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Valuations for Canadian office real estate have taken longer to adjust than properties in other advanced economies.Jeff McIntosh/The Canadian Press
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As the US economy moves meaningfully ahead of the Canadian economy, so does its private commercial real estate sector, which is adapting more positively to the post-pandemic reality.
That is particularly evident in the private office property markets of both countries. While the United States is well down the path of converting, demolishing or otherwise disposing of vacant office space, Canada is effectively frozen following a wave of markings in 2023. That has made valuation assessments nearly impossible.
“There is a big dichotomy, and the Canadian market so far has not corrected,” said Victor Kuntzevitsky, portfolio manager with Stonehaven Private Counsel at Wellington-Altus Private Counsel Inc. in Aurora, Ont., which holds private real estate assets in credit and equity vehicles in Canada and the United States
It’s no secret that last year was a tough time for Canadian private real estate owners, with many pension fund managers losing money as high interest rates drove up borrowing costs, inflationary operating costs rose and vacancy rates remained high or is climbing age.
The Caisse de dépôt et location du Québec saw its real estate portfolio decline by 6.2 percent in 2023. The Ontario Teachers’ Pension Plan experienced a 5.9 percent loss in its real estate book, while commercial properties owned by Ontario Municipal Employees Retirement System (OMERS) led to a 7.2 percent drop in its real estate portfolio.
However, there are pockets of strength that investors can look to, says Colin Lynch, managing director and head of alternative investments at TD Asset Management Inc. These include multi-family residential and outdoor retail centers, as well as industrial properties, which have been consistent performers following strong returns through the pandemic.
It is a view that is consistent with other analyzes of the Canadian market. BMO Global Asset Management’s latest commercial property outlook indicates that the industrial and multifamily segments remain strong due to strong investor demand and tight supply.
“Office remains the asset class of greatest concern and near-term focus,” says the BMO GAM report, estimating a “timeline for a return to ‘normal’ of at least five years .”
Mr. Lynch says that while that timeframe may be accurate, private real estate investors need to evaluate opportunities on a city-by-city basis.
“Every city is very different. In fact, the smaller the city, the better the office property market has performed overall because commuting times are much better, so office attendance is much higher,” he said.
He points to cities like Winnipeg, Regina and Saskatoon, where commute times can be 10 minutes and office workers in an average of four days a week.
However, there is also room for more bad news, with some property owners struggling to refinance expensive debt in a longer-term higher rate environment that could force fire sales for lower-quality buildings.
The US and other developed real estate markets, such as the UK, are “a quarter ahead” of where the Canadian office market is in terms of valuation adjustments, Mr Lynch said. One of the main reasons is that much of Canada’s commercial office real estate is owned by a relatively small group of large investment funds.
“At the peak of the trough in the UK, for example, there were around 20 per cent reductions,” he said, noting that the Canadian market has not corrected to that extent, but is holding up.
Mr. Kuntzevitsky says this private fund assets are valued based on activity.
“The US market is deeper, there is more activity in it compared to Canada,” he said. “The auditors I talk to who value these funds say, ‘Listen, if there’s no market activity, we’re just making assumptions.'”
Nicolas Schulman, senior wealth advisor and portfolio manager with Schulman Group Family Wealth Management at National Bank Financial Wealth Management in Montreal, holds private real estate funds for clients and says he is preparing to evaluate new investments in the Canadian space later in 2024.
“We don’t think the recovery would take a full five-year window, but we believe it will take a little longer. Our conviction is that we want to start looking at the sector towards the end of this year,” said Mr Schulman.
Mr Kuntzevitsky says he has been allocating any excess cash to the US market in private and publicly listed vehicles.
“The opportunity here is that you redeem your open-ended private [real estate investment trusts (REITs) in Canada] and reallocate the money to the United States, where the private market reflects [net asset values] based on recent activity, or you can invest in publicly listed REITs,” he said.
Still, Mr. Kuntzevitsky is watching developments closer to home for evidence of the market turning.
In February, the Canada Pension Plan Investment Board and Oxford Properties Group Inc. to an agreement to sell two office buildings in downtown Vancouver for about $300 million to Germany’s Deka Group — about 14 percent less than they were targeting.
“Hopefully that will activate the market,” said Mr. Kuntzevitsky. “But so far, we haven’t seen that yet.”
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