Canada’s economic conditions gradually improved in the second half of 2015 as the country climbed out of a technical recession. But as the economic tailwinds linger, what’s the prognosis for the real estate market in 2016 and what options do institutional investors need to consider this year?
“We feel that income will be the focus for the next little while,” says Derek Warren, an assistant-vice president at institutional money manager Lincluden Investment Management in Mississauga, Ont., who focuses on real estate investment trusts.
Despite the overall health of Canada’s real estate market in 2015, Warren notes real estate investment trusts had a relatively weak year on the stock market, which suggests values have peaked and “2016 will see a small decline in the value of real estate.”
“The focus should be on the income component or value add,” he says, citing development or redevelopment opportunities from investments in properties in trendy neighbourhoods.
“The biggest trend right now is mixed use,” he says, referring to developments that combine commercial and residential components.
Despite some areas of weakness and pundits’ concerns about a major correction, there are still plenty of economists predicting continued stability for the overall market this year.
“We should expect real estate markets across much of the country to remain stable in 2016, benefiting from low interest rates and firmer economic growth,” says Sal Guatieri, senior economist at BMO Capital Markets. “Markets in the oil-producing regions should begin to stabilize as we expect oil prices to recover partially.”
And even though Guatieri expected interest rates to rise in 2015, he didn’t anticipate the drop in oil prices that led to the Bank of Canada cutting rates twice last year. He forecasts rates will hold steady in 2016 but predicts “longer-term bond yields will drift modestly higher in response to tighter monetary policy in the U.S.”
The Canada Mortgage and Housing Corp., however, is calling for interest rates to “rise gradually from current levels starting late in 2016.” Already last month, the Royal Bank moved on the issue by increasing its fixed rates for some mortgages by a small amount. On the other hand, the year began with predictions by some experts, such as BMO Financial Group chief economist Doug Porter, that the Bank of Canada would once again cut its rate at some point in 2016.
When interest rates rise more generally, Guatieri warns the Vancouver and Toronto markets could be at risk of a correction, although it won’t happen in 2016. “As crazy as it sounds, prices are likely to continue rising in these two regions,” he says.
The average price of a detached home in Toronto was $669,400 in October 2015, up 11.7% annually from 2014, according to the Multiple Listing Service. In Vancouver, the price was $1.2 million, a 20% annual increase. By December, year-over-year price growth for detached and attached houses in Toronto was 11% with townhouses coming in slightly lower at 10% and condominiums seeing a 4.7% rise, the Toronto Real Estate Board noted in a January report looking back on 2015 and ahead to this year.
The Toronto and Vancouver average prices remain high compared to other major cities, with Montreal at $316,500 and Calgary at $496,800.
Rising property costs are concerning since Canadian homeowners already feel housing is unaffordable. A recent Manulife Bank of Canada survey found less than half (46%) of residents of Toronto, Montreal, Calgary, Vancouver and Edmonton described their property markets as affordable. That compares to 68% nationally.
Still, buyer demand in Vancouver and Toronto will remain steady in 2016, notes Guatieri, due to millennials and an influx of foreign investors. “Montreal will continue to strengthen as Quebec’s economy is poised to pick up in response to stronger exports,” he adds. “Calgary’s battered market should stabilize as oil prices are expected to increase moderately in 2016.”
Meanwhile, strong rental demand from immigrants and millennials has pushed condo construction in Canada to its highest level in two decades, says Adrienne Warren, senior economist and manager at Scotiabank.
On an annual basis, overall housing starts are expected to range from 153,000 units to 203,000 units in 2016 and 149,000 units to 199,000 units in 2017, according to the CMHC.
“Even with this new supply, the national average rental vacancy rate has edged only modestly higher over the past year and remains low at 3.3% for purpose-built apartments and just 2.3% for condominiums,” said Scotiabank’s Warren in a report.
And even with the stock-market signals, Lincluden’s Warren says there are still plenty of opportunities to invest in real estate investment trusts “just because of the discounts that are being seen.” The opportunity, he says, is for institutional investors to make careful investments in the types of real estate they want to own, earn a decent return and wait for prices to go back up. Nevertheless, with real estate being fairly illiquid and still relatively expensive, he urges caution. “But that doesn’t mean the right deal is not available,” he says.
U.S. expected to outperform Canada
The real estate picture is somewhat more positive south of the Canadian border. Most U.S. regions still offer good real estate value, says Guatieri.
The median price of a resale home in the third quarter of 2015 was $227,400, according to the National Association of Realtors. The cost of a new home during that time was $294,100.
Lawrence Yun, chief economist of the National Association of Realtors, agrees U.S. markets will continue to do well. “Sales will be driven by increasing consumer confidence and solid job growth — especially in the states in the West and South that are leading the rest of the pack and will continue to see further job creation,” he said in a report.
He noted southern and western states have the most competitive real estate markets. “Affordability concerns remain heightened as low inventory continues to drive up prices.”
And affordability could become more difficult as interest rates rise. Yun forecasts the U.S. Federal Reserve could raise rates again in March 2016 after December’s increase. He predicts mortgage rates will likewise rise to 4.5% by the end of 2016.
Guatieri notes other factors could drive up prices, including “pent-up demand from the millennial generation, which delayed its home buying plans because of elevated student debts and the psychological scars from the housing bust.”
Further, stronger economic growth in the United States, “led by American consumers, suggests the U.S. housing market will outperform Canada’s market in 2016.”
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Glenn Kauth is editor of Benefits Canada. Suzanne Sharma is associate managing editor of Advisor Group. Part of this article originally appeared on Advisor.ca.