For investors seeking signs of what lies ahead for the Canadian economy in 2018, the real estate market offers some intriguing clues. The residential and commercial real estate industry is integral to the performance of the economy, but additionally, the industry reflects and responds to demographic influences and trends occurring in important industries that drive the Canadian economy.
Today, real estate represents a lot more than where Canadians live and work. Its presence in Canada’s investment picture has grown considerably.
James McKellar, director of the Brookfield Centre in Real Estate and Infrastructure at York University’s Schulich School of Business, says pension fund advisors and foreign investors are now significantly more active in the real-estate market than they have been in recent years. “The old benchmark was [that] less than 3 per cent of your investments should be in real estate. Today, 20 per cent doesn’t make people nervous,” he says.
With real estate poised to continue its growing impact on the economy and the investor, here are eight factors to follow that will shape the real estate market in the year ahead:
1. Sustainable growth
The good news for 2018: Solid growth should continue in the commercial real-estate market, while the residential market is likely to simmer along gently – both signs of healthy and sustainable growth in GDP and employment.
A new report from real-estate investment advisory firm Bentall Kennedy, Perspective 2018, looks at key demographic and secular trends as well as traditional macroeconomic indicators to provide an in-depth outlook for the year ahead.
Canada is expected to end 2017 having grown about 3 per cent, outpacing both the G-7 average and the U.S. economy, Perspective notes. But, while debt-laden households did most of the heavy lifting in 2017, this dependence on consumer-driven growth is anticipated to ease in 2018, the report says.
“While this strong showing over the past year signals that the Canadian economy is heading in the right direction, real GDP growth is likely to ease to a more sustainable pace of around 2.0 per cent in 2018,” it forecasts.
2. More jobs, newer jobs
In the report, Bentall Kennedy highlights the impact of employment growth, particularly in Canada’s largest urban centres, and cites Canada’s impressive rate of full-time job creation in 2017, with about 394,000 new jobs being added to the country’s labour force. Employment trends are being driven strongly by demographics, particularly the growing influence of millennials in the workplace, many of who are gravitating to new economy jobs in the urban cores. The Perspective report says employment growth momentum in Canada, particularly in the expanding tech sector, has enabled absorption to keep pace with the new supply of office space.
The continued strength of the financial services industries, combined with the emergence of an expanding tech sector in Canada’s major cities continues to drive vacancy lower and rents higher in most markets outside of Alberta. Toronto, Vancouver, and Montreal have been the primary recipients of this surge for space, but Waterloo and Ottawa have also benefitted from tech-driven office demand.
3. Suburban opportunities
This new-economy jobs surge in downtown areas – and resulting upward pressure on prices – means more companies will look to suburban areas to house their operations.
“In Vancouver, the lack of availability in the downtown core is shifting demand into the suburbs, where leasing options are more affordable and plentiful,” the Perspective report states. “Suburban Toronto is also experiencing this spillover in excess demand, albeit to a lesser degree. This should continue to bode well for the North (Toronto) submarket where the new TTC [subway] extension makes it a feasible option for some downtown tenants.”
However, not all suburban locations are created equal. Suburban areas that possess “urban-like” characteristics, such as access to public transit, restaurants and retail amenities within walking distance, and adequate parking are garnering the bulk of the demand.
4. Signs of life in the oil patch
When it comes to the once-thriving energy-industry markets that were hammered by the oil-price plunge, there’s some cause for optimism.
“One of the biggest headwinds has been the struggle of Alberta’s oil-ravaged office markets,” the Bentall Kennedy report says. “The outlook for the energy sector is still tentative, but crude oil prices have stabilized and could see moderate gains in 2018 as global economic growth improves. Evidence of an economic recovery has emerged, helping to slow rising vacancy in the office market, but a recovery to [a] balanced market is still a long way off.”
5. Watch those interest rates
The Bank of Canada’s next moves on interest rates is one of the variables likely to affect the real estate and broader markets.
“One of the biggest questions for investors these days is how higher interest rates will impact cap rates and valuations,” Perspective says. “Elevated debt levels and rising interest rates are expected to slow discretionary spending as households focus on ‘normalizing’ their balance sheets.”
However, it adds: “Fortunately, the recent momentum in wage growth should help mitigate some of these headwinds and help sustain a more moderate pace [for] retail sales growth.” That’s good, if not stellar, news for the retail sector – a key factor to consider for investors in commercial real estate and the broader equities market.
6. Residential ripples
Canada’s housing market may also throw some curveballs during 2018. Perspective notes that new, more stringent federal mortgage rules came into effect at the start of 2018, after which applicants for an uninsured mortgage will need to qualify at higher interest rates. For an average priced Canadian home of roughly $500,000, this will require an additional $16,000 of annual income, an 18-per-cent increase.
The new rules, along with record prices in major cities, have sparked concern about first-time buyers, particularly millennials, being priced out of the market.
Frank Magliocco, national leader in Real Estate for PwC Canada, says many developers have told him they are seeing a slowdown in sales, with some Canadians experiencing difficulty getting conventional mortgages and having to seek alternative lenders offering higher rates.
“We can’t forget that the residential market, right across Canada, has a fairly significant and profound impact on the Canadian economy. If we choke that too much it could have a ripple effect on our economy. It touches on services. It touches on trades. It touches on raw materials. It pretty much covers the entire spectrum of our economy,” he says.
7. Dollar signs
The value of the Canadian dollar is also something to watch, according to Davin Raiha, professor of business, economics and public policy at Western University’s Ivey Business School. For example, “if the Canadian dollar were to remain below 70 cents, that would probably drive up housing prices quite a bit, because it would make the price of Canadian properties much cheaper for foreign buyers, which would be one source of demand,” he says.
Prof. Raiha expects 2018 will “probably end up being a fairly modest year in terms of an appreciation. I don’t anticipate a return to the kind of record-breaking years that we had in 2015, 2016, in terms of really sky high, double digit rates of appreciation on real estate in Canada,” he says.
8. NAFTA: Will he or won’t he?
Trade tension in North America is growing, injecting risk factors that investors cannot ignore. Canada signaled its intention to play tough with the Trump administration in early January, submitting a wide-ranging complaint to the World Trade Organization about U.S. use of punitive tariffs; and the “will-he-or-wont-he” speculation on President Trump’s threat to throw out NAFTA continues to cast a shadow over 2018. The Perspective report warns that the trade pact’s renegotiation adds more uncertainty and an element of risk to the Canadian economy, which could impact real-estate investment.
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