Retail was the best performing asset type last year for institutional investors represented in the MSCI/REALPAC Canada Property Index. Newly released 2024 results, capturing 54 participating commercial real estate portfolios, reveal year-over-year improvement in all four of the major property sectors, as the average total return across all standing assets crept up to 3.21 per cent after coming in flat in 2023.

That was realized through a 4.91 per cent income return to offset a 1.63 per cent loss in capital value. Similarly, improved average total returns for retail, multifamily, industrial and office were largely attributable to income return. Industrial and office both lost capital value, while average capital gains were very modest for retail (0.8 per cent) and multifamily (0.1 per cent).

Income was also the major factor in seven of the eight surveyed regions, with Halifax standing out as an anomaly in posting 5.4 per cent capital growth. Among the four largest markets, Calgary delivered the top average total return, at 6.5 per cent, followed by Vancouver at 4.1 per cent, then Montreal and Toronto both hovering around a 2 per cent average total return.

In parsing out those results, industry analysts draw connections to unfolding real estate cycles. That has a brought a vast injection of new industrial supply since earlier in the decade when investors were realizing outsized returns on their industrial assets. Meanwhile, relatively modest retail development activity has fallen behind the pace of population growth.

“It was the case that a portfolio overweighted to industrial would outperform, but that has fallen off now. From a portfolio standpoint, it’s coming back to fundamental real estate management — not necessarily over-allocating or under-allocating, but selecting the best properties and managing the right properties,” Peter Koitsopoulos, vice president with the index producer, MSCI, told a gathering on hand in Toronto last week for the release of the investment results. “I think the industry has partly lost track of that. It’s good to see those fundamentals coming back.”

Industrial market returning to balance

Continuing with that theme, he theorized that below-average total returns for industrial properties in Toronto and Montreal are symptomatic of a flood of new investment. Canada-wide, industrial assets delivered a 3.4 per cent total return on average — breaking down to a 4.2 per cent income return against a 0.7 per cent decline in capital value. Among the four largest markets, that varied from average total returns of 6 per cent in Vancouver and Calgary to 2.1 per cent in Toronto and negative 0.8 per cent in Montreal.

“Not too long ago, those two markets were having year-over-year returns of 30 or 40 per cent, which is quite remarkable for real estate. That triggered a lot of building, a lot of supply coming to the market, and that excess supply really being absorbed by investors in Toronto and Montreal,” Koitsopoulos recounted. “This is actually a good thing in the sense that it creates a balanced market for Toronto and Montreal, which is something we haven’t seen for a long time. Having a balanced market, even though it lowers returns, is actually positive.”

Investors enjoyed positive average total returns on retail properties across all markets, but recorded the best results in Calgary, with an 8.6 per cent total return. Average total returns mimicked retail’s 6.5 per cent national average in Vancouver and Toronto, and settled at 5.2 per cent in Montreal.

Commenting on the sector’s strengths as part of an associated panel discussion, Cathal O’Connor, chief executive officer of Salthill Capital, cited: rising rents as lease renewals catch up with inflation; population growth that has eroded Canada’s “over-retailed” accumulation of enclosed malls; and a particular competitive advantage for grocery-anchored, open-air centres from lower operating costs and taxes than enclosed malls.

“We’ve been under-building retail now since 2016 and, quite frankly, tenants can’t afford to pay rents for new retail (that does get built),” he said. “That’s why retail is a good buy.”

Office posted a flat average total return across the index after a negative 5 per cent total return in 2023. There was a further 5.4 per cent drop in capital value last year (following a 9.9 per cent decline in 2023) against a 5.7 per cent income return. Calgary and Vancouver saw modest average total returns of 1.9 per cent and 0.5 per cent, respectively, and Toronto rallied somewhat from a negative 5.1 per cent average total return in 2023 to negative 1.1 per cent in 2024.

Ottawa also improved from a negative 9.9 per cent total return in 2023 to negative 3.3 per cent in 2024, but remained the worst performer among office markets. “The government workers are starting to go back to the office and that’s having a positive impact in Ottawa, but, over the last couple of years, Ottawa has been hit hard by those workers being slow to go back to the office,” Koitsopoulos observed.

Focus on income returns and portfolio diversification

Other panellists echoed Koitsopoulos’ general conclusions that income returns and strategic management are primary focuses for investors, particularly with the sudden added uncertainties of tariffs and other geopolitical upheaval.

“Coupled with available financing, especially in the major asset classes, you’re buying for a really good equity yield right now,” advised Michael Fraidakis, chief investment officer for LaSalle Investment Management’s Canadian holdings. “I wouldn’t bank on cap rate compression for the next little while. We’re back to income and having a portfolio that’s diversified enough to maintain that.”

Looking beyond, retail, multifamily, industrial and office, panellists also pointed to positive prospects for niche assets. “From public pension funds, there is money for certain sectors — data centres, self storage, university rentals,” O’Connor said.

However, slight existing inventory and hefty costs to develop new supply present barriers. Thus far, some Canadian investors have largely stuck to financing other developers and deal-makers in those burgeoning areas.

“Our credit book has lent to student housing and data centres, but data centres are very big cheques and I think we’ve taken the approach that we’d rather not (invest directly) right now,” reported Liz Murphy, chief financial officer, with Oxford Properties. “We haven’t seen a lot of opportunity (for data centres) here in Canada, or for student housing either. There’s a lot more opportunity for both those sectors in the U.S.”

“The space is crowded from an investment dollars perspective relative to the universe of assets,” Fraidakis concurred. “That is a sleeve that will continue to grow no matter what your portfolio looks like, particularly an institutional portfolio. It’s just that Canada is lagging other countries, particularly the U.S., in terms of the numbers of assets.”