Economic Headwinds and Canadian REITs

By Salmaan Alvi, Partner, BDO Canada

Real estate fundamentals overall are relatively strong in most parts of the country, but Canada’s markets are feeling the blows of many of the same economic headwinds tempering market sentiment in the U.S., including currency risk and a decline in commodity and oil prices. What trends will be driving Canadian REITs and commercial real estate this year?

Historically weak loonie adds pressure. Despite concerns that Canada could be facing a real estate bubble, foreign buyers are willing to pay a premium for in-demand properties, and we could see the trend of increased inbound money continue–especially as the loonie stays subdued, trading at its lowest level in 15 years. China remains the top player, but we’re also seeing significant investment from the Middle East, as well as the U.S.

On the flip side, though, with more foreign investment comes more potential risk. Foreign buyers that are speculative can create upward price pressure. This is underlined by home prices in markets like Vancouver, which have jumped to averages of more than U.S.$1 million.

As prices continue to jump, residents of the city are stretched increasingly thin, and many are forced to move. And as price weakness persists, REITs continue to trade at a discount to their net asset value across the board, leading many to pursue aggressive growth strategies throughout the remainder of the year.

Consumer spending tempered, but growing more confident. In the third quarter of 2015, Canada recorded its highest level of consumer debt since 1990, becoming the most indebted country in the G7 since 2000. Total household debt amounted to 171 percent of disposable income, according to the Parliamentary Budget Officer. This means that for every C$100 (U.S.$78) of disposable income, households had debt obligations of C$171 (U.S.$133).

Spending on the lower end has dropped as consumers shy away from the excess they may have embraced a few years ago, as factors like ultra-low interest rates and increased housing prices weigh on their minds. The Parliamentary Budget Officer projects household debt will continue rising in the near term, reaching 174 percent of disposable income later this year. That said, there is a prevailing wind of cautious optimism, mirroring what’s being seen in the U.S. economy.

Millennial preferences shape CRE. Millennials’ growing preference for multifamily urban living that caters to the live-work-play mindset is leaving its mark on Canada’s residential real estate market. In the retail sector, Target’s failure in Canada exemplifies the disruption the sector is feeling. Millennial tastes are also impacting the office sector: As more people gravitate back toward urban markets, so too do many employers that had once inhabited suburban office parks. As a result, office and retail REITs are showing a heightened interest in mixed-use developments.

Low oil prices drive mixed results. Overall, low oil prices are benefiting most industries, as is the case in the U.S. In major markets like Toronto and Vancouver, low global oil prices are creating ripple effects reaching the broader economy. Also similar to what’s been experienced in the U.S. is the effect of low prices on boom towns that over-constructed to accommodate the influx in oil sands workers before prices crashed. For example, Alberta, historically heavily oil driven, is experiencing double-digit vacancies.