“Lenders, according to interviewees, have been tightening borrowing requirements, which, along with higher financing costs, are making it harder for real estate companies to raise capital and move projects forward,” the report said. “This, in turn, is leading to reduced competition for deals during a period of price discovery in which sellers and buyers find themselves at odds over pricing expectations and valuations as some real estate assets come under pressure.”
Some companies are staying out of the market, taking a wait-and-see approach until the market settles, the report said. Supply chain delays and cost increases for labour and materials further inform that position.
A second trend in real estate is sustainability.
“At a time when financing is both less available and more expensive, companies with a strong ESG track record will have an advantage in attracting investment from institutional players and sourcing new forms of capital that continue to grow in Canada,” the report said.
It also noted that climate disclosures, such as the draft sustainability disclosure standards from the International Sustainability Standards Board, will increasingly affect real estate companies in Canada.
Third, the housing affordability crisis requires more supply.
“In Canada, the supply is insufficient to meet housing demand, for all types of homes,” a release accompanying the report said. “Demand will continue to rise, especially as the Canadian government commits to higher immigration targets in the coming years and the country welcomes large numbers of temporary residents.”
The real estate industry is attempting to address supply by incorporating technological innovation and improving processes so that housing development is faster and more economical, the report said. It suggested multi-family residential housing as a potential opportunity for investors.
Another best bet for investment, given the trends, is industrial real estate — warehousing, fulfillment, data centres and self-storage.
However, the pressures affecting real estate as a whole, such as rising interest rates, are also affecting industrial properties, so opportunities must be carefully assessed, the report said.
An ETF to Consider While Investors Pick Up Distressed China Real Estate
Investors are giving the China real estate market a second look as the country continues to work through the real estate doldrums brought on by last year’s Evergrande Crisis. As such, this opens up opportunities for exchange traded funds (ETFs) that get exposure to Chinese real estate.
It’s often said in the investment world to follow the “smart money.” That could mean tailing the bets of institutional money managers such as Brookfield Asset Management, which is looking at opportunities in distressed Chinese real estate.
Per a South China Morning Post article, “Brookfield Asset Management is on the lookout to acquire premium commercial property from distressed Chinese developers, aiming to increase its footprint in the world’s second-largest economy where fresh capital is needed to bail out the troubled real estate sector.” Based on the report, the Canadian firm is targeting properties in specific cities with the probability of generating returns in the long run.
“We are seeing opportunities and are pursuing lucrative deals,” said Yang Yiwen, senior vice-president of real estate portfolio management for Brookfield in China. “There will be drawn-out negotiations because of pricing gaps to close.”
As mentioned, the value stems from last year’s Evergrande Crisis, which saw a number of large real estate developers come close to defaulting on their loans. This prompted them to sell real estate such as commercial buildings at low prices in China’s prime locales, giving real estate investors plenty of opportunities to snatch up property at a bargain.
An ETF to Play the Real Estate Bounce
ETF investors looking to play a rebound in China’s real estate market can obtain exposure using the Global X MSCI China Real Estate ETF (CHIR). CHIR seeks to provide investment results that generally correspond to the price and yield performance, before fees and expenses, of the MSCI China Real Estate 10/50 Index.
The underlying index tracks the performance of companies in the MSCI China Index (the “parent index”) classified in the real estate sector, as defined by the index provider. Summarily, ETF investors get the following:
- Targeted exposure: CHIR is a targeted play on the real estate sector in China — the world’s second-largest economy by GDP.
- ETF efficiency: In a single trade, CHIR delivers access to dozens of real estate companies within the MSCI China Index, providing investors with an efficient vehicle to express a sector view on China.
- All share exposure: The index incorporates all eligible securities as per MSCI’s Global Investable Market Index Methodology, including China A, B, and H shares, red chips, P chips, and foreign listings, among others.
A look back, and ahead, at Canada’s commercial real estate landscape
This year’s Global Property Market conference opened with presentations which looked both forward and back . . . reviewing the major trends of 2022 and offering an investment outlook for 2023.
