Canadian real estate investors advised to buy distressed U.S. assets, Canadian apartments, underperforming infill space near major Canadian cities in 2011: PwC/ULI report

Cindy Allen

TORONTO , November 3, 2010 (press release) – 2011 promises slowing, steady growth and decent prospects for Canadian real estate investors as long as the U.S. economy does not drag them down, according to the Emerging Trends in Real Estate® 2011 report, released today by PwC and the Urban Land Institute (ULI). The report reflects interviews with and surveys of more than 875 of the industry's leading real estate experts, including investors, developers, lenders, brokers and consultants in both Canada and the U.S.

Canadian property owners and financial institutions cannot help contrasting their reasonably healthy condition with precarious U.S. markets. Canadian fundamentals trend near equilibrium, employment is recovering and banks boast sound balance sheets, putting Canada in a better place and boosting confidence that the local market can escape issues faced in the U.S. However respondents say a weak U.S. dollar and sputtering U.S. economy dampen cross-border commerce, especially hurting Ontario industrial markets, which serve Midwestern U.S. manufacturing centres.

"The big difference for Canada has been the sound condition of its banks," says Chris Potter, leader of the Real Estate Tax practice for PwC Canada. "We have no distressed banks and few distressed owners and sales. Now, rising interest rates coupled with tight bank requirements and broader economic concerns tamper down a recent home buying spurt, particularly in Ontario and B.C., where purchasers stepped up activity before HST went into effect."

While capital returns, investment opportunities will be limited. Institutions dominate the major central city markets, holding on to assets for steady income instead of trading. Emerging Trends respondents exemplify the hold-on mentality: they think it is a good time to buy, but do not want to sell. In this "compressing cap rate" environment, many deal-starved Canadians will be active in the U.S., where they should have greater opportunity to spend and find higher yields.

Canada has one of the world's healthiest capital markets and few borrowers confront refinancing issues. Overall in 2011, Emerging Trends respondents expect a reasonable balance in debt market capital availability and an oversupply of equity capital, the result of non-satiated buyers.

"In Canada, the real estate industry didn't get overleveraged and the markets never suffered any interruption of credit availability," says Holly Allen, leader of the Real Estate Deals practice for PwC Canada. "Canadian banks benefit from a combination of institutional risk aversion and relatively stringent government regulation."

* Insurers and Pension Funds - A dominant handful of large insurance companies and public pension funds will continue to command ownership of the nation's trophy commercial assets—downtown office space and regional malls.
* REITs - Prices levelled off after strong run-ups in 2009. For 2011, analysts do not see "much room for big gains," and these stocks should stick close to valuations.
* Foreign Investors - It is hard enough for domestic investors to find good acquisition opportunities, foreign players will struggle even more to break in. Offshore investors can't build portfolios easily.

Best 2011 Investor Bets in Canada
Respondents to the Emerging Trends cite the best investor bets for 2011, including:

* Remove portfolios of select low-yielding assets and reinvest opportunistically in a U.S. market recovery.
* Time investments to the market and buy down-but-not-out city-centre hotels and struggling industrial properties in the Greater Toronto area.
* Buy apartments if you can find anything available, they offer the best security.
* Look for underperforming infill retail or commercial space and position for redevelopment as condos. Canadian cities will continue to grow vertically as planners seek to encourage 24-hour environments.
* Reserve land sites inside the Toronto greenbelt for future residential development; demand and pricing should continue to increase.

Markets to watch
For 2011, major Canadian real estate markets settle in a fair to good investment range, with only modest investment prospects and constrained development potential. Toronto bumps Vancouver from the top ranking city to invest and develop in the Emerging Trends survey, while Calgary must hope to recuperate from cooled demand and a touch of development binging. Population continues to concentrate in and around a handful of major 24-hour cores scattered from coast to coast, leaving extremely limited investment opportunities in small cities and rural areas in between. Shut out of primary cores, some investors scrounge for product in select secondary and suburban markets.

