High interest rates remain the biggest factor at play as commercial real estate markets enter 2024.<\/p>\n
The Bank of Canada\u2019s decision to hold its policy rate steady at 5% on Dec. 6 meant no immediate relief for investors wrestling with high payments and strategizing around refinancing this year.<\/p>\n
\u201cThe bank is continuing its policy of quantitative tightening,\u201d the bank said in announcing its decision. \u201cGoverning Council is still concerned about risks to the outlook for inflation and remains prepared to raise the policy rate further if needed.\u201d<\/p>\n
Derek Holt, vice-president with Scotiabank Economics, doesn\u2019t expect any rate cuts before mid-year. A cut too soon could delay bigger cuts if inflation persists, extending the pain for investors, in his analysis.<\/p>\n
\u201cPatience could pay more handsomely by waiting until they have conviction to deliver bigger and more durable cuts later,\u201d he said in a briefing note last month.<\/p>\n
This amounts to a dramatic change in the investment environment. When the policy rate headed north of 20% in August 1981, it was merely double what it had been a year earlier, the culmination of a steady increase in interest rates that proved short-lived. By the end of the year, rates were falling. A year later they were back in single digits.<\/p>\n
By contrast, the series of increases since March 2022 has resulted in a 20-fold increase in rates \u2013 the kind of shift only the best-capitalized investors can handle.<\/p>\n
\u201cWe\u2019ve faced the sharpest, steepest rise in the history of central banking, and that\u2019s taken a lot of people by surprise,\u201d said Tony Quattrin, vice-chair, capital markets with CBRE Ltd. in Vancouver. \u201cWe\u2019ve dealt with a lot more receiverships this cycle than we have in any other down cycle.\u201d<\/p>\n
Development land has been hit hardest. It isn\u2019t generating cash flow, and the combination of prolonged approval times, carrying costs and purchases needing refinancing at dramatically higher rates have sunk several projects.<\/p>\n
\u201cMost of that was just land that took a long, long time to rezone,\u201d Quattrin said. \u201cIt looked all the way along like the numbers were going to work, but when they finally got the zoning and finally got there ….. the proformas [were] unworkable.\u201d<\/p>\n
It isn\u2019t easy on the sell side, either. High financing costs and uncertainties about when conditions will stabilize have kept buyers on the sidelines.<\/p>\n
Greater Vancouver residential land transactions were down 55% in the first nine months of 2023, according to Altus Group data. However, this was an improvement from the 64% decline seen in the first half even as financing remained challenging.<\/p>\n
Ray Wong, vice-president and head of data solutions with Altus Group, said rates have already shown signs of falling, coming off the highs seen last fall.<\/p>\n
“The renewals are still going to come in high, but ultimately this will soften the blow a little bit,” he said. “We\u2019re not going to go back to 1, 2% interest rates but it\u2019ll be down from the 6.5, 7.5 that we\u2019ve seen in the past couple of months.\u201d<\/p>\n
What\u2019s jazzing investors right now are income-producing assets, particularly in the multifamily and industrial sectors. Both were flagged in the annual emerging trends report PricewaterhouseCoopers prepares for the Urban Land Institute as best bets for commercial real estate investment in Canada in 2024.<\/p>\n
The high cost of building new \u2013 and financing it \u2013 has added lustre to existing assets, especially those in prime locations with solid tenancies. Many industrial investors are owner-occupiers seeking an escape from higher rents driven by the strong demand of the past few years.<\/p>\n
While availability rates increased by about 100 basis points over the past year, Wong said occupiers are willing to pay to control their destiny. This has driven more aggressive pricing on desireable assets.<\/p>\n
High construction costs are showing signs of limiting development activity, squeezing the supply of residential and industrial product to the market and in turn further ramping up demand for existing properties.<\/p>\n
Residential is where demand is most out of whack with supply.<\/p>\n
\u201cWe\u2019re looking at dramatically slower housing starts next year,\u201d Wong said, even as Ottawa has raised its immigration targets. \u201cSo the need for housing is strong, but the supply of housing will lag pretty significantly, at least in the next couple of a couple of years.\u201d<\/p>\n
A downward shift in interest rates will help, but the amount needed \u2013 about two percentage points, in Wong\u2019s opinion \u2013 isn\u2019t likely until 2025.<\/p>\n
Canada Mortgage and Housing Corp. reported in June 2022 that BC would require 560,000 new homes by 2030 above and beyond what\u2019s usually built to achieve anything like affordability for buyers.<\/p>\n
An update to the report in September indicated a worsening situation in the intervening 15 months, with a need for an additional 610,000 units of housing.<\/p>\n
\u201cThe supply gap increases because of a lower projected number of housing units that will be built,\u201d CMHC explained.<\/p>\n
Ironically, while all levels of government try to tax units back into the market, higher interest rates may be equally effective.<\/p>\n
Many condominium investors have stepped back due to financing costs. Some recent buyers are also returning product to market, realizing they can\u2019t cash-flow the properties at current mortgage rates.<\/p>\n
While housing stocks continue to be compressed by historical standards, the Lower Mainland and other markets within BC have seen total listings start to rise. Recreational properties are also being affected, with many owners who counted on vacation rentals running into lower than expected demand as pent-up demand for overseas travel exploded just as interest rates began rising.<\/p>\n
\u201cWe are seeing more homes come online as mortgage rates have climbed over the past year and a half,\u201d said Barry Benson, broker with Royal LePage Rockies West Realty in the city. \u201cAlthough demand for Invermere homes has stayed steady, growing supply levels have moderated price growth. I expect this will be the norm for the near future as borrowing rates remain higher than normal.\u201d<\/p>\n
Quattrin and Wong are both optimistic regarding an uptick in deal-making as interest rates improve.<\/p>\n
“The second half of next year, that\u2019s when I think we\u2019re going to see some transaction volume start to pick up and that will lead into 2025,\u201d Wong said. \u201cCompanies are positioning their capital and getting their assets ready in anticipation that we\u2019re done with increasing interest rates.”<\/p>\n