Canada’s reputation as a haven for capital continues to stoke foreign and domestic investments in commercial real estate, according to recent reports and commentary by Vancouver experts.

The average national cap rate, a measure of real estate value to owners, has been declining steadily since 2009. The most significant diminishing factor of a cap rate is usually high real estate prices.

It dropped to 5.9% in the second quarter of this year, marking the first time it has fallen below 6%, according to CBRE’s quarterly report on cap rates and investment trends.

To get the cap rate, the expected return on a real estate investment is first calculated by taking a property’s gross income and deducting from that various costs such as property taxes, maintenance and management to arrive at the net operating income. The cap rate is that net operating income divided by the purchase price of the property.

One of the causes of skyrocketing prices and falling cap rates has been strong demand by foreign investors. By the end of the first quarter of 2016, foreign investment into Canadian commercial real estate exceeded $1.0 billion, surpassing the 2015 total by 28v, according to CBRE. By the end of June, $2 billion in foreign capital had come into the Canadian market this year, or 19% of the $10.6-billion total in commercial real estate investment, the report said.

Vancouver received 72% of that national foreign investment in the first quarter, although a few deals with massive price tags accounted for most of that, said Jim Szabo, CBRE’s vice-chairman of capital markets, in Vancouver.

“We just traded Bentall Centre I, II, III, and IV for just north of a billion dollars,” Szabo said, referring to Anbang Insurance Group Co. Ltd. of Beijing buying a 66% share of the complex owned by Ivanhoé Cambridge in downtown Vancouver. (More recent reports indicate that Great-West Life Assurance has reached a deal to sell the remaining interest in the Bentall Centre to Anbang group for approximately $367 million.)

In January, German billionaire Klaus-Michael Kuehne paid about $400 million for Royal Centre, a 36-storey building at 1055 West Georgia St. in Vancouver.

“Those assets in our market are very, very rare,” Szabo said. “Those attract the larger funds and the larger sources of overseas capital, but there’s a significant amount of mid- to smaller-sized office buildings that have traded over the last 24 months.”

Szabo said the running total of annual foreign investment over the past four years as been about 15% of the market. “That popped to 33% last year in Vancouver, and it’s not just in Vancouver. If we look at 2016 … right across Canada, it’s 19% of the total investment market.”

When assessing cap rates, it’s standard practice to compare the rates to Government of Canada bond rates, Szabo said. “What we have right now is the largest gap in bond rates compared to current cap rates that we’ve ever seen,” he said, noting that cap rates tend to float around 250 to 300 basis points over the Canada bond rate.

Now, cap rates are 489 basis points above the 10-year bond rates. “If you ask me where cap rates are going — provided bond rates don’t go up — I think there’s probably more compression coming,” he said. “Most people would rather own real estate today than buy the bonds.”

Many property owners are now taking advantage of conditions to achieve once-in-a-generation pricing, according to Collier International’s own quarterly assessment of local and national cap rates, which marked A-class downtown Vancouver office cap rates at a high of 4.5% for the second quarter of this year. (Industrial cap rates stayed flat at 4.25 to 5% for single-tenant class-A properties, retail also remained flat at 4.25 to 5%, while multi-family apartment cap rates were listed at 2.25 to 3% for highrise properties and 2.75 to 3.5% for low-rise).

“Investors are counting on increases in capital value as opposed to earning an annual yield,” said Chris Blanchette, managing director with Colliers in Vancouver. “I’ve been in this business for 43 years and I can remember a day when apartment buildings would trade at eight and nine per cent cap rates, and now we’re well under 3% in many locations. Certainly in the more popular locations we’ve seen trades at 2 to 2.5%.”

He said the reason for low cap rates is simple. “It’s clearly telling us that the investor doesn’t give a hoot about how much they are going to earn on an annual basis in terms of annual yield. They’re counting on selling the property in six months or a year or five years.”

The market reports suggest that investment is strong and will remain strong “because as expensive as things are here, there are other places on this planet where they are way more expensive,” Blanchette said.

“We’re seeing outside investors coming in and buying properties here at a very low cap rates because there is a significant demand to get into the Vancouver market place,” he said.

“There’s so much money chasing so little product and there’s so much money available by lenders,” said David Goodman, a principal with the Goodman Report. “We’re not just talking about the Canadian Mortgage and Housing Corporation, we’re talking about conventional lenders that are offering phenomenal terms,” he said. “I think it’s added fuel to the fire.”

He said Vancouver’s market is now in the same category as cities like London, San Francisco and Zurich. “The world recognizes that Vancouver is a place where it’s safe. They can park their money, sleep well at night. There’s stability here and there’s massive immigration growth.”

CBRE’s Szabo said foreign capital could be the game-changer. “If foreign capital pulls up and stops pursuing assets in Canada, Vancouver or Toronto, then that would create less demand and you would see prices ease,” he said. “That’s a possibility.”

Brexit could also muddy the investment waters as investors in the UK could re-aim their capital over the next year or more, he added. “That capital has to go somewhere and it always tends to go to safe havens,” he said. “Right now, North America — not just Vancouver — looks pretty safe.”

Foreign Capital Drives Vancouver Commercial Real Estate Buying Boom by Evan Duggan | Vancouver Sun