Canadian Oil Boom Reverberates in Offices as Returns Rise
Office vacancies are falling in Toronto and the rest of Canada amid economic growth led by the oil and natural-gas industries. Investor interest in commercial property is rising after the total return on real estate climbed almost 16 percent last year, the most since 2006 and outpacing gains in the U.S., according to the REALpac/IPD Canada Annual Property Index.
Low vacancies and increasing demand are pushing developers to build 8.9 million square feet (827,000 square meters) of office space in Canada, the most since the first quarter of 2010, according to CBRE Group Inc. (CBG) Calgary, the center of the energy business in Canada, is leading the way with more than 3 million square feet under construction.
“They have had a commodities-fueled boom across the country,” Dan Fasulo, managing director at property-research firm Real Capital Analytics Inc. in New York, said in a telephone interview. “The fundamentals of the property markets are in very good shape.”
Office property values probably will rise 20 percent this year in Calgary and about 10 percent in Toronto and Vancouver as low vacancies help landlords raise rents, according to estimates by CoStar Group Inc. (CSGP)’s Boston-based Property and Portfolio Research Inc. Montreal values are expected to gain 4 percent.
Boost to REITs
The increase in rents and occupancies has helped Canadian real estate investment trusts. The 13-member S&P/TSX Capped REIT Index (SPRTRE) had a total return of 13 percent in the 12 months through March 29. Canadian REITs are likely to have strong returns in 2012 as well, said Heather Kirk, an analyst at National Bank Financial.
“The key Canadian office markets are doing very well,” she said in a telephone interview from Montreal. “The demand is very robust right now.”
Canadian REITs are estimated to have a total return of 15 percent to 25 percent this year, partly because of low and falling vacancies, limited new construction and demand from investors for income-producing securities, according to a Feb. 29 report by CIBC World Markets Inc. analysts led by Alex Avery. The REITs gained 22 percent last year, including reinvestment of dividends.
Smaller U.S. Return
The total return for U.S. commercial real estate in 2011 was 14 percent, according to the National Council of Real Estate Investment Fiduciaries, a trade group for institutional investors based in Chicago. U.S. commercial-property prices rose 1.9 percent in January from a year earlier, according to the CoStar National Composite Index.
In Canada, the top-performing REITs this year have been Artis Real Estate Investment Trust (AX-U), an owner of office, industrial and retail properties, and Boardwalk REIT (BEI-U), which focuses on apartments. Both companies’ shares have gained 14 percent since the beginning of 2012.
Scotia Plaza, which has 2 million square feet, mainly in its 68-story main tower, is worth C$1.3 billion to C$1.5 billion, said Robin White, a broker and executive vice president at real estate services firm Avison Young Inc. in Toronto. The complex, whose tenants include Scotiabank and law firm Borden Ladner Gervais LLP, also includes a 27-story tower completed in 1951. Both buildings are for sale.
“It is poised to break all the records,” said John Andrew, a real estate professor at Queen’s University in Kingston, Ontario.
Commercial values are rising as demand for housing in Canada has been supported by some of the lowest mortgage rates in decades, fueling purchases even as home prices rise close to records. Canada’s biggest banks are tightening lending standards for condominium builders at the urging of regulators, requesting higher pre-sales and deposits as policy makers warn the Toronto and Vancouver markets are overheating.
Policy makers including Finance Minister Jim Flaherty have warned about the risks of record consumer debt and soaring housing prices that some investors say may be inflating a condo bubble in Toronto and Vancouver. Canadian housing prices may fall as much as 3 percent over the next year, Home Capital Group Inc. (HCG) President Martin Reid said this week.
Commercial demand is strongest in Calgary, which has been subject to the volatility in the oil industry. Calgary led the nation’s biggest commercial property markets with a total return of 22 percent, which includes income and gains in property values, according to the REALpac/IPD Canada Annual Property Index, according to a Feb. 16 statement from London-based Investment Property Databank Ltd. REALpac is an association of institutional investors.
Vancouver was second, gaining more than 15 percent last year.
“We do not see the current success of the Canadian markets as a bubble,” John Affleck, international economist at Property and Portfolio Research, said in a telephone interview. “We think it’s justified and we think it’s likely to continue.”
Downtown Calgary’s vacancy rate plummeted to 3 percent in the fourth quarter from 9.7 percent a year earlier, according to data from brokerage Cushman & Wakefield Inc. Asking rents in the Calgary area rose 5 percent to C$23.93 as 9.1 million square feet of space was leased last year.
