Multifamily assets delivered the lowest income return to institutional investors of the four property sectors represented in the MSCI/REALPAC Canada Property Index last year — an outcome that was likely the least surprising revelation for commercial real estate industry insiders on hand in late January for the release of 2019 results. Analysts tracking investment sales have consistently slotted multifamily cap rates at the bottom of their charts for the past several quarters.
“The national average cap rate figure for each of the four multifamily property types (high-rise and low-rise, class A and B) compressed in Q4 2019 and yields in each of these categories sit at their lowest levels on record,” David Montressor, executive vice president of CBRE’s National Apartment Group, reported in his firm’s recently released Canadian Cap Rates & Investment Insights for last year’s final quarter.
Nationally, the average cap rate for high-rise class A buildings was pegged at 3.79 per cent, but it dropped below that threshold in Vancouver, Toronto and Ottawa, with the lowest rates in the 2.5 to 3 per cent range in Vancouver. In comparison, the national cap rate for class AA office was 4.85 per cent; the national cap rate for class A industrial buildings was 5.06 per cent.
That trend is reflected in the 47 institutional real estate portfolios participating in the Canada Property Index. While the average income return across all 2,723 directly held standing assets slipped to the lowest level yet recorded in the index — at 4.6 per cent — the average income return for residential properties was another 80 basis points lower, at 3.8 per cent.
Nevertheless, multifamily properties produced strong total returns on a foundation of 7.3 per cent capital growth. The sector was the second best performer, after industrial, with a total return of 11.4 per cent. That’s largely on par with the 11.5 per cent total return in 2018, when industrial and multifamily were also the top two sectors. However, industrial properties made significant gains in 2019, as the average total return for the sector jumped to 16.4 per cent from 13.8 per cent in 2018.
“Last year, industrial and multi-res were very close at the top. Wow, that spread has widened,” observed Michael Brooks, chief executive officer of REALPAC, who steered a panel discussion in response to the index results. “Is the multi-res cap rate too low?”
Elsewhere, knowledgeable market observers suggest it’s not scaring buyers away yet. “Investors remain confident that low initial yields will improve substantially as leases roll to higher rent levels,” maintains CBRE’s vice chair, valuation and advisory services, Paul Morassutti, in the Q4 2019 cap rate report.
One of the more startling outcomes in the 2019 Canada Property Index results seems to validate that perspective. Halifax ranked as the top-performing Canadian market, delivering an average total return of 13.3 per cent one year after a 1 per cent loss on return had it positioned eighth of the eight surveyed markets.
The resurgence is predominantly tied to a deal for a 14-building portfolio that CBRE cites as “the city’s largest real estate transaction ever”, translating into a nearly 40 per cent average total return on multifamily properties. That contrasts with a nearly 16 per cent loss on return in the Halifax retail sector.
“Halifax took kind of an unprecedented rocket ride to the top, but there are good reasons for that,” acknowledged James Harkness, executive director with MSCI.
“I would say, obviously, the biggest surprise is Halifax,” concurred Christina Iacoucci, managing director with BentallGreenOak.
Although she projected that total returns would not be sustained at 2019 levels in Halifax, steady demand, setbacks for new supply and still more shoppers jostling for scarce product all combine to suggest that multifamily investment will retain favourable status in institutional portfolios.
Jon Ramscar, executive vice president and managing director with CBRE, theorized that Canada has moved from a safe haven in foreign investors’ estimation to something of a safe-haven-plus category. “From a sentiment point of view, there’s an appetite for Canadian real estate right now,” he said.
Alternatively, Iacoucci pointed to some brakes on development momentum. “Construction costs have really gone through the roof. It has really slowed down the growth in purpose-built rental,” she submitted.
Meanwhile, a yearly influx of new residents, roughly equivalent to 1 per cent of Canada’s population in 2019, is flowing through to all property sectors and underpinning much of the confidence in what has been a prolonged real estate cycle.
“That’s a lot of GDP growth and that’s a lot of demand for everything,” Brooks reiterated.