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The following article was written by Mahek Shah, Senior Research Analyst, National Research Insights, and Raymond Wong, VP of Data Operations at Altus Group.
A combination of hesitancy and elation have characterized the first half of 2022 in Canada’s real estate market. When comparing the first half of 2022 with the first half of 2021, investment volumes have increased across all asset classes, with the exception of the hotel asset class.
Slightly more than $50 billion was transacted across the office, retail, industrial, multi-family, land and hotel asset classes, a 46% jump from the first half of 2021. Transaction counts also increased across all asset classes with, except for hotels again, and more interestingly also the multi-family asset class.
While the outlook for the Canadian commercial real estate industry appears positive at first glance, the industry has been impacted by rising interest rates and increasing construction costs. The extent of the impact is expected to become more apparent in the second half of the year, by way of market activity and cap rates.
Source: Altus Group
As the Bank of Canada has continued to announce interest rate hikes as a method of responding to inflationary pressures, the Canadian real estate industry has been facing concerns about a possible recession being triggered. Understanding that this is a very real possibility, Altus Group conducted a survey of a diverse group of industry professionals to gauge how the recent hikes will impact development and investment parameters in the commercial real estate industry for the rest of 2022. This group included investors, lenders, brokers, consultants, and developers.
Results of our Impact of Rising Interest Rates on CRE survey
Survey respondents were asked to indicate how much they believe interest rates will rise by the end of 2022. No respondents maintained that interest rates would remain steady.
Lenders were the most pessimistic, with 62% believing that the increase would be between 50 and 75 basis points (bps). Brokers/consultants were slightly more optimistic with most assuming a 50-bps increase, and investors were almost even, with 26% predicting a 50-bps increase, and 22% believing it would be 75-bps.
When asked if they were expecting a recession, 90% of respondents agreed that they were, however, debate around whether it will be shallow or deep, continues. In light of a recession however, 60% of respondents, including industry leaders, noted that they are adjusting their cap rate and discount rate (IRR) expectations. Looking at the markets across Canada, it became clear that core urban markets are better positioned to weather the imminent recession than the suburban markets. This can be attributed to the larger demand for assets seen in urban markets driven by their larger populations.
Looking at specific asset types, 41% of respondents believed that industrial cap rates would continue to have stable cap rates in major urban markets, with 35% of respondents believing the same for multi-family assets. Multi-family and industrial assets also rank amongst the top preferred assets by investors across the country, according to Altus Group’s Investment Trends Survey.
Meanwhile, three quarters of respondents agreed that office cap rates will continue to rise in major urban markets. Retail assets are also expected to see an adjustment in cap and hurdle rates. Industrial and multi-family assets continue to remain favoured by investors owing to their flexible and essential nature. Office assets are still experiencing volatility when considering investor sentiment as investors overwhelmingly believe that office cap rates will need to be adjusted. This is because employers are still continuing to figure out their office needs, with the coming months being crucial for the asset class when determining its demand in investor portfolios. Results were similar for IRR expectations for the asset classes mentioned.
Cap rate change in quality assets in core urban markets
Types of assets |
Stable |
25bps |
50bps |
75bps |
100 bps |
More than 100 bps |
|---|---|---|---|---|---|---|
Office |
9% |
25% |
34% |
14% |
12% |
6% |
Retail |
20% |
26% |
30% |
14% |
7% |
3% |
Industrial |
42% |
26% |
26% |
1% |
4% |
1% |
Multi-residential |
35% |
32% |
19% |
10% |
1% |
3% |
(n=293)
Cap rate change in lower quality assets in suburban markets
Types of assets |
Stable |
25bps |
50bps |
75bps |
100 bps |
More than 100 bps |
|---|---|---|---|---|---|---|
Office |
3% |
8% |
26% |
29% |
21% |
14% |
Retail |
6% |
13% |
31% |
25% |
16% |
9% |
Industrial |
21% |
21% |
36% |
12% |
4% |
8% |
Multi-residential |
16% |
30% |
31% |
16% |
1% |
6% |
(n=293)
Altus Group | Survey: Impact of Rising Interest Rates on CRE (August 2022)
When asking developer respondents how they would deal with future interest rate rises, their responses fell into three overarching strategies:
- Increasing the pricing of the project
- Altering the building form to maintain current pricing
- Scaling back their development pipelines
With #3 implying they would pause existing projects, reduce land acquisitions, or reduce the number of new projects they may undertake. As developers were allowed to choose more than one option, it may be that they are not looking to pursue just one of three strategies, instead opting to employ a mix.
This survey provided a first look into changing sentiments within the industry and probed a diverse group of industry professionals. It became clear that with the rise of interest rates, the commercial real estate industry is definitely going to have a challenging second half of 2022. With developer strategies such as scaling back their projects, or raising prices, and investors preparing to adjust their hurdle rates, investor and developer sentiments remain highly cautious.
With more interest rate hikes expected, and the impact of these becoming more apparent in the latter half of the year, it will be interesting to see how the Canadian commercial real estate industry emerges from this new set of challenges.
About Altus Group
Altus provides the global commercial real estate industry with vital actionable intelligence solutions driven by our de facto standard ARGUS technology, unparalleled asset level data, and market leading expertise. Altus empowers real-estate professionals to make well-informed decisions with greater speed and scale to maximize returns and reduce risk.
