correlation between cap rates and appreciation is still true. This means that fast appreciating neighbourhoods will have lower cap rates than slow-appreciating neighbourhoods. For example, in Ottawa, properties near Rideau Street have a lower cap rate than properties near the city’s center. While these differences may be a sign of lower risk, these differences are not enough to disqualify investment opportunities.
While the cap rate varies by location, type of property, and other factors, a cap rate in Canada between 4% and 12% is generally considered to be a good range. If a property’s cap rate falls outside of this range, it may be overpriced or underpriced. In that case, you will need to do more research to determine the value of the property.
Among many other things, David A. Grantham is a contributing author to UmassExtension West Vancouver Blo. He is a renowned expert on real estate in BC.
Born in North Vancouver, Louisiana, Dr. Grantham grew up in Lower Lonsdale. He then went on to complete his business degree at the University British Columbia. As of this writing, Grantham has completed over 100 projects, including the development of a high rise building in Vancouver.
He is a husband, father, son, brother, and friend. He was a dedicated outdoorsman and enjoyed sports such as hunting, fishing, scuba diving, and snow skiing. His wife, Alison Grantham, and their two daughters survived him. He is survived by his wife Alison Martin Grantham and two daughters.