Institutional investors compare 10-year Canada bond rate to real estate returns

Bond rate signals to institutional investors

Monday, November 23, 2020

A 100 basis point slide in the 10-year Canada bond rate over the course of the COVID-19 pandemic contributes to real estate’s continuing allure for institutional investors. Speaking at last week’s REALPAC/Ryerson Virtual Research Symposium, Colin Johnston, president, research, advisory and valuation, with Altus Group, tracked a widening spread between 10-year bond yields and presumed real estate returns that measured 561 basis points in favour of real estate at the end of September.

“This is what pension funds and the life (insurance) cos look at,” he said. “They look at the spread between 10-year Canada bonds and internal rates. Right now, that does provide a potential buffer to values going forward.”

He submits that’s reflected in steady or even shrinking cap rates for multi-residential and industrial properties over the first three quarters of the year. Johnston’s presentation also revealed a general alignment between MSCI data for the Canada Property Index and results of Altus’ quarterly investment trends survey, based on responses from 150 Canadian commercial real estate executives. MSCI charts strong national returns in both the industrial and multi-residential sectors — averaging 12.4 per cent and 8.6 per cent respectively — while survey respondents tag those properties as their preferred investments.

“What’s in demand? It’s industrial; it’s industrial land; and it’s apartment buildings,” Johnston tallied. “What’s not in demand? The enclosed malls: the tier 1; the tier 2 regionals; the community (shopping) centres.”

Together, industrial and multi-residential properties account for nearly 42 per cent of Canada-wide investment sales value during the first eight months of 2020. Across all asset classes, year-over-year sales values dropped by 17 per cent and transaction volume declined by 11 per cent compared to January-August 2019. That was most notable in the office sector, which recorded $7 billion in sales during the first eight months of 2019, but was down to about $3 billion in sales for the comparable period of 2020. In contrast, industrial sales volume increased in 2020 and multi-residential registered the least amount of slippage among the other asset classes.

Looking at other factors that influence returns and investor outlook, Johnston pointed to September tenant delinquency rates ranging from 26 per cent in enclosed malls to 0.5 per cent in large-bay industrial facilities. Delinquency has abated from springtime levels for all property types — in May it peaked at 64 per cent in enclosed malls — and was pegged at 3.5 to 4 per cent for small-bay industrial, office and multi-residential properties as the third quarter came to an end. Meanwhile, tenant delinquency remained in the double-digits, at 14 per cent, for strip malls and open-air shopping centres.

“National office delinquency is less than 4 per cent, but there’s this disconnect between people who are paying rent and actually not occupying space,” Johnston mused. “The estimate is office attendance is somewhere below 20 per cent and I’d say, if we’re in the major CBD markets like Toronto, Vancouver, Montreal, it’s less than that.”

He ties the sparser attendance rates in those big city downtowns to workers’ heavy reliance, in normal times, on public transit, suggesting that contributes to current uncertainties in the office sector. Nevertheless, from a regional perspective, MSCI reports Toronto, Vancouver, Ottawa and Montreal delivered positive returns over the first nine months of the year, and those are also the markets Altus survey respondents favour.

“Vancouver, Toronto and Montreal, absolutely (are understandable). They’re big attractive markets with huge CBD districts, etc.” Johnston acknowledged. “Ottawa, I would say has done very well in this pandemic simply because it’s a large government town. If you think of concerns with regard to office occupancy, the government moves slowly. So I think people look to that market as one that will be fairly stable going forward.”

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