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Real estate in 2019: Four things investors should know
Real Estate in 2019
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FOUR FACTORS THAT WILL SHAPE
REAL ESTATE IN 2019


These shifts in multi-family residential, industrial and commercial real estate markets should be on the radar of savvy investors

CANADIANS will pass their time walking in and out of buildings that directly impact their livelihood, with little thought as to who owns them. Yet, these buildings comprise a growing proportion of institutional investors’ portfolios, where billions are invested annually in Canadian commercial real estate.

According to real estate advisory firm CBRE, investment in Canadian commercial real estate weighed in at more than $38-billion in the first three quarters of 2018, well on pace to surpassing 2017’s record-setting $43-billion mark.

Globally, 2018 saw institutional investors continue to deepen their commitment to the commercial real estate sector, with public pension funds, insurance companies and other investor groups allocating $2.53-trillion (U.S.) to those assets, according to data insights firm Preqin. A new report, Perspective 2019, from real-estate investment advisory firm Bentall Kennedy, predicts “property fundamentals in Canada [will] remain buoyant,” despite GDP growth easing off. “Barring any unanticipated shocks, the net impact from the current upside and downside risks should remain positive for the Canadian economy as we head into 2019”, it says.

With the growing importance of commercial real estate to institutional investors, here are four factors to follow in 2019:

1. SOLID ECONOMIC GROWTH WILL CONTINUE TO SUPPORT DEMAND FOR REAL ESTATE

1. SOLID ECONOMIC GROWTH WILL CONTINUE TO SUPPORT DEMAND FOR REAL ESTATE

Pending U.S. Congressional approval, the United States-Mexico- Canada Agreement (USMCA) largely quells the North American trade tensions many Canadians felt this time last year. The Bentall Kennedy Perspective 2019 report anticipates that globally, growth will remain in the same ball park as each of the prior two years, at 3.7 per cent, but notes that global trade risks still linger.

“We continue to see strong demand for real estate − and that’s underpinned by strong business and consumer confidence,” says Paul Zemla, President, Investment Management and Chief Investment Officer of Bentall Kennedy in Canada. “We’re focused on the labour market and its direct impact on space markets across the country. We’ve seen strong job growth in Canada in recent years and although it has slowed somewhat this year, the economy continues to produce significant,high-quality full-time positions.”

Although some global economists are concerned about potential stress caused by the divergence between the booming U.S. economy, and a slowdown, or even stagnation, in other countries, Mr. Zemla sees Canada benefiting from its neighbour’s prosperity, with the USMCA removing a key downside risk to Canadian growth. Canada’s big challenges for the year ahead? High consumer debt levels against rising interest rates, and a shortage of qualified labour due to record low employment.

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2. OPERATIONAL EXCELLENCE WILL BE A DIFFERENCE MAKER LATE IN THE REAL ESTATE CYCLE

2. OPERATIONAL EXCELLENCE WILL BE A DIFFERENCE MAKER LATE IN THE REAL ESTATE CYCLE

With the exception of the Alberta office market − which continues to struggle with near-record high vacancy rates − and some secondary and tertiary retail properties, real estate fundamentals in Canada should remain strong through 2019, says the Perspective 2019 report. In this environment, growing net operating income will hinge on operational excellence.

Mr. Zemla notes: “Managing real estate in this maturing phase of the current cycle will be much different from the earlier part of this expansion, when missteps mattered less, because declining interest rates drove cap rates lower, lifting property values. Those tailwinds are gone.”

We continue to see strong demand for real estate − and that’s underpinned by strong business and consumer confidence.

Paul Zemla
President and Chief Investment Officer,
Bentall Kennedy (Canada) LP

Mr. Zemla adds: “Now, investment returns are really going to be more income-oriented − and that means making sure that buildings are occupied and that income is both secure, and hopefully growing.” He suggests maintaining an “up-in-quality bias” that favours markets with better growth prospects and superior liquidity characteristics. Assets that are close to transit, amenity rich, and that have sustainability features will continue to be attractive to occupants.

3. WHEN IT COMES TO INDUSTRIAL REAL ESTATE, THE ‘LAST MILE’ IS STILL THE HARDEST MILE

3. WHEN IT COMES TO INDUSTRIAL REAL ESTATE, THE ‘LAST MILE’ IS STILL THE HARDEST MILE

The whole supply logistics chain has shifted,” says James McKellar, professor and director of the Brookfield Centre in Real Estate and Infrastructure at York University’s Schulich School of Business. “I used to tell people that the industrial building of the future is called a truck − because you want to shorten the time between production and consumption – but we’ve discovered that you still need real estate in that chain.”

Prof. McKellar thinks industrial real estate, a traditionally strong performer, will continue to thrive in 2019, largely because of e-commerce’s increasing need to find space that’s optimally situated for both inbound suppliers and outbound urban customers − a sweet spot for moving goods the so-called “last mile” between a transportation hub and the end consumer. The facilities don’t need to be fancy or be able to accommodate massive cubic storage needs. What they need most is to be near urban populations and be easily accessible by workers. With transportation costs accounting for approximately half of end-to-end costs, companies are competing for the most strategically located industrial infills.

The Perspective 2019 report includes analysis of infill industrial real estate rents for properties within a 30-minute drive of the downtown Toronto core, compared with those in the periphery. As recently as two years ago, there was little rent premium to being closer to the core, but Bentall Kennedy sees that trend in full reversal now. The premium for infill industrial is expected to continue due to insufficient supply to meet strong demand. Industrial property vacancies are at record lows in Vancouver as well as Toronto, with low vacancy rates in most major Canadian cities.

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4. RESIDENTIAL RENTS ARE ON THE RISE IN A NEW RENTAL-LIVING REALITY

4. RESIDENTIAL RENTS ARE ON THE RISE IN A NEW RENTAL-LIVING REALITY

The multi-family residential rental market is poised to generate strong returns again in 2019. Mr. Zemla believes multi-family properties remain under-allocated in many investment portfolios. He says heavy demand for rental properties is a function of strong population growth, driven by immigration and a vibrant labour market. Eroding housing affordability has made it harder for first time home buyers to enter the market, meaning there are fewer people leaving the rental market, and more opting for rental as they form households.

“Even though this past year was one of the most significant in terms of new purpose-built apartments being brought to market,” says Mr. Zemla, “it’s still not enough to satiate demand.”

Michael Brooks, CEO of Realpac, a Canada-wide real estate industry association, sees this trend continuing. “In the GTA and in Vancouver, the two most expensive markets in Canada, purpose-built rental has seen a drastically reduced market share, with rental condos picking up the vast majority of new supply,” says Mr. Brooks.

He traces this product shortage to a combination of factors: under-zoned properties, lengthy development approval timelines, and the perception shared by many developers that a condominium poses less risk. Added to this is the challenge of diverging policies on rent control across the country. Despite these variables, Mr. Brooks says “purpose-built rental is by far the superior product,” and maintains his favorable outlook on the investment performance for purpose-built multi-family residential property. Citing the Q3 2018 MSCI/REALPAC Property Index, he notes, “the multi-family residential sector yielded a 12-percent return over a 12-month period to September 2018.”

Bentall Kennedy includes Bentall Kennedy (Canada) Limited Partnership, Bentall Kennedy (U.S.) Limited Partnership and the real estate and mortgage operations of their affiliates. This information is not intended to render any investment advice or recommendations.

This content was produced by The Globe and Mail's Globe Content Studio.
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