Oil Futures Rise
Rising oil prices are helping boost Calgary’s economy. Oil futures have gained 4 percent to $103.32 a barrel this year through March 29 amid concern European and U.S. sanctions against Iran will lead to military conflict in the Middle East, home to more than half the world’s oil.
A dependence on commodities, however, make both Calgary and office properties across Canada vulnerable to a downturn.
“Calgary tends to be a bit of a boom-bust town,” Bill Argeropoulos, vice president and director of research for Canada at Avison Young, said in a telephone interview. “Right now it’s riding a wave of development and good growth.”
Gross domestic product grew at a 1.8 percent annualized pace in the fourth quarter after a 4.2 percent rate in the third quarter, according to Statistics Canada. The country’s GDP grew 2.5 percent in 2011, boosted partly by mining and oil and gas production, according to the Ottawa-based agency.
Demand for commercial property remains strong even as the economy’s growth slows. Large, well-leased properties such as Scotia Plaza in Toronto rarely come on the market as owners hold on to properties. Scotia Plaza is 99.5 percent leased, Andrew Chornenky, a spokesman for Scotiabank, wrote in an e-mail. Scotiabank occupies 61 percent of the property, he said.
The Canadian commercial-property market is “relatively small,” making it difficult for investors to enter and establish a large footprint in the country, said Colin Johnston, a president at Altus Group Ltd (AIF)., a Toronto-based real estate data and information firm.
A group of developers, including Ivanhoe Cambridge, the real estate arm of Caisse de Depot et Placement du Quebec, Canada’s largest pension-fund manager, is building a 40-story, 850,000-square-foot tower in downtown Calgary. The building, with an estimated cost of C$500 million, already has a tenant -- Athabasca Oil Sands Corp. (ATH) -- that will lease 27 percent of the space, Arthur Lloyd, executive vice president of the western region for Ivanhoe, said in a telephone interview. Steel and concrete for the tower has been ordered, he said.
‘Can’t Get It’
The developers last year finished a 1.1 million-square- foot, 49-story tower as part of the same project.
“The problem that tenants are starting to bump into is they need room for expansion and they can’t get it,” Lloyd said of the Calgary market. “There’s just a shortage of physical space.”
Projects also are planned in Toronto, the nation’s financial center, which has almost 2 million square feet under construction, according to CBRE. Toronto’s vacancy rate was 6.7 percent in the fourth quarter, down from 7.8 percent a year earlier, and asking rents gained 3.2 percent, according to Cushman. That compares with a 9.1 percent vacancy rate in Manhattan.
British Columbia Investment Management Corp., a Victoria, British Columbia-based pension and institutional fund manager, opened a 650,000-square-foot office tower last year in Toronto as part of its C$800 million Southcore Financial Centre complex, which also will include another office tower and hotel, both scheduled to open in 2014.
The second office building, to be called Bremner Tower, is “well on its way” to being 50 percent leased, Mary Garden, vice president of real estate at British Columbia Investment, which has a Canadian portfolio valued at C$14.4 billion.
“In a market like Toronto, we would not proceed with a project on spec,” Garden said in a telephone interview, referring to speculative development started without tenants lined up. “As soon as we hit the 40 percent level, we were comfortable to proceed with the building.”
Supply of new buildings is “in check” and the construction taking place will not lead to a supply glut, said Michael Missaghie, a portfolio manager at Sentry Investments, a Canadian investment company with C$7 billion under management.
Most developers don’t go ahead with projects “in a major way anymore” without having some tenants committed for their buildings, said Johnston of Altus.
No Sector Immune
The biggest risk for investors in Canadian commercial real estate is a lack of economic growth, according to Andrew, the Queen’s University professor.
“No sector of real estate is immune from that,” he said.
In January, the Bank of Canada forecast about 2 percent growth for 2012. The country’s economy is cooling as the strong Canadian dollar hurts exports.
Real estate investment trusts, along with pension funds, are large holders of property in Canada. REITs accounted for more than 31 percent of acquisitions last year, up from less than 16 percent in 2010, according to CBRE. Commercial real estate deals totaled C$23.6 billion in 2011, a 21 percent increase from the prior year.
Pension funds may be among the investors pursuing Scotia Plaza, said White of Avison Young. Canada Pension Plan Investment Board, the country’s second-biggest pension fund, may consider bidding for the property, Chief Executive Officer David Denison said in a February interview.
The main Scotia Plaza skyscraper at 40 King St. West is the second tallest in Canada, after the 72-story First Canadian Place in Toronto. The building was completed in 1988.
“It’s a marquee asset,” Andrew of Queen’s University said of Scotia Plaza. “It’ll be over a billion, no question.”
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