Canada’s commercial property market expanding

Canada’s commercial real estate sector and REIT investment market are set to outperform for a fifth-straight year, says CIBC World Markets.

“All of the fundamentals seem to be supporting the continuation of an extended recovery,” from the market lows of 2008, says Allan Kimberley, vice-chairman of Real Estate Investment Banking at CIBC.

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The bank says low interest rates, the continued availability of equity and debt, and healthy supply-demand fundamentals have set up Canada’s real estate capital markets for strong profits.

Also, these conditions are relatively unchanged from 2012, which saw “record levels of new issuance, total returns exceeding those of the broader S&P/TSX Composite index, a growing list of IPO and M&A activity, against a backdrop of declining volatility,” says Kimberley.

Equity analyst Alex Avery sees favourable property and REIT market conditions continuing in 2013. There’s one caveat, however, since “property and REIT pricing have risen to reflect the current positive environment. We expect attractive returns from Canadian REITs in 2013, but more modest than seen in recent years.”

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Avery adds returns from REITs in 2013 will be driven by attractive distribution yields and modest further appreciation in unit prices. Over the next 12-18 months, he’s forecasting returns to “average 5%-to-10%, comprising close to 6% in average yield and 0%-to-5% in capital appreciation.”

REITs that deliver the highest funds from operations growth are likely outperform all others.

“With more than a dozen new REIT formations during 2012, and the potential for as many in 2013, the Canadian REIT universe is expanding rapidly to offer investors numerous new alternatives,” says Avery.

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“We believe these new entrants offer the greatest opportunity for investors to outperform the broader group, with smaller, growth-oriented REITs offering significantly higher growth potential than the larger capitalization, more established trusts. However, these new entrants also tend to lack liquidity, public track records of financial results, and management ability to execute strategy.”

Two factors that can spoil attractive property fundamentals are the cost and availability of debt and supply of new developments, Avery points out.

“Wide spreads and forecasts for higher, but still low benchmark interest rates suggest favourable borrowing conditions could continue,” he says. “Committed and proposed development activity currently remains measured in the context of the overall inventory of investment property in Canada, [but] development proposals having picked up sharply in recent months.”

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Avery Shenfeld, chief economist at CIBC, says the real estate market will be supported by “national vacancy rates for both office and industrial space [which] are likely to remain well-contained,” while retail properties will continue to benefit from new entrants from the U.S.

Meanwhile, M&A activity will be supported by the combination of low interest rates, accessible credit markets, and a high-yield market that continues to expand. “M&A activity could continue in 2013, with privatizations among the higher-quality and larger capitalization REITs, and mergers between smaller capitalization REITs.”

In 2012, real estate was the third most active sector in Canadian M&A.