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Friday, November 1, 2013

Avison Young Presents Its Fourth Quarter 2013 Commentary on North American Commercial Real Estate Markets

By Mark E. Rose (Toronto)

Ongoing improvement in the United States real estate markets despite political distractions; Canada awaits impact but investment market activity remains strong. 

Here we are in the final quarter of 2013 and U.S. politics continue to capture the headlines - impacting not only the domestic, but also the international business community. The temporary shutdown of government services this fall erased $24 billion from the U.S. economy (according to Standard & Poor’s), leading to a downward fourth-quarter growth adjustment in GDP.

North of the border, the Bank of Montreal has already cut its fourth quarter outlook to 2.1% from 2.3%.  The full impact on the commercial real estate sector in Canada may not reveal itself until 2014. The impact of major geopolitical events on employment is always a concern, but for now, Canada continues to create jobs at a slow-but-steady pace. Coming off a strong 59,000 jobs created in August, Canadian employers created only 12,000 jobs in September. However, that was still in line with the average pace of 12,560 jobs per month this year, prompting the unemployment rate to fall to 6.9% -- its lowest level in almost 5 years. This monthly pace is roughly half of last year’s average of 25,860 jobs. Thus, while employment was up 1.2% (or +212,000 jobs) compared with 12 months earlier, the consensus is that the aforementioned U.S. shutdown may temper job growth in the near term.

For the office and industrial property markets, the good news is that hiring increased in the financial and natural resources sectors. The bad news is that hiring declined in manufacturing and public administration.

I would like now to switch gears and take a moment to address the topic of rising interest rates and the impact on commercial real estate investment activity. Noteworthy metrics are drawn from our recently published Fall 2013 Canada, U.S. Commercial Real Estate Investment Review, covering 24 regions across North America.

Canadian Highlights
Canada has exceeded pre-credit-crisis investment dollar volumes and pricing for most asset categories, while improving property market fundamentals continue to fuel investment activity in the U.S. There is no evidence that the recent rise in interest rates slowed activity on either side of the border in the first half of 2013. However, it will be interesting to watch the appetite of the biggest buyer group – interest-rate-sensitive real estate investment trusts (REITs), and whether they will be taking a break from their insatiable buying spree.

Robust demand and available capital for quality assets are evident on both sides of the border. Whereas Canada continues to be stable, if not at peak pricing, the U.S. seeks to improve if the politics of sequestration, government shutdowns and debt-ceiling limits do not prolong the delay in recovery. Interest rates will remain the wild card as U.S. tapering of bond purchases and the inevitability of inflation will impact both countries.

Slightly more than $14.4 billion (CAD) worth of commercial real estate assets changed hands in the first half of 2013 – up $1 billion, or 8%, compared with the first half of 2012.  Throughout Canada, industrial properties were the most actively traded asset class in the first half of 2013, outpacing the office sector with 24% of total first-half investment dollar volume. In all, $3.5 billion worth of industrial product sold at an astounding year-over-year increase of 92%. Industrial sales increased in every market.

Toronto, Canada’s largest city and commercial real estate market, remains the investment market of choice, recording $6.5 billion in sales (a 45% share of the national total), which was up 15% compared with the first half of 2012, beating the 8% national year-over-year growth in sales.

Although capitalization rates are lower on average than one year ago, further interest rate hikes may moderate or even signal the end of cap-rate compression for some property types. Cap rates are lowest for multi-family investments, and once again, Vancouver yields the lowest cap rates in every asset category except retail (which tied with Toronto). Financing acquisitions on a go-forward basis, however, will be tricky.

Canadian debt markets were very active in the first half of 2013, despite a couple of the larger institutional participants withdrawing as a result of meeting their allocations. The second half of 2013 will be tempered by the U.S. Federal Reserve’s actions on reducing market stimulus. Expect higher ‘all-in’ interest rates driven by deteriorating bond prices in anticipation of the Fed’s reduction of market stimulus. Lenders will be very conscious of funding deadlines in what we see as a potentially rising interest-rate environment.

The United States
Congress and the President’s recent resolving of the immediate debt-ceiling and budget impasse, and re-opening of the federal government, signal a positive turn for the economy. Wall Street and business have responded with some confidence. Nevertheless, we can look forward to further political debate in the fourth quarter as new deadlines loom in early 2014.

The Bureau of Labor Statistics reports that the number of unemployed was 11.3 million people and the unemployment rate was 7.3% in August. This is only a small improvement since our mid-year 2013 report, though down from 8.1% a year ago. Unemployment peaked in the U.S. in October 2009 at 10%.  The markets that added the most jobs in the 12-month period ending in July include:

1. New York, New Jersey and Long Island Metro, adding nearly 145,000 jobs
2. Houston adding almost 98,000 jobs, and
3. Dallas adding 90,000 jobs.
4. And for the 12 largest Metros in the U.S., Houston, Dallas, Atlanta, Boston and San Francisco all outpaced the national employment growth rate of 1.7%.

In all, we expect the U.S. economy to continue its modest growth through 2013. Constraints on construction overall, as well as an uptick in occupier demand, have led to improved market conditions in many metro areas. The 10.3-billion-square-foot office market posted a vacancy rate of 11.6% at the end of the third quarter – down from 10.7% in the second quarter. We expect that office will continue on its slow improvement path through year-end. In industrial properties, the average vacancy rate fell further during the third quarter of 2013 and ended the period at 8.3%. The 20.8-billion-square-foot market will see further improvement before year-end with new deliveries less than half the amount absorbed in the third quarter alone.

For the U.S. investment sales market, rising interest rates have failed to halt investor appetite for stabilized core properties, and office and multi-family sales accounted for 80% of the sales volume in Avison Young markets at mid-year.  Commercial sales rose primarily on the strength of multi-family sales. Sales in the first half of 2013 for office, industrial, retail and multi-family assets in Avison Young markets increased by 28% over the first half of 2012.

International capital still favors the U.S. Year-to-date, Canadian buyers lead foreign investment by far, purchasing roughly $8 billion of assets, according to Real Capital Analytics. In 2012, Canadian buyers completed transactions totaling $9.2 billion in the U.S.  Manhattan and Los Angeles have each captured more than $1 billion in Canadian capital in 2013, and Chicago and Seattle are the next top destination markets with $557 million and $501 million, respectively.

Three standout markets accounted for 47% of U.S. sales volume, among Avison Young markets, by mid-year: New York, Los Angeles and Washington, DC. Nevertheless, core buyers looked beyond their top acquisition markets and several U.S. markets registered notable year-over-year changes in sales volume including: Las Vegas + 73%; Orange County + 66%, Atlanta + 63% and San Mateo +56%. Look for further gains before year-end with overall sales volume likely to exceed 2012 totals.

For the full details and analysis, we invite you to visit and download the report from the Avison Young website.

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