The first quarter ended very differently than it began across Canadian real estate markets as a long-conjectured brake on momentum arrived in an unexpected form. Analysts foresee cap rates will hold steady in the coming months because few trades are expected. Rather, CBRE’s newly released quarterly cap rates and investment report — the first for the new decade — is more an exercise in weighing and digesting the “significant turbulence” that has engulfed the business landscape.
“It has become clear that the short-term economic impact of COVID-19 will be unprecedented and real estate asset values will not escape the carnage,” surmises Paul Morassutti, CBRE’s vice chair, valuation and advisory services. “However, at this point, there is little actual evidence of material cap rate expansion. NOI (net operating income) erosion as a result of widespread rent concessions will likely have greater impact.”
The national average cap rate hovered just below 6 per cent at the end of March with a 493 basis point spread above the 10-year bond yield. Similar to several recent previous quarters, rates were tightest in the multifamily sector, at an average of 3.79 per cent nationally for Class A high-rise product, and in select industrial markets, including Vancouver, Toronto, Ottawa and Montreal.
CBRE analysts project the office, industrial and multifamily sectors are better positioned to recover solidly once business activity resumes, while retail and hotels will take longer to catch up. Although the circumstances of the 2008 financial downturn were very different, Morassutti sees some likely parallels for commercial real estate.
“That crisis saw deal flow essentially halt and resume once the smoke had cleared,” he recounts. “We fully expect that this will be the case in Canada as well-capitalized owners have little inclination to sell into a market at a discount if they believe conditions will be markedly different 12 months from now.”
“In a world which came to a jarring stop for everyday life and conventional commerce, the principles of commercial real estate haven’t changed but implications have,” observes Carmin Di Fiore, executive vice president, debt and structured finance, with CBRE. “Systemic pragmatism about the flow of rental payments through the real estate daisy chain is now the singular focus for tenants, landlords, lenders, regulators and governments.”
Accordingly, it’s expected office landlords will be primarily focused on issues around rent deferrals and mechanisms for payment support well into Q2. Meanwhile, social distancing imperatives have accentuated somewhat diametrical trajectories for industrial and retail assets. The potential for strong e-commerce gains should bolster industrial fundamentals, while bricks-and-mortar retail reels from radically curbed consumer demand and retail tenants’ mounting business constraints.
“The critical role of industrial assets in omnichannel and global supply chains is only forecast to increase and will ensure the sector remains well supported by strong fundamentals, especially on a relative basis,” CBRE analysts hypothesize. “Mandatory closures (in the retail sector) have had severe impacts on business revenues across the industry. Given current market conditions, it’s expected that this slowdown will have significant impacts on near-term operating proformas moving forward. That said, the magnitude of NOI deterioration is yet to be seen.”
Multifamily landlords are deemed to have more of a cushion. “Due to the record strength in fundamentals pre-shutdown, its overall inherent resilience and its counter-cyclical relationship to economic downturns, the multifamily sector is well-positioned relative to other sectors and investment products,” maintains David Montressor, executive vice president with CBRE’s national apartment group.
Nevertheless, Morassutti suggests all real estate players will be navigating much rougher terrain than the signs indicated three months ago. “Buckle up,” he advises.