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Monday, September 24, 2012

Canadian and US Residential Markets: A Study in Contrast

By Amy Erixon, TORONTO

Hardly a week goes by without a dozen articles expressing divergent views on Canadian residential construction levels, prices and prospects.   Home ownership levels are now higher in Canada than in the United States (70% versus 65.4%), despite prices more than three times as high on average.   Will the shoe drop in Canada, like it did in the US?  Will the US ownership market turn around?  And if-so, when?  A current snapshot reveals there is a condo boom going on in Canada, and an equally vibrant apartment investment renaissance in the USA.   How long will these last?

Eventually, all things being equal, prices revert to the mean.   However, all things are not equal. There is a lot of intervention occurring, directly and indirectly in residential and financial markets in both countries, with profoundly different results.  It’s instructive to look at the differences in governmental policy, the role of investor confidence, and capital availability for insights.   In the end, market timing likely hinges on investor confidence; which is increasingly tied to governmental policy.   Interest rates will stay low for some time, oversupply is getting absorbed, and liquidity is ample.  Governments are getting these pieces of the equation right if the goal is improving real estate markets.   Real estate is enjoying improved image relative to other investment alternatives, but frankly other choices these days are pretty unattractive, and that’s not likely to change very quickly either.  How long will confidence hold, and whether very low interest rates cause a second asset bubble - are important questions for a later blog.  Let’s start with assessment of current conditions and the impact of public policy on respective markets. 

Issues from cursory view of Canada:

  • Prices are very high and at record multiples to median income
  • Massive amount of new condo construction
  • Increasing percentage of units being acquired by investors and foreigners
  • Numerous non-traditional players jumping in the game

Factors that are the same in the US and Canada:

  • Shortage of attractively priced investment alternatives with underwrite-able risk
  • Government agencies subsidizing credit flowing to the housing sector, with different approaches being utilized in Canada and the US
  • Record low interest rates which if raised could squeeze both owners and buyers
  • Gateway markets seeing inflows of international “fear and flight” money
  • Rising unit prices/values, and a gap between existing prices and cost of new construction

Differences in Canadian vs US Government Housing Policies relevant to the market:

  • High land values and rent control in Canada means virtually no purpose-built apartments, creating a natural demand for rental of investor-owned condominiums. 
  • No sub-prime lending or personal residence mortgage interest deductions in Canada
  • Canadian government actively trying to cool speculative activity and both supply and demand
  • US Government is actively trying to move assets off its balance sheet and into the market

With higher income security in Canada and more disposable income to allocate to housing, (due in large part to do with differentials in public funding for health care, university education, public schools and social security) ownership is preferred.  But the differential in pricing between the US and Canada is likely unsustainable given the similar economic profile of the residents of each country.  To deal with the rising prices in Canada the market has been shifting away from single family toward smaller, less costly multi-family unit mix.  These units represent an easy entry, attractive investment property option for domestic and foreign individuals, as well as attractive homes for young people entering the market and empty nesters.  Most projects are located in urban centers and amenity rich locations.  So long as supply does not grossly outpace demand, this segment of the market should hold its own.    If demand lets up, the sector could see significant oversupply.

The US market has likely overcorrected.  While showing signs of recovery, it remains in serious oversupply.  The lower confidence levels are manifesting in surging ranks of renters.  Apartment REITs in the US are outperforming other sectors.  The surge in demand has been so strong that in the past 6 months 2 Canadian REITs have been IPO’d and numerous funds and clubs whose strategy is acquisition of US apartments have been formed - including our own product which launched in May of this year. 

Net/net, future market prospects largely come down to buyer and seller confidence holding or improving.  If confidence sags, there is a chance of significant dislocation in Canada, and reversal of current recovery trends in the US.  If it holds, we will enjoy a good run.   

Friday, September 21, 2012


“Big Data” and the Federal Government

by Dan Gonzalez

This is the second installment on the high tech trend of “big data analytics” and its impact on the Northern Virginia data center market.  The focus this time will be on the federal government’s role in creating and deciphering “big data.”  
 
