Canadian real estate delivered uncharacteristic, although not entirely unexpected, low investment returns in 2016. Annual results of the REALPAC/IPD Canada Quarterly Property Index, released late last week, reveal a year of below-average performance for index participants’ directly held standing assets.

A total return of 5.7 per cent across 43 portfolios, encompassing more than 2,400 individual properties collectively valued at nearly $142 billion, trails the projected global average of 10.7 per cent, and is well below the three-year, five-year and 10-year Canadian return. Modest capital growth of 0.7 per cent cloaks more marked regional disparity, as values declined in six of eight surveyed national markets. An income yield of 4.9 per cent fell below the 2015 level that index producer, MSCI Inc., had deemed “the tightest in 15 years” to achieve new distinction as “the tightest in 30 years”.

“If you exclude the financial crisis, 5.7 per cent is the lowest return we have seen in literally decades,” Simon Fairchild, MSCI’s executive director, told a Toronto gathering. “We are starting to feel significant and meaningful falls in value in Calgary and Edmonton. If you think of the market as a whole, you’d bundle it into the slipping category, but, relative to the rest, Toronto and Vancouver are showing some resilience.”

Industry insiders on hand for Fairchild’s presentation affirmed they had been prepared for a slip in 2016 real estate returns, but not necessarily a pervasive downward trend across all markets and sectors. With prompts from REALPAC chief executive officer Michael Brooks, the on-the-spot panel deciphered the results through the lenses of the Canadian economy and real estate cycle, global market trends and institutional investors’ strategic needs — concluding that one year of weaker results is unlikely to trigger a panicked pullback from new construction and/or planned overhauls of assets, but could raise the profile of other options.

“Institutional capital isn’t really thinking in terms of developing or not developing. They are looking at real estate in relation to other asset classes,” advised Blair McCreadie, senior vice president and fund manager with Fiera Properties. “It’s a question of: how much money are we going to flow into real estate based on what else is out there?”

From the longer term perspective such investors typically favour, index participants have seen better 10-year (9 per cent) and five-year (9.1 per cent) returns on their standing assets than bonds, equities or REITs have garnered. However, REITs have been the top performer, at 8 per cent, over the three-year horizon, while both the broader equities class, and REITs within it, soared past the index last year, with returns of 21.2 per cent and 18.2 per cent respectively.

Low yields are new norm

Steadily increasing values over the past several years also play into this year’s numbers. MSCI’s historical chart plots all property types and markets in the “pricier” range since 2011, while 2005 was the last year that the majority fell in the “cheaper” half of the graph.

“Falling cap rates have been part of our lives in real estate for the last decade,” Fairchild said. “Returns are low because yields are low. In a sense, this is the new norm.”

“One of the big reasons income has been going down is because capital is so high,” McCreadie reiterated.

The Canadian 2016 index results are among the first of 32 national indices that MSCI will release in the coming weeks. Many country-to-country comparisons are still not definitive, but Ireland is placed as the world-beater again this year, with a total return of 12.4 per cent. The United States also outperformed Canada, with a total return of 7.6 per cent. Both countries have fallen off their 2015 pace when Ireland recorded a 25 per cent total return and the U.S. surpassed 10 per cent.

“I think the general trend here, and you’ve got Canada with it, is that returns have slowed,” Fairchild said.

Among property types, only residential showed improved performance with the chart-topping total return of 8 per cent, up marginally from 7.9 per cent in 2015. Office was this year’s laggard, delivering a 4.7 per cent total return in the face of a 0.6 per cent drop in capital value. Retail and industrial were closely bunched in the middle, with returns of 6 per cent and 5.8 per cent.

“In the grand scheme of things, that’s not a very wide spread in sectors. What’s much more noticeable is the spread across the markets,” Fairchild said.

Even so, more than half of the properties in the index are located in Vancouver or Toronto, somewhat cushioning the impact of weaker performance elsewhere. The two metropolises outdistanced the pack, but with results below their 2015 performance. Vancouver recorded total returns of 12 per cent; Toronto followed with total returns of 8.6 per cent. Six other markets slumped below the national average, ranging from Winnipeg’s 5.1 per cent return to Calgary’s 2.8 per cent loss on investment.

Pain and possibilities

Calgary is home to about 13 per cent of the index, and panellists identified slope for its slide to continue. Although discount prices were largely unseen in earlier phases of what has now been a prolonged downturn, there is an expectation that any new round of transactions will reset the bar.

“In a falling market, you always have a lag. I think that’s where we are at,” said Pierre Bergevin, managing partner with Brookfield Financial.

“I think we are testing the bottom on leasing,” observed Vince Brown, president and chief executive officer of Triovest, but he foresees values could dip further.

“The vendors recognize they’ve got to take some pain,” McCreadie concurred. Yet, on the potential upside, he points to the now approved Trans Mountain pipeline and renewed expectations for the Keystone XL pipeline as stimuli for Alberta’s oil and gas sector and Calgary’s office tenancy.

In exploring how 2016 results might apply to 2017 decisions, panellists agreed investors will be looking outside Canada, but may also become more proactive within its borders. For example, Bergevin drew a correlation between the higher performance of super-regional malls — a 7.2 per cent total return in 2016 — and the massive capital investment that owners have poured into refurbishment and expansion projects in recent years.

“You can sit passively and accept these returns or you can do something else,” he said. “The super-regional malls are bucking the trend and doing a tremendous job.”

Brown also pointed to the perennial consideration of diversification and weighting of assets, which keeps investors open to opportunities as they arise in various sectors and markets. “There is activity, but it is careful and thoughtful activity,” he reported. “This sort of market is actually a great market if you’re somebody, as most of us are, who just loves to operate real estate.”

When asked to predict, panellists all pegged the 2017 total return in the range of 6 to 6.5 per cent. Turning to past prognostication, Greg Spafford of LaSalle Investment Management was named the annual contest winner for most closely targeting last year’s total return — a prediction of 5.9 per cent, made in February 2016.

“You had to be on the bearish end of the spectrum to get it right,” Fairchild noted.

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