The U.S. and Canadian real estate markets are projected to remain stable in 2020, as both economies are expected to continue to grow due to a combination of strong employment, positive consumer sentiment and fiscal stimulus, according to LaSalle Investment Management’s Investment Strategy Annual (ISA) 2020. However, fundamentals vary considerably market-to-market, requiring careful analysis. The same is true for the demographic, technology, urbanization and environmental factors impacting property sectors. To best position themselves to capitalize on opportunities and mitigate risk in the year ahead, investors should maintain a strategic balance of offensive and defensive positions in their real estate portfolios.
While North America’s two largest economies are positioned to continue experiencing slow, sustained growth, each is susceptible to risks to their respective outlooks. Both countries are struggling to deal with stagnant middle-class income growth and sharply divided electorates. Moreover, unforeseen consequences, including protracted trade wars, a rapid loss of confidence in capital markets and geopolitical conflict, could negatively impact the U.S. real estate market. Canada, on the other hand, is more vulnerable to volatility in commodity markets. All things considered, investors can take comfort in the fact that both countries have flexible labor, capital and real estate markets. They also have room to use monetary policy to inject liquidity into their banking systems to stimulate their economies.
Jacques Gordon, global head of research and strategy at LaSalle, said, “After 10 years of unprecedented growth following the global financial crisis, we anticipate that the next few years will bring more headwinds to the world’s real estate markets due to a progressively slowing global economy, ongoing trade and treaty disagreements, divisive domestic politics, high asset valuations and disruptive technology. However, we do not expect the generally positive current environment to quickly deteriorate due to a mix of macro tailwinds. For instance, low inflation, falling interest rates and balanced fundamentals in most developed countries create ideal conditions for real estate to thrive. And, while technology poses some level of risk, it is also allowing for more informed decision making and, in many cases, making properties more attractive to their end users. Even if the potential for a sharp global reversal is unlikely, investors still need to proceed with caution and pay close attention to the macro forces driving each country and each specific market in their portfolios.”
Select ISA 2020 findings for the U.S. include:
- Current real estate market conditions are benign relative to historical patterns with rent growth generally at or slightly above inflation. Returns are predominantly from income with some appreciation, which is expected to continue in 2020. However, the overall stable returns mask a wide spread between the industrial sector’s outstanding performance and negative returns in the mall and power center segments of the retail market.
- Demographics are becoming a headwind for the economy. The growth of the U.S. labor force is expected to slow due to the baby boomer generation reaching retirement age and slowing immigration.
- Current interest rates are supportive of current real estate values and this is expected to persist in 2020. Some cap rate compression is possible in core-plus and value-add segments where buyer financing is based on short-term interest rates.
- Capital market momentum is expected to be as important as fundamentals to identifying outperforming assets, markets and property types. In the year ahead, active market participants should consider leveraging newer, larger data sets and focus on comparison of pricing metrics to find attractive risk-adjusted returns.
- Capital flows to U.S. real estate will be a mix of headwinds and tailwinds. Cross-border investment activity in the United States is expected to remain diminished in 2020, but lower interest rates could provide a slight boost. Retail investors are expected to continue to provide a boost to institutional real estate through the new generation of nontraded REITs. 2019 buying power from this segment is estimated at $15 billion and should continue to increase in 2020 and beyond. For U.S. institutions, steady new allocations to real estate are expected.
Rich Kleinman, head of research and strategy in the United States for LaSalle, said, “In the U.S., the gap between the index returns of different property types has been historically wide in recent years, driven by the growth of e-commerce and shifts in investor sentiment. Our expectation is this gap will start to slowly narrow and be much more narrow for new investments where market pricing is already addressing differences in property type outlooks. We remain bullish on the outlook for apartments and industrial. Retail property investors will have both opportunities and pitfalls in the rapidly evolving landscape of that sector. There continue to be opportunities in specialty property types to acquire superior-to-core cash flow at equal or better pricing than core.”
Canadian outlook
Canada’s economic and real estate market performance has been better than expected in 2019. Overall, the country is in a good position to withstand a potential slowdown in 2020 due to its stability and strong financial sector. While real GDP growth is projected to slow to modestly in 2020, it is expected to rebound in 2021. Despite this, job growth has been resilient, fueled by immigration and tech demand, with unemployment near 45-year lows. As a result, the industrial availability rate is at an all-time low and apartment vacancy is at a 10-year low. Many of Canada’s large pension plans will continue to sell partial, non-managing interests in core office and retail properties, creating opportunities for core buyers. This will continue the trend of strong transaction volumes established over the last few years. While foreign acquisitions of Canadian real estate have slowed since Chinese capital retreated in 2017 and 2018, capital from the United States, Europe, and other Asian countries has escalated in terms of direct deals, privatizations, and fund investments.
Chris Langstaff, head of research and strategy for Canada at LaSalle, said, “While an inverted yield curve in the second half of 2019 potentially signals an economic downturn, Canada’s low volatility and relatively strong market fundamentals will act as a shock absorber through a period of slower global growth, solidifying its position as an attractive destination for real estate investment. The best core opportunities in Canada through 2021 include urban apartments and warehouses in major markets. Investors with higher return strategies should focus on renovation, repositioning and development of industrial and offices to add value and grow net operating income, given the rising pricing levels for most asset types.”
Canada’s low interest rate environment will allow investors to be opportunistic buyers across asset classes. Investors have increasingly been looking at development, with new supply pipelines in office, industrial, and apartments showing upward momentum. The industrial and apartment sectors are gaining traction among investors given their exceptionally strong average annual unlevered returns, which are outperforming the overall MSCI/REALPAC Canada Annual Property Index. Offices have also shown momentum due to improving fundamentals and strong job growth, while retail generally remains out-of-favor.