As noted previously, not all data centers are capable of handling big data users as there are special requirements for handling the one-megawatt-plus users.  Big data centers require mega-storage, higher power, and cooling densities.  Currently, only Virginia, Texas, and California have data centers large enough to handle the big data volume.

Significantly for Northern Virginia, six federal agencies recently teamed up on a $200 million investment to access, organize, and understand the huge volumes of digital data being generated. The agencies involved are:

     National Institutes of Health
     Department of Energy
     National Science Foundation
     Department of Defense
     DARPA
     U.S. Geological Survey

This commitment on the part of these agencies will benefit Northern Virginia in terms of public/private partnerships and major investments in data center facilities and technology.  The driver behind this investment and cooperative was the President's Council of Advisors on Science and Technology.  Its stated goals for the initiative are to:
 
·         “Advance state-of-the-art core technologies needed to collect, store, preserve, manage, analyze, and share huge quantities of data;
·         Harness these technologies to accelerate the pace of discovery in science and engineering, strengthen our national security, and transform teaching and learning; and
·         Expand the workforce needed to develop and use Big Data technologies.”


Tuesday, September 18, 2012

The Story Behind Cap Rates

By Rand Stephens (Houston)

Short for capitalization rate, a "cap rate" is the unlevered annual cash-on-cash yield of a real estate investment.  Divide an investment property’s annual net operating income (“NOI”) by the asset value, and you have the annual yield assuming an all-cash investment.

The difference between cap rates and the 10-year Treasury (“Spread”) is supposed to represent the risk premium of owning real estate versus the 10-year Treasury, which has traditionally been thought to be the least risky comparable investment since it’s backed by the credit of the U.S. government.

Cap Rates vary based on asset class (office, industrial, retail, multi-family, etc.), and the Spread, when looked at over time, provides investors a perspective on current valuations compared to other time periods.  This analysis is similar to how investors look at historical price/earnings multiples for stocks to get a feel for whether the overall market is underpriced or overpriced.

Since most investors use debt to acquire investment property, they are underwriting the investment on a levered basis using an internal rate of return investment analysis.  With debt involved in the equation, a real estate investment takes on considerably more risk than owning a property with no debt, and using a cap rate when a property is levered as a barometer for reflecting a risk-adjusted return compared to the 10-year Treasury, is not particularly relevant.

In addition, investors use cap rates in their underwriting analysis like a comparable, to check a sales price or valuation of a property, compared to other simlar transactions.  Cap rates are also used in an investment analysis as a way to calculate a terminal value at the end of the projected investment period.

Spreads have been increasing, which means as the Spread moves back into a more historical norm, otherwise referred to as "cap rate compression", property values will go up the  same way bond values go up when interest rates come down.   

With Spreads at historical highs, investment real estate looks like a very attractive asset class.

Saturday, September 8, 2012

Houston - Are we at a Market Top?

By Rand Stephens (Houston)

The answer lies in how you feel about the energy industry.  If you think oil is going to $200 then Houston is poised to explode.  If you believe oil is going to $65, then Houston's economic growth will soften from the 3+% annual growth that we've been enjoying.

Over the last 30 years the evidence is overwhelming that the Houston economy is all about energy as   prices, rig count, job growth, real estate occupancy and rental rates all move in unison.

Since the health of any commercial real estate market is linked directly to job gowth, it's not surprising that Houston's real estate markets are very healthy as this city is rockin' and rollin'!  The collapse of the capital markets have also helped  Houston's real estate fundamentals...Say what?..because there's been no new development coupled with a high demand for space. 

I've spent most of my professional career in the Houston real estate business...lived through our train wreck of the 80's, as well as several other ups and downs.  Houston's real estate fundamentals are the best I've ever seen!

The postings on this site are those of the bloggers and do not necessarily represent the views or opinions of Avison Young.