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Market Outlook: Canadian commercial real estate is poised for a tech upgrade in 2018

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The past year brought with it considerable political and economic uncertainty for Canada, as many watched the US economy grow under a low inflation environment. Moving into 2018, the Canadian commercial real estate market appears to be capitalizing on opportunity. With supremely competitive markets in Toronto and Vancouver, major pension funds have consistently looked to overseas markets for prime investment opportunities due to a lack of supply within the Canadian market. As competition grows with high-quality commercial property growing scarce, the need for dependable, reliable and accurate data has become critical, since complex real estate decisions are expected to be made under tighter timelines. Commercial real estate will continue to search for effective ways to harness, analyze and present the tremendous amount of data that is so paramount in creating effective real estate strategies. Data plays an essential role in helping investors and companies mitigate risk, improve asset performance and better understand their target market. The year 2018 will be marked by a rise in technology, as the Canadian commercial real estate market looks to take a massive leap forward.

Canada’s overall economy remains poised for another solid year after a challenging 2017. The Bank of Canada suggests a more rational pace for job growth, which will assist in tempering the Canadian economy to about 2.2% overall growth in 2018. The Conference Board of Canada indicates that, from a provincial perspective, Alberta, British Columbia, Saskatchewan and Ontario will be the key provincial drivers, each forecast to experience above 2.0% growth this year. In addition, The Bank of Canada implemented its first interest rate increase in seven years; however, these rates continue to remain historically low, which should do little to impact the Canadian commercial real estate market. Where the impact can be seen is on the tightening spread between cap rates and the 10-year Government of Canada bond yield. With such marginal differences, investors are looking at non-traditional markets and asset classes where returns are potentially higher; further causing modest cap rate compression in some secondary markets. Overall, as demand continues to outplace supply for high-quality investment assets, the Canadian commercial real estate market is marked by a hyper-competitive environment.

INSTITUTIONAL CONSOLIDATIONS

The first quarter of 2018 has been marked by two major institutional consolidations: Blackstone, one of world’s leading investment firms, with 2,300 employees and 25 worldwide offices according to its website, announced that it will be acquiring Pure Industrial Real Estate Trust (PIRET) in a reported $3.8 billion dollar transaction. This move highlights the hyper-competitive market conditions that will remain throughout 2018, especially in the search for logistics and distribution space. Tyler Henritze, Head of North American acquisitions for Blackstone Real Estate commented in a release, that acquiring PIRET can be viewed, “as a continuation of our global strategy to acquire high-quality logistics assets in key urban areas.”1 The second major consolidation recently announced will see Choice Properties Real Estate Investment Trust create Canada’s largest REIT by acquiring Canadian Real Estate Investment Trust (CREIT) in a transaction worth a reported $6 billion. “Choice sees the acquisition as an opportunity to both diversify and expand its asset base, adding significantly more and varied retail, industrial and office properties and expertise.”2 With so little available supply, and increasing demand, consolidation appears to be one way to remain competitive for investment trusts moving forward.

TECHNOLOGY’S INCREASING ROLE

Technology firms will continue to occupy considerable space across multiple asset classes. While tech firms continue to occupy office space, driving higher population and job growth, the significance only begins there. The industrial market is seeing the impacts of technology as demand for logistical space continues to increase, as consumers gradually transfer their spending habits from traditional brick and mortar to e-commerce. This unprecedented demand for high-ceilinged, large-bay and multi-level industrial property is driving the major market’s industrial sector. As customers demand quicker turnarounds and increased service offerings, retailers must position themselves as strategically as possible. Amazon’s most recent announcement of its newest fulfillment centre outside Calgary highlights the impact e-commerce is having on the industrial market. The 600,000 square foot facility joins six other distribution centres, four in the Greater Toronto Area and two in the Vancouver area. Online shopping continues to exert its influence on traditional retail centres as well; retail property owners and investors are facing greater scrutiny from their customers whose expectations continue to grow; requiring retail centres to transform into destinations with a wider range of appeal.

Additional technological advances to keep an eye on through 2018 include, the rise of driver-less vehicles, drone technology and virtual reality. Autonomous vehicles are looking to disrupt the market by raising questions surrounding the future need for parking requirements. With less parking in residential, commercial and retail properties, there may be a potential opportunity to increase density by re-developing existing space, generating new unachieved value. Canada is not only looking to join in on this commute trend, but to take a firm hold of the steering wheel; Edmonton has not been shy about its desire to lead the country in automated vehicle research, and has explored setting up a test track at the University of Alberta. The impact of drone technology is already making its presence felt by taking marketing materials to new heights; however, considerable opportunities also include the abilities to track construction progress, highlight new development and assess potential sites. 3D virtual tours are helping to provide unique experiences for real estate professionals to showcase and highlight feature listings without scheduling tours, creating greater efficiency and allowing prospective buyers to visualize their space in real time. Applications and augmented reality will also significantly impact the retail sector through 2018. Take IKEA’s new IKEA Place App,3 which aