Insights from Emerging Trends in Real Estate 2013: Canada’s continuing equilibrium
Release date: January 4, 2013
Host: Sandra Cusato
Guests: Chris Potter, Chuck DiRocco, Jonathan Miller
Running time: 22:30 minutes
In a world struggling to manage unprecedented debt levels and economic upheaval, Canada enjoys a stable real estate economy. Its real estate markets are moving along in a state of near-perpetual equilibrium — at least compared with other volatile regions, including most obviously the U.S. In this podcast, Chris Potter, a partner in PwC Canada’s Real Estate practice, real estate analyst and author Jonathan Miller, and Chuck DiRocco Jr, a director with PwC U.S. discuss the state of the real estate market and the findings of the 34th annual Emerging Trends in Real Estate.
Voiceover: Welcome to Strategy Talks, the business podcast series from PwC Canada. This interview series, featuring new topics and guests every episode, is designed to give you valuable insight into some of today’s hottest issues affecting your business.
Host Sandra Cusato: In a world struggling to manage unprecedented debt levels and economic upheaval, Canada enjoys a stable real estate economy. Its real estate markets are moving along in a near-perpetual state of equilibrium, at least compared with other volatile regions – including most obviously, the U.S. Welcome to Strategy Talks. I’m Sandra Cusato, your host for today’s episode. Here to discuss the state of the real estate market and the findings of the 34th annual Emerging Trends in Real Estate 2013 are Chris Potter, Partner in PwC Canada’s Real Estate practice, real estate analyst Jonathan Miller and Chuck DiRocco, Director of PwC Real Estate Research, U.S. Welcome, everyone.
Let’s start with Chris: Tell us about emerging trends in real estate.
Chris Potter: Hi Sandra. As you pointed out, Emerging Trends in Real Estate has been in publication for about 34 years and I guess over that time, it has emerged to be the industry’s longest and – I think – most well respected, predictive, industry publication. We’ve been focused on Canada for the last six years and the book has evolved to include a chapter specifically devoted to Canada, and over the last two years, we’ve had a focused edition that was the “Canada edition”, to differentiate it even further.
We’re very proud of our involvement in this publication and it’s really part of a larger commitment that PwC has to the real estate industry. Our clients expect that when we come to see them that we understand the industry, and this gives us a perfect entre to really get to the heart of the issues, to understand the issues and what is concerning to the industry and to take that content and understand where they’re going in their business and what their expectations are for the following year.
Sandra: Interesting. Canada’s real estate markets have done much better than the U.S. of the last few years, but the real estate markets in the U.S. seem to be showing some improvement. What’s changed? Let’s start with Chuck.
Chuck: Well I think overall we’re basically seeing improvement in real estate fundamentals. As I say that, I think you also have to keep it into context in regards to certain markets and in certain properties. We have a breakdown in the Emerging Trends publications this year we call our “Big Six Properties” which are the six core, prime, markets against the rest of the field, which is more or less secondary and tertiary markets.
We really see a better improvement in secondary markets as a whole. As the Big 6 markets kind of slow down a little bit, prices are back to pre-recession levels, cap rates are in that sub-5 category, so we do think that things are better overall but it’s still kind of slow paced. The economy is still somewhat questionable but we think it’s stabilized some. The housing market – which has been a bit concern – has been difficult through the years but we are starting to see some stabilization there as well. So, we think that investors are ready to enter back into the commercial real estate market, and to actually get into some of the other markets that they haven’t invested in quite yet.”
Sandra: Jonathan, would you like to add to that?
Jonathan: Well it is about fundamentals and the fact of the matter is that over the last four years there has been very little development. Demand hasn’t been that robust, but demand is slowly coming back. So without development and improved demand you’re seeing improvement in vacancies across the commercial sectors.
Multi-family has been quite strong. You’ve had a lack of development until recently, plus you’ve got a lot of demand from the demographic cohort the growing “echo/boomer” group, as well as empty nesters who are leaving single family homes and looking for smaller, apartment-style multi-family type accommodations that more fit their lifestyles today. Plus, the housing bust has encouraged lots of people to move out of single-family and into smaller rental apartments, so it’s been very good for multi-family.
So, fundamentals are improving across the commercial sectors and have been very strong in multi-family, so that’s good. And now, housing is showing first signs of improving, after the crash. Things are moving in the right direction across all property sectors.
Sandra: Very good. Chris, do you have anything to add?
Chris: I think that it’s always very interesting to hear the perspective that both Chuck and Jonathan bring on the U.S. markets. As we look back over the last few years I think we’ve been typically Canadian and cautiously optimistic because we have done well, and as we’ve reported with Emerging Trends in Real Estate really since about 2008-9, Canada has had a better story to tell and we’ve been able to see significantly better results here in Canada, and the U.S. struggled.
I think what’s different this year is we have seen some improvement in the U.S., and Chuck and Jonathan have done a good job of explaining that. What’s different in Canada, I think, is there’s been an awful lot more attention paid to what’s been going on in our housing markets, most particularly with the condo markets in Toronto and in Vancouver. We have seen a little bit of the boil come off, and we have seen demand start to fall. Now, I think the media has made a lot out of part of the information that is relevant to the discussion, but we have seen – and the industry has been calling for, and we’ve reported in Emerging Trends in Real Estate – that our housing market, particularly our condo market, needed a bit of a healthy pause and we’re seeing some of that.
So, the fundamentals in Canada are still good and I think that people in the industry are working together to get to a better place, and we are seeing a bit of a pause. So, maybe a little bit more of a convergence where the U.S. is improving and Canada is still doing well – but we’re not on fire, as one of our respondents had said, and we’re starting to see things maybe come back a little bit to a normal pace.
Jonathan: Yeah but Chris, your fundamentals in Canada are really so good and they’ve maintained the equilibrium for quite a while. It was 20 years ago or more where you really hit the skids and since then, the industry lenders, the government have worked very well together to maintain an equilibrium that’s really benefited investors, lenders and developers. We’re seeing the fruits of that today, even though growth is slowing some, you’re in a position to sustain the markets very nicely.
Chris: I think that’s a good point, Jonathan. I think that our industry, our real estate industry learned quite well from what happened in the ’80s and the ’90s (the late ’90s) and between the industry discipline and the discipline brought by the regulators and the banks, we do have a good balance. I think that we’ve avoided some of the excesses and some of the missteps that might have been made in other areas; I think it has done well for us and will continue to do well for us.
Sandra: Interesting perspectives. Chris – what are the major themes coming out of the 2013 report?
Chris: There’s a number of major themes, Sandra, that are coming out of the report. One of them is something that we’ve actually just talked a little bit about: we’re calling it ‘Equilibrium Maintenance’. We have a good, healthy pull between demand and supply which really gets to the discipline that Jonathan and I were just talking about. We have an environment where we have not seen the industry build a lot of product on speculation, hoping that somebody will come and buy it. There has been a good relationship between people demanding product and then the industry supplying it. And I think that’s been true across all of the asset categories so we have avoided getting into the boom & bust mentality that maybe has characterized other markets. So, that’s one major trend.
Interest rates, I think we’re continuing to look at and see that they are expected to stay low in the near term, but I think the industry has also indicated that they do expect it to rise over the next few years -- really looking out over a five-year horizon -- but I think that they’re looking forward and have that expectation as part of how they temper their activities and how they see their business evolving over that timeframe.
Sandra: Jonathan, what is your perspective?
Jonathan: Well you’re seeing other things here too. The urbanization track continues. Canada is becoming more “citified.” The people are moving into cities and really looking for the amenities of cities and the convenience of cities, and you’re seeing that in the high-rise residential construction that’s going on across Canada. It’s coming off the boil – as Chris said, to some degree – but it’s also extending into secondary markets and [in] what were suburban areas, you’re seeing more high-rise and more mid-rise living. This is what people want, and the government has encouraged.
But you’re also seeing – especially in a place like Toronto – a shortage in the single family [homes]. And then for retailers, it’s not just kind of the suburban strip or regional mall outlet. They need to find places in the city where [there’s] all this new residential development ... and so you’re having different mixed-use approaches to urban retail, and ... you fit in the power centre stores and department stores into the urban fabric. That’s a major challenge for developers and planners.
Chris: I think that’s right, and I know Chuck’s going to want to weigh in as well but I think it’s going to present challenges and opportunities to city planners, as well as the industry as we look forward and try to anticipate and respond to the market needs as some of the younger folks that are coming back to the city start to marry and have families, and have a different demand for living accommodations.
The other thing that I think is important with the urbanization trend, Jonathan, is what we have in the past referred to as a ‘reverse migration.’ We’ve actually seen employment trends starting to move as well where jobs that might have in the past moved out of the core and into the suburbs are now starting to come back into the core, or closer to the core in order to be closer to where their employees are wanting to be.
Sandra: Chuck, do you have anything to add?
Chuck: Yeah, I think we’ve got a very mixed review on the markets in a macro perspective. Our interviewees seem to continue to have an appetite for commercial real estate transactions, but what we heard repeatedly is that it’s very difficult to find deals. Some of the prices were just basically, too high, but at the same time you’d also hear that they’re ready to put this capital into the markets, even at this point. And that’s the possibility to even have those prices increase, even greater.
We heard again that investors are really looking for those quality assets with obviously strong fundamentals, strong tenants, and the older properties are really just going to kind of sit in limbo, at this point.
Another topic I think we heard repeatedly was the importance of the efficiency of space, as tenants look to become more efficient in the use of their properties and of course, the green aspect of properties as well.
And then, I saw in the breakdown of our markets-to-watch section a move to the West from the East. This is this move into the secondary markets, and it’s similar to what we saw in the U.S. response. It’s kind of a chase of where employment and growth has more potential in the coming year. So we saw maybe in our responses (overall in our survey responses) a little bit of a better move in our ratings and rankings to some of the markets in Canada that were out West over some of the prime markets that you see on the east side.
Jonathan: Yeah, like Calgary and Edmonton, where the oil sands activity is and you have unemployment in those markets under five per cent, and robust growth and jobs growth. You see immigration tracking that way too; immigration is so important in this country and immigration used to focus on Toronto and Montreal and the East has now shifted dramatically to the West where the jobs are.
Chris: I think we are seeing a shift in immigration; I’m not sure I’d say it’s really dramatic but I think that having said that, small changes have big implications. I mean, the reality is that we still have a very large amount of immigration coming into Toronto and the greater Toronto area every year. But, I do agree that we are seeing some shift in the total immigration to this country going out West for the simple reason that there is a different growth story in Alberta, for example, than in Ontario.
The other thing I think we should mention as a trend – going back to our earlier discussion as I pointed out – the industry did call this pause in sort of the growth in the condo market in Toronto and in Vancouver. So, I think that we will continue to see the boil come off. I think it’s a healthy pause, and I think the industry sees it as a healthy pause. So, we do expect that we will see less growth in that area over the next year.
Sandra: Those are impressive findings and I think that as we go through the next few questions we’ll be talking about that a little further.
Emerging Trends 2012 speaks of equilibrium in the market, but also notes that there is more capital than available deals. Shouldn’t this cause prices to increase? Let’s start with Chris.
Chris: I think that when you look at it on the face you would expect that, and I think that rather than looking at it in the context of prices to increase, I think what it would probably do is maintain prices at their current level. I think that there is some thought in the market, and by the industry that cap rates may compress a little further in certain sectors. But again, going back to the discipline we talked about earlier, I think there has been a healthy response by the industry not to move too far forward. Yes, there’s a lot of capital available but I think that capital is disciplined and the market repeatedly shows us that it’s disciplined in Canada. They’re not going to rush out and build for the sake of building, and they’re not going to buy at any cost.
I think that what that does mean is that folks that are motivated to sell, and let’s not forget that in Canada we have a lot of players that buy and hold – there’s not a lot that necessarily sell on an active basis – but those that are motivated to sell will have people that are willing to buy. But, those buyers are sophisticated and disciplined, and will buy on good fundamentals, I believe.
Sandra: Jonathan, over to you.
Jonathan: I think that’s right, and I think in the United States you’re seeing some level of discipline in the major gateway markets that have become fully priced. And so, I think that is leading to investors to chase yield in secondary markets and in properties that aren’t as high quality as what you would find in the major downtowns. So, you’re seeing some discipline. You see it in the survey where Washington D.C was the number one market for the U.S. for the last three or four years through the recession but it’s dropped in its investment ranking. [It’s] still a place where people want to be, people aren’t fleeing it and people are continuing to pay good prices there, [there’s] just not as much interest / appetite for where prices are right now. I think that’s very encouraging for the markets in the near-to-medium term.
Sandra: Let’s hear what Chuck has to say.
Chuck: I agree with Chris and Jonathan. I think it is just going to be a matter of discipline in the coming year. I think there is still going to be that continued hunt though, for quality assets, and trying to get them at somewhat reasonable prices, but ... those properties also have to offer some form of growth. That seems to be the question in some of the prime markets throughout Canada: “where is the growth going to come from? Is there still potential for greater growth, moving forward?” On that note, then, I do think I’m going to stick back to our theme that we have in our report: that there is going to be that move to secondary markets, a greater increase in investments, a little more development in those markets – again – offering more employment and some more opportunities there. There you might see some more cap break / depression. I think though, that the prime markets, the larger markets are going to be pretty stable at this point.
Sandra: Those are great points. Can you comment on the overall development climate in Canada vs. the U.S.? Emerging Trends speaks of a reasonable development pipeline in Canada, but concerns still in the U.S. Let’s start with Chris.
Chris: Sandra, I think looking back at some of the comments that we’ve talked about and certainly what we’re seeing in some of our markets – for example, a little bit of a pull back in the condo market – I think what we’re going to expect to see is perhaps a more measured response by the industry to development. Development will continue and I think all indications are there is still opportunity for development, really, in all of the sectors. Perhaps maybe not as much in hotel and industrial, but certainly in office, in housing ... we will still see development. I think we will perhaps see our markets move back to a more traditional, more normalized sale development cycle.
If you look back over the last few years and focus on condos, for a moment, we were seeing projects that would open on a Friday or a Saturday and sell out in a very short period of time. I think the industry is seeing the current pull back and seeing the current market dynamic such that instead of a blow out in a very short period of time, a normalized sales cycle might now come back into their reality. When they do open a new project, they will not expect that sales are going to blow out in a matter of weeks, and that it may take a matter of months and even years with the large projects.
I think that with the other sectors, the fundamentals will continue to evolve as they have. I think that the industry is giving the indication that they will still wait for there to be a good level of demand before they move forward.
Sandra: Chuck would you like to add anything about the development in the U.S. markets?
Chuck: Let me just add one little point for Canada that I thought was pretty interesting: I do think that development is going to maintain control, as Jonathan and Chris have already stated. I do think though, that low interest rates are going to continue to push buying and I’m focusing a little more on the housing and the condo market. I thought that there were some interesting statistics that I saw from the conference board of Canada. Now, in 2012, they looked to be basically on pace with what they were in 2011 on housing starts – I think the number that I saw was a little over 200,000 housing starts overall. But in 2013, they’re really looking for those housing starts to really decline about seven per cent. Declines aren’t normally a good sign, but I think that declines in this market are a good sign for things to maybe slow down a little bit on the housing side.
When you look at the breakdown of really, the markets that we cover, and you look at the East vs. West kind of comparison, and again – I’m saying the West is where you’re getting more of the employment and more of the job growth – when you look at the housing starts for the West ... they’re looking to increase about 2.1 per cent next year. When you compare that to the east, that’s about 1.3 per cent. So again, I think it just gives a good sign of what’s going to stay a little tighter, a little more in control, compared to really what’s going to have more opportunities for growth and obviously, for fulfilment.
Sandra: Very impressive findings. Well thank you, Chris, Jonathan and Chuck.
For more information or to download a copy of our Emerging Trends in Real Estate 2013, please visit us at www.pwc.com/ca/emergingtrends.”
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