In order to gauge market health, developers need to measure the rate of income return on a real estate investment. To do so, they look to capitalization rates, commonly referred to as “cap rates”, to help determine their investment. This percentage is based on the expected income that the property will generate. For example, a $1 million property that generates $100,000 annually after expenses would give the owner a 10% cap rate.
According to the Colliers Q1-2015 Cap Rate Report, Canada is currently seeing stability with respect to returns on real estate. However, not all provinces are experiencing this consistency. Thanks to dropping oil prices, Alberta has been hit the hardest. Companies have had to make employment layoffs and cut costs and, as a result, the downtown Calgary office market has increased in vacancy by 11% in the first quarter, up from 8.13% year-over-year.
But it’s not just our neighbours that are experiencing compressed cap rates. In Vancouver, we’ve been undergoing lower levels due to high demand and low stock. Outside competition from foreign investors coupled with property owners retaining their assets has equated to limited quality product in our highly desirable market. In addition, low interest rates and the weakened Canadian dollar may cause many real estate investors to forego developing across the border. Refocusing on the local market, this only escalates the competition. Consequently returns and yields are at record lows.
Cherry Lane Mall in Penticton sold for $74.9m, one of the institutional purchases that made up just 6% of acquisitions in 2014 according to Avison Young. | Photo: Loopnet
According to our panel at our June 25th Breakfast Event, cap rate compression is currently happening in prime real estate. Michael Deighton of BOSA Properties shared that if capital continues to pump money into property, “you’ll see further cap rate compression in the core markets. Rationale has become decoupled from actual returns and wealth. We’re not in sync with core assets anymore.”
As a highly sought-after place to live, Vancouver’s demand for commercial development and acquisition doesn’t seem to be slowing down any time soon. While investors may not be experiencing the same capitalization rates as ten years ago, our commercial real estate market currently represents a somewhat safe haven, offering stable returns from both local and global investors.