Canada's commercial mortgage market – are there reasons for optimism?

Sector has remained resilient despite high-profile challenges, but there is a cautionary note too

Canada's commercial mortgage market – are there reasons for optimism?

There’s space for “cautious optimism” in Canada’s commercial mortgage sector looking ahead, with current milder activity set to pick up when interest rates fall, according to a top commercial market analyst.

Keith Reading (pictured), senior director of research at real estate firm Morguard, told Canadian Mortgage Professional that investment on the commercial side remained muted at the beginning of the year, although opportunities are still present.

“The market is quite slow at the moment – and again, it’s interest rate influenced,” he said. “A lot of groups that depend on positive leverage through low interest rates are relatively inactive at the moment because the cost of debt capital is just too high for them to make sense in the current economic environment.

“Having said that, if you bring a quality asset to the market – a high-quality, top-tier asset with a strong tenant roster – groups are buying those types of properties.”

Where is the commercial market surging – and lagging?

In lower market tiers, high borrowing costs are also weighing against interest for value-add type properties with some vacancy, Reading said, and buildings that need to be repositioned or redeveloped.

He was speaking as Morguard released its commercial real estate outlook for the fourth quarter, which showed that the market remained largely healthy despite challenges including economic uncertainty and high interest rates.

Multi-residential rental apartment buildings are still proving a strong option for investors alongside properties in the industrial space, Reading said, although familiar challenges remain for the office sector.

“Part of that is rental fundamentals. We’ve got record-high vacancy and very weak demand [in the office space],” Reading said. “And so the prospects of rent growth and stability going forward are pretty uncertain in the office sector – but even then we do have the odd sale of a top-tier property with a good tenant roster.”

The latter asset types are attractive to investors, he added, because they’re stable – and there’s also some room for optimism on the retail front, whose outlook has improved in recent months after dipping at the height of the COVID-19 pandemic.

Among the indicators of a resilient retail space include the purchase of a 49% stake in Vaughan Mills shopping centre outside Toronto to LaSalle Investment Management in December, a deal that ranked as one of the largest retail transactions its long-term owner Ivanhoé Cambridge has conducted in recent years.

Office remains troublesome asset class in commercial realm

That “relatively healthy” long-term outlook for retail contrasts sharply with uncertainty in the office asset class, where plenty of tenants are unsure of their future and what their businesses might look like in the coming years.

“So it’s a wait-and-see prospect for office tenants,” Reading said. “That uncertainty is obviously playing into how well properties perform. In a nutshell, tenants are saying, ‘OK, we’re just in a holding pattern right now,’ and that’s really impacting the office market.”

Retail and office are both witnessing a “bifurcation” between top-quality assets and riskier investments, according to Reading, although that trend isn’t apparent in the industrial space.

That asset class has been boosted by investment in apartment buildings – particularly after Canada and Mortgage and Housing Corporation (CMHC) recently revealed extremely tight rental supply nationally.

Morguard’s report noted that multi-suite residential rental properties’ growth appeared to be slowing somewhat by Q4 of last year, although transaction volume spiked by over 30% compared with the prior quarter.

Its strong performance characteristics and proven long-term track record were two of the chief factors behind the sector’s success, according to the report.

Still, despite some patches of optimism for the commercial space, Reading emphasized that much will depend on the Bank of Canada’s timeline for rate cuts down the line.

The central bank has thus far remained non-committal on a possible timeline for rate cuts, although most observers believe the first drop will arrive at some point this year.

“I believe it’s going to take a first cut, or at least [the sense that] the first cut is imminent [for activity to pick up],” he said.

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