After falling below 6 per cent for the first time on record in Q2 2016, the average national cap rate for Canadian commercial real estate (‘CRE’) assets fell even further in Q3 2016 to 5.86 per cent.
This once again breaks the record for a historic low cap rate and continues the steady decline of rates since 2009. As both foreign and domestic demand for Canadian CRE assets continues to intensify, the average national cap rate has declined in 27 out of the 30 quarters since Q2 2009.
“Last quarter we proposed that conditions were supportive for further cap rate compression and, while few would have predicted it, the average cap rate moved lower yet again in Q3. Globally, we are in a low-growth environment, so chasing yield has become the name of the game. When you consider the historic high spread over government bonds and the political uncertainty arising from the U.S. elections and Brexit, its little wonder why capital is being driven to Canada,” commented Paul Morassutti, executive managing director of CBRE Canada.
According to findings of Q3 2016 Canadian Cap Rates & Investment Insights Report, despite the ongoing declines in cap rates, Canadian CRE assets still provide an attractive spread over 10-year Government of Canada Bond yields at 486 basis points (‘bps’).
Exceptionally strong investment activity in Canada’s largest metropolitan areas, Toronto, Montreal and Vancouver, drove the overall decline in national cap rates. In Vancouver and Toronto, cap rates each dropped by 25 bps to 3.75 per cent and 4.00 per cent respectively for AA office product, with all classes of downtown offices also dropping by a similar amount. As a result, Vancouver and Toronto now rivals Manhattan (3.75 per cent) and Los Angeles (3.50 per cent) in having the lowest cap rates for Class AA offices in North America.
According to the report, cap rates also fell for all classes of downtown office product in Montreal, dropping to 4.75 per cent-5.25 per cent for Class AA product. Elsewhere, cap rates for the remaining seven major Canadian downtown office markets remained stable.
“Canada provides investors with a safe, stable real estate market in a country that protects property rights and has demonstrated incredible resilience to global volatility. As such, it’s no surprise that investment activity has been extremely strong in 2016 and has seen a record amount of foreign investment. What’s more, foreign investors have been prepared to a pay a premium to secure Canadian assets, particularly in Vancouver and Toronto which is playing a significant role in setting aggressive pricing.
“We’re also beginning to see global and domestic investor interest spill over from Toronto and Vancouver into Montreal given the value it offers relative to these cities. All commercial property types are being targeted but higher sales volumes are being inhibited by a limited desire to sell,” added Morassutti.
The report also revealed that cap rates had also fallen across industrial, retail and hotels in Vancouver, with apartments the only major asset class not registering a decline. A-class high rise and A-class low rise apartments remained constant at 2.50 per cent-3.00 per cent and 2.75 per cent-3.25 per cent respectively. Multi-family apartments are subject to the new tax on foreign investors in B.C. and there are early signs that foreign investment capital may be shifting to commercial properties which are not subject to the 15 per cent tax.
“It’s too early to tell if the new tax will negatively affect pricing, but it has caused a pause in the apartment market. Investors are currently sitting back and taking stock to get better clarity on potential impacts,” added Morassutti.