Following are snapshots of what MSCI head of real estate economics Jim Costello and LaSalle Investment Management global strategist Jacques Gordon had to say during their talks at the Nov. 29 event at the Metro Toronto Convention Centre.
MSCI is a New York City-headquartered provider of decision support tools and services for the global investment community and Costello has 30 years of experience analyzing the relationships between real estate and economics.
LaSalle is a global real estate money manager with more than $81 billion in assets under management.
Gordon has been responsible for the macro strategy and micro research used to guide all investment decisions in 30 countries, but will soon take a new role as executive in residence at the Massachusetts Institute of Technology Center for Real Estate.
Jim Costello, MSCI
Costello said the real estate industry has enjoyed a period of tremendous returns globally and in Canada, but that dropped significantly in Q3 and major challenges remain ahead.
The global volume of real estate deals valued at more than $10 million is down from last year, when there was an enormous flow of capital into the sector. It is still, however, at an elevated level compared to historic deal flows.
“It was just a lot of folks hungry for yield in a period when interest rates were exceptionally low,” Costello said. “But as rates reset, there are going to be challenges for some of those investments.”
Many of the deals being done were larger as smaller assets that were traditionally purchased by investors with limited pools of capital behind them stopped moving earlier.
Liquidity fell in 97 of 155 global markets in the third quarter and Costello doesn’t see it picking up again for a while.
New York City was the most liquid market in the world from 2017 to 2020, but the Australian city of Sydney now holds that title.
Larger gaps have been created between buyer and seller price expectations. Costello said price corrections are needed to drive U.S office liquidity.
He believes sellers need to cut their price expectations by 15 per cent to get deals done and that number could increase.
Deal activity was down in Q3 in every asset class and the most popular markets have also changed.
Instead of traditional front-runners New York City and London, Los Angeles and Dallas have become the top global markets owing to their large number of logistics facilities and apartment buildings — two asset classes investors continue to chase.
Alternative real estate sectors — including self-storage, data centres, medical office, research and development, manufactured housing, student housing and seniors housing — have been gaining ground on more traditional asset classes.
Jacques Gordon, LaSalle Investment Management
Gordon said there were four inflection points affecting global economies and real estate in the transition from 2022 to 2023 and beyond. Things are moving:
• from interest rates being lower for longer to higher rates with a heavier drag on cash flows;
• from a COVID rebound to a global stall;
• from upward price pressure to downward price pressure; and
• from fossil fuel-driven economies to renewable energy-driven economies.
“Most of us are in private equity real estate,” Gordon said in talking about interest rates. “Whether we’re debt or equity players, we’re putting money to work for multiple years at a time.
“When you do that, you realize that we’re going to have to endure this period of, probably, 12 to 18 months of higher inflation and higher interest rates, but this too shall pass.”
Gordon said the COVID-19 pandemic “blasted a hole in the global economy” in 2020, but last year there was a “supercharged rebound with governments just blasting out surplus money.”
However, gross domestic product (GDP) numbers in countries around the world have been well below expectations in 2022.
Oxford Economics’ GDP forecasts for next year aren’t good, with several countries (including Canada) expected to have negative growth.
Real estate experienced major upward price pressure through 2021 and the first part of 2022, but now investors are having to deal with downward price pressure and declining transaction volumes in the sector.
Gordon said the depth of buyer pools has retreated across property types and, although deals can still get done, there are fewer bids for properties and sellers often don’t want to accept them.
Office vacancy rates are on the rise. JLL figures show a global vacancy rate of 14.5 per cent, with Europe at 7.2 per cent, Asia Pacific at 14.1 per cent and the U.S. at 19.1 per cent in the third quarter.
Coal, oil and gas comprise 77 per cent of the global primary energy mix, but Gordon said the future of energy looks nothing like its past.
He believes it’s going to take a lot of hard work to reduce the reliance on fossil fuels and shift toward more environmentally friendly energy.
“We in this room can commit to a net-zero-carbon world, but we need the rest of the world to come with us,” Gordon said. “Otherwise, we won’t get there.”
Cities Face Long-Term Neglect, Not Just A Real Estate “Doom Loop”
There’s been a sudden spike in worrying about city problems created by declining commercial real estate (CRE) values, especially urban office buildings where increased working from home (WFH) has reduced in-office work. But instead of a CRE “apocalypse” or “urban doom loop” that some are predicting, we may just see increased economic and budget pressures, the latest chapter in America’s long-term neglect of its cities
Although the “doom loop” argument highlights real challenges, it’s a mistake to suggest American cities were in great shape prior to the Covid-19 pandemic. This framing appears in a widely-discussed recent essay in the New York Times by Thomas Edsall, “How a ‘Golden Era for Large Cities’ Might Be Turning Into an ‘Urban Doom Loop’.”
As my new book Unequal Cities (from Columbia University Press) points out, American cities have suffered persistent inequality for decades. It’s true that pre-pandemic, American cities were doing better in many ways—lower crime, growing populations, and appreciation from some scholars and policy makers that cities are important drivers of the nation’s economic innovation, prosperity, and growth. But it wasn’t a “golden era.”
Edsall relies on an excellent recent paper from Columbia University professor Stin Van Nieuwerburgh, which views significantly increased WFH as permanent, with “broader implications for investors in equity and debt markets, productivity and innovation, local public finances, and the climate.” He contrasts a troubled urban future with recent decades, “which were in many ways…a golden era for large cities.”
The urban “doom loop” would start with increased WFH reducing urban jobs and commercial real estate values, leading to lower tax revenues and reduced city services (including police, transit, and sanitation), leading to more WFH, etc. Edsall seems to endorse the view “that the shift to working from home, spurred by the Covid pandemic, will bring the three-decade renaissance of major cities to a halt, setting off an era of urban decay.”
Van Nieuwerburgh also has a first-rate recent paper with New York University’s Arjit Gupta on falling CRE values in New York, where they introduced the concept of an “office real estate apocalypse.” As I discussed here in September, their strong empirical work is sobering, but also looks like a worst case scenario that doesn’t envision much potential mitigation from alternative uses of excess office space.
There’s no question WFH has slowed office use, especially in some central business districts, and that slowdown in turn is hurting commercial real estate values and city budgets. Of course, the Federal Reserve’s continuing interest rate hikes and apparent pursuit of a recession to fight inflation aren’t helping either.
But there are two problems with the “doom loop” discussion. First, real estate markets always fluctuate. Edsall’s essay quotes Harvard economist Ed Glaeser on potentially dire urban scenarios from CRE problems. But Glaeser also notes “conventional economic theory suggests that real estate markets will adjust to any reduction in demand by reducing price” and that’s not always a bad thing. If financial markets have over-valued CRE assets, then there will be a correction, but not necessarily an “apocalypse.”
Underused office buildings, including older and less competitive ones, still have value. I’ve written about how they can be converted into residential real estate or other uses. Edsall does quote the great urbanist Richard Florida, who notes that “downtowns and the cities they anchor are the most adaptive and resilient of human creations; they have survived far worse.”
University of Southern California economist Matthew Kahn (whose work should have been referenced in Edsall’s essay) sees expanded WFH as a force that can revive cities, especially older second-tier ones. This could lead to a more balanced national economy with wider opportunity not concentrated in a few superstar cities.
And contrasting a mythic urban “golden age” against the pending “doom loop” is dramatic, but misleading. America’s metropolitan form and politics are consistently biased against cities, and urban inequality has been persistently high for decades.
Cities anchor regional economic prosperity but are surrounded by literally hundreds of politically independent suburbs which reap many economic benefits without fully sharing costs. Cities bear a disproportionate share of those costs—education, poverty, crime, aging infrastructure, a constrained tax and revenue base—reproducing inequality and racial discrimination. Federal and state policies and aid also disfavor cities, making it very hard for them to fight inequality on their own.
Of course, a commercial real estate meltdown will make cities’ problems even harder to solve. A CRE meltdown and attendant city budget and social pressures would be another episode in how badly we treat cities and their residents. But America always has disliked and disfavored its cities, and we shouldn’t view current urban problems through distorting rose-colored glasses that see a lost “golden age” for American cities.
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