* Toronto - Some softness creeps into the office market as major tenants "play musical chairs" and move into new Class AAA development projects. Market vacancy will not increase materially above the current mid-single digits, and any near-term additional office development will be small and niche. New condo projects pop up in all directions. Some respondents worry about flattening apartment rents as condo investor's lease out units. High housing prices and immigration flows help make apartments a good bet. Investors retain interest in buying and holding industrial properties, which should recover from higher-than-average vacancies and rent declines once the U.S. gets untracked.
* Vancouver - Office and condo markets almost defy logic and stay "red hot." Many wealthy Asian investors park money with plans for eventual citizenship. Institutional investors control the relatively small office market, which enjoys minuscule vacancies. Vancouver's natural barriers control development and attract investors—a powerful combination. But some respondents are uneasy: "The market is artificially inflated; it's been too hot for too long." The HST raises costs and temporarily cools demand for mid-tier housing in some areas outside the core.
* Ottawa - Nothing much will change. The government does not downsize but the city will never attract the same lobbying intensity or contractor-related business seen in the U.S. The Ottawa Convention Centre opens next year and could provide a potential market lift, particularly for hotels and retail.
* Montreal - The Montreal market will continue to hold its own as respondents cite its good value and better yields. Besides mainstay Quebec provincial government offices, the city benefits from a fairly diversified economy, including aerospace and financial services.
* Edmonton - Edmonton avoids the level of oversupply that deflates Calgary. The oil services business thrives and locals expect positive impacts to filter through the economy, including employment growth.
* Calgary - Sprawl and overbuilding "temporarily" subdue outlooks, but "absorption will come." Developers retreat in the face of high vacancies and show no appetite for new office projects. Locals put faith in robust commodities markets and U.S. consumption of oil from tar sands. Expect spreading hot growth to resume in coming years.

Reflecting modest expectations, property sector ratings improve over last year's tepid forecasts, especially for apartments and offices. Retail and industrial hold up, but hotels suffer from reduced U.S. tourist travel. Commercial markets promise to deliver cash flow but not much appreciation, while housing prices could ebb after an unsustainable surge. Most investors take heart in consistent metrics from markets, which linger in reasonable equilibrium; it beats write-down's, defaults, and foreclosures.

"Not only has the Canadian real estate industry been able to weather the downturn in the economy better than other markets, the environment in the U.S. has allowed Canadian investors to be opportunistic," says Lori-Ann Beausoleil, national leader of the Real Estate practice for PwC Canada. "Canadian investors looking to expand into the U.S. market or who are already in the U.S. have been able to take advantage of some great growth opportunities and purchase assets at a distressed price."

Now in its 32nd year, Emerging Trends is the oldest, most highly regarded annual industry outlook for the real estate and land use industry and includes interviews and survey responses from more than 875 leading real estate experts, including investors, developers, property company representatives, lenders, brokers and consultants.

A copy of the full Emerging Trends in Real Estate® 2011 report is available at www.pwc.com/ca/emergingtrends or www.uli.org/emergingtrends.

PwC firms provide industry-focused assurance, tax and advisory services to enhance value for their clients. More than 161,000 people in 154 countries in firms across the PwC network share their thinking, experience and solutions to develop fresh perspectives and practical advice. See www.pwc.com for more information. In Canada, PricewaterhouseCoopers LLP (www.pwc.com/ca) and its related entities have more than 5,300 partners and staff in offices across the country.

"PwC" is the brand under which member firms of PricewaterhouseCoopers International Limited (PwCIL) operate and provide services. Together, these firms form the PwC network. Each firm in the network is a separate legal entity and does not act as agent of PwCIL or any other member firm. PwCIL does not provide any services to clients. PwCIL is not responsible or liable for the acts or omissions of any of its member firms nor can it control the exercise of their professional judgment or bind them in any way.

The Urban Land Institute (www.uli.org) is a non-profit education and research institute supported by its members. Its mission is to provide leadership in the responsible use of land and in sustaining and creating thriving communities worldwide. Established in 1936, the Institute has more than 40,000 members representing all aspects of land use and development disciplines. The Urban Land Institute is an active and growing organization in Canada. With nearly 900 members across the country, Canada's first ULI District Council was established in Toronto in 2005 and a second District Council exists in British Columbia. ULI Toronto has over 500 members in Toronto.

"PwC" refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership, which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity.

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