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Thursday, October 25, 2012

Fourth Quarter 2012 North American Market Update

By Mark E. Rose (Toronto)

With summer now well behind us, please find below Avison Young’s summary overview of Q4 market conditions in North America.
In the U.S., all eyes and ears have turned to the looming presidential election and the “fiscal cliff,” and in Canada, astonishingly, to rising consumer debt levels. These factors, coupled with the on-going debt crisis in Europe and the potential slowdown in China, are undoubtedly altering business operations, which have and will temper real estate decisions affecting the leasing and investment markets.
As I will discuss, there are trends in the sector that directly impact how positive or negative our markets will be. On the one hand, the lowest interest rates in recent history have put a floor underneath fundamentals and valuations. On the other hand, there is nowhere to go but up for interest rates. Despite this cheap capital, the U.S. has not seen significant increases in transaction velocity and continues to bounce along a cyclical trough.
Canada has used its stable banking system and financial strength to weather the storm and provide liquidity, which has led to a recovery in investment activity and pricing that is meeting or exceeding 2007 levels.
 Said differently, North American investment opportunities most likely shift to the U.S., which is bottoming, and away from Canada where risk is inherent and pricing is most likely at a near-term top.
As always, we communicate with clients to advise and provide solutions, and when we believe there is a need for them to review and adjust their investment strategies.
So let’s move to the details:
The labour market is a key barometer for us and something we watch carefully, especially with rising consumer-debt levels and the potential rise in interest rates, and the impact they may have.
Following strong gains in the spring, and a lull in the summer, Canada put together two solid months of job creation to end the third quarter of 2012 on a positive note. In all, 52,000 positions were created, mainly in full-time work. However, the unemployment rate increased 10 basis points from the previous month to 7.4% as more people participated in the labour market.
The headline number of 52,100 jobs in September puts Canada on much more solid footing than most of its peers. Compared with 12 months earlier, employment is up 1% or 175,000, driven by an increase of 157,000 (+1.1%) in full-time work.
Now on to the real estate markets….
Apart from some soft patches here and there, we are not reporting any material slowdown in the commercial real estate sector in Canada. The market, for now, remains healthy.
While leasing velocity has been steady to date (which is not entirely surprising given the sound fundamentals), we are surprised at the amount of real estate that continues to change hands. Though we haven’t finalized third quarter figures yet, the first half of the year has been very good for Canada, with almost every market reporting higher investment dollar volumes over the same period one year ago.
Nearly $12 billion in commercial real estate assets changed hands in the first half of 2012 – up 26% compared with the first half of 2011. While the investor profile is varied, REITs remain very active, often competing and outbidding pension funds and life companies for some of the most prized assets in the country.
Given the current deal pipeline, continued sound underlying market fundamentals, and barring any deals being pushed into next year, 2012’s investment volumes may very well match, if not exceed, the previous peak of $24 billion in 2007 – so stay tuned!
As I mentioned earlier, this could be the sign of a near-term top in the markets.
Now let’s look at the U.S….

The typical summer slowdown coupled with the upcoming presidential election and lingering economic woes translated into a loss of momentum and lackluster performance for many of the U.S. commercial real estate markets. 

In mid-October, the Bureau of Labor Statistics released its regional and state unemployment summary and reported a national unemployment rate for September of 7.8%, 1.2 percentage points lower than in September 2011. Unemployment is down, but we are not yet feeling the positive impact of job growth.
In 2012, employment growth has averaged 146,000 per month, compared with an average monthly gain of 153,000 in 2011.
The largest year-over-year job increases occurred in Texas (+262,700 jobs), followed by California (+262,000 jobs) and New York (+125,000 jobs.) Not surprisingly, these are major real estate markets that are doing quite well on a relative basis
The 10-billion-square-foot U.S. office market stalled in the third quarter of 2012, with the 12.1% vacancy rate unchanged from the previous quarter, and down slightly from the year-end 2011 rate of 12.3%.  
On a positive note, office construction remains constrained, and the volume of new buildings being delivered has remained well below the historical average since 2009.
The 20.6-billion-square-foot industrial market showed further improvement during third quarter, ending with a 9.1% vacancy rate -- and, as with office, development remains well below historical levels.
The U.S. also continues to attract foreign investment. As of October, Canadian investors dominated, with investments in the U.S. totaling $3.5 billion.
Illustrating how unevenly markets in the U.S. are performing, here are some highlights from select Avison Young major office markets:

A negative trend ― Washington, DC, one of the country’s safe havens of investment and strong commercial real estate fundamentals, felt the slowdown with sales volume and leasing velocity both lower so far in 2012.

A positive trend ― In Chicago’s 1.1-billion-square-foot industrial market, 2.3 million square feet of construction is underway ― including speculative construction! 

A neutral trend ―  In Manhattan, the office market showed little movement through the third quarter as vacancy rates were stable and overall absorption was relatively flat.

If the U.S. resolves the fiscal cliff by the end of the year and a pro-business attitude is adopted out of Washington, the possibilities and opportunities for recovery and growth are exciting. And given the size of the U.S. market, any positive momentum in U.S. capital flows would have an equally positive impact on Canadian and European capital flows.

Until then, and despite the safe-haven status of the U.S., most clients will still be worried about investing in an uncertain U.S. environment and, hence, will continue to gravitate to core products in core markets throughout the U.S. and Canada… and....... will have their fingers firmly on the pause button.
Please also view our inaugural Fall 2012 Canada U.S. Commercial Real Estate Investment Review on our website at

You can also listen to this Q4 2012 Audiocast Message on our website at 

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