Canada’s institutional investors typically view multifamily rent slippage as a pandemic-related blip that was never expected to be lasting. Newly released 2021 results from the Canada Annual Property Index reveal that multifamily assets posted the largest year-over-year decline in net operating income (NOI) among the four main property sectors — a 5.8 per cent drop from 2020 — while delivering a 7 per cent total return on investment for the year.

Speaking as part of an industry insider panel tasked with providing on-the-spot feedback alongside the online release of the results last week, Jaime McKenna, managing director and group head of real estate with Fengate Asset Management, advised that an uptick in rents in the fourth quarter of 2021 will begin to flow through more obviously this year. Last year’s data is considered more reflective of 2020 trends.

“What’s happening in the marketplace is always about six to 12 months ahead of what’s happening with the returns,” she maintained. “What we did see for the first six months of COVID is that nobody moved. People stayed in place or those who moved were exiting the rental market. So we saw vacancy grow and we came into the new year (2021) either in decline or, at best, holding.”

“The concessions that were probably offered on the front end (of 2021) to bring renters back in, that’s also making its way to this data,” added Eric Plesman, head of global real estate with the Healthcare of Ontario Pension Plan (HOOP).

Capital growth belies decline in net operating income

In the big picture, multifamily assets were the second best performers in the index — which encompasses 2,367 directly held standing assets in 46 portfolios, collectively valued at $171.6 billion — last year. Industrial topped the scale with a 31.6 per cent total return, while office and retail offered more modest matching total returns of 2.8 per cent.

Looking at the components of the total return, industrial assets saw a whopping 26.4 per cent increase in capital value, following a 7.8 per cent gain in 2020. Multifamily recorded 3.8 per cent capital growth, outperforming a 2.2 per cent increase in 2020. Office and retail properties posted another year of eroding value, but at a more muted level — at 1.8 per cent and 1.5 per cent respectively — than in 2020.

Across the entire index, NOI fell by about 15 per cent between Q1 2020 and Q1 2021. In analyzing how that influenced capital appreciation or decline, Simon Fairchild, executive director with the index producer, MSCI, outlined some varying impacts according to sector.

“Not all of that fall was eating into capital values because valuers didn’t expect that to continue into the future,” he advised. “They expected a recovery and, indeed, it’s happening so that would seem to have been the correct assumption.”

In retail, a 17.4 per cent year-over-year jump in NOI has had little impact on capital value because it’s still only a partial climb back from a 30 per cent drop in 2020. “On the other side of things, obviously valuers and investors have a positive view on residential. They’ve almost discounted the current fall in NOIs,” Fairchild noted.

Similarly, Paul Mouchakkaa, managing partner and Canadian head with BentallGreenOak, observed that would-be apartment buyers are unlikely to find any COVID-triggered bargains. Plesman concurred with McKenna that rents are beginning to rise again, and described an uneven pandemic fallout in HOOPP’s portfolio.

“I was surprised when I saw the number (for declining NOI). We haven’t been hit as tough as this with our own portfolio,” Plesman reported. “I think part of it is the mix of suburban versus urban. Our urban assets got hit a lot more than the suburban assets. It was just stickier (in the suburbs) and we didn’t see the same declines.”

Portfolio weighting shifts away from office and retail

Last year saw approximately $703 million of net new investment in multifamily properties within the index. That’s a 6.5 per cent boost to the $660 million inflow in 2020, yet well back of the cascade of new investment in industrial properties, which surpassed $2.4 billion.

An 87 per cent increase in industrial investment for the year also occurred in the context of a $913 million, or 30.6 per cent, year-over-year reduction across the index as a whole. Furthermore, Fairchild noted that a disproportionate share of the “other” category, which received more than $1.5 billion of new investment, is development land destined for industrial projects.

“This is really a very strong tilt in terms of net new money going into these portfolios,” he said. “The flipside of that is disinvestment from retail and offices to the tune of about $1.6 billion.”

The sell-off in the two sectors, which Fairchild reiterates “have been the bedrocks of institutional investment in Canada for decades”, augments evidence of the shift in weighting of asset types that is occurring in commercial real estate portfolios. Mouchakkaa traced that change in both directly held and listed portfolios, while Bryan Reid, MSCI’s executive director of real estate research, illustrated how investors are now seeing the widest divergence in returns based on property type rather than, as has conventionally been the case, the region where they are located.

“Close to three quarters of the transactions last year were in the multifamily and industrial space. Historically, it’s closer to 40 to 50 per cent. About 20 years ago, multifamily and industrial combined were about one eighth of the private market index in Canada, so roughly 12 per cent. Today that portion is now one third,” Mouchakkaa observed. “That’s not a fluke. That’s really a change, both in investor preference and in value.”

“Historically, the spread of returns has been greatest across countries and cities, and property type has actually played a much smaller role in diversification or the alpha story,” Reid said. “Really, in the last two year’s we’ve seen this blowout in sector spreads. I think this is why a lot of people look at allocations to sectors and think: this is potentially going to be quite a significant driver of returns going forward.”

Barbara Carss is editor-in-chief of Canadian Property Management.