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Valuations for Canada's office real estate have taken longer to adjust than properties in other advanced economies.Jeff McIntosh/The Canadian Press

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As the U.S. economy has pulled meaningfully ahead of Canada’s, so too has its private commercial real estate sector, which is adjusting more positively to the post-pandemic reality.

That’s particularly evident in both countries’ privately held office property markets. While the U.S.’s is well down the path of transforming, demolishing or otherwise ridding itself of empty office space, Canada’s has practically frozen in place following a wave of markdowns in 2023. That has made valuation assessments next to impossible.

“There’s a big dichotomy, and the Canadian market so far has not corrected,” says Victor Kuntzevitsky, portfolio manager with Stonehaven Private Counsel at Wellington-Altus Private Counsel Inc. in Aurora, Ont., which holds private real estate assets in credit and equity vehicles in both Canada and the U.S.

It’s no secret that last year was a difficult period for owners of Canadian private real estate, with many pension fund managers losing money as high interest rates drove up borrowing costs, inflation increased operating costs and vacancy rates remained high or even climbed.

The Caisse de dépôt et placement du Québec saw its real estate portfolio decline 6.2 per cent in 2023. The Ontario Teachers’ Pension Plan experienced a 5.9-per-cent loss in its real estate book, while markdowns on commercial properties owned by the Ontario Municipal Employees Retirement System (OMERS) resulted in its real estate portfolio dropping by 7.2 per cent.

However, there are pockets of strength investors can look to, says Colin Lynch, managing director and head of alternative investments at TD Asset Management Inc. These include multi-family residential and open-air retail centres, as well as industrial properties, which have been steady performers following strong gains through the pandemic.

It’s a view that dovetails with other analyses of the Canadian market. BMO Global Asset Management’s latest commercial property outlook notes that the industrial and multi-family segments remain strong due to high investor demand and tight supply.

“Office remains the asset class of the greatest near-term concern and focus,” the BMO GAM report states, estimating “a timeline for a return to ‘normal’ of a least five years.”

Mr. Lynch says while that timeframe could be accurate, private real estate investors need to evaluate opportunities on a city-by-city basis.

“Every city is very different. In fact, the smaller the city, the better the office property market has generally performed because commute times are much better, so in-office presence is much higher,” he says.

He points to cities such as Winnipeg, Regina and Saskatoon, where commute times can be 10 minutes and office workers are in four days a week on average.

However, there’s also room for more bad news, with some property owners struggling to refinance expensive debt in a higher-for-longer rate environment that could force firesales for lower-quality buildings.

The U.S. and other advanced real estate markets, such as the U.K., are “quarters ahead” of where the Canadian office market is in terms of valuation adjustments, Mr. Lynch says. A major reason is much of Canada’s commercial office real estate is owned by a relatively small group of large investment funds.

“Peak to trough in the U.K., for example, declines were about 20 per cent,” he says, noting that Canada’s market hasn’t corrected to that extent, but it is catching up.

Mr. Kuntzevitsky says these private fund assets are valued based on activity.

“The U.S. market is deeper, there’s more activity within it compared to Canada,” he says. “The auditors I speak to who value these funds are saying, ‘Listen, if there’s no activity in the marketplace, we’re just making assumptions.’”

Nicolas Schulman, senior wealth advisor and portfolio manager with the Schulman Group Family Wealth Management at National Bank Financial Wealth Management in Montreal, holds private real estate funds for clients and says he’s preparing to evaluate new investments in the Canadian space later in 2024.

“We don’t think the recovery would take a full five-year window, but we do believe it’s going to take a bit more time. Our conviction is, we want to start looking at the sector toward the end of this year,” Mr. Schulman says.

Mr. Kuntzevitsky says he’s been allocating any excess cash to the U.S. market in both private and publicly listed vehicles.

“The opportunity here is that you redeem your open-ended private [real estate investment trusts (REITs) in Canada] and reallocate the money to the U.S., where the private market reflects [net asset values] based on recent activity, or you can invest in publicly listed REITs,” he says.

Still, Mr. Kuntzevitsky is watching developments closer to home for evidence the market is turning.

In February, the Canada Pension Plan Investment Board and Oxford Properties Group Inc. struck a deal to sell two downtown Vancouver office buildings for about $300-million to Germany’s Deka Group – about 14 per cent less than they were targeting.

“Hopefully, that will activate the market,” Mr. Kuntzevitsky says. “But so far, we haven’t seen that yet.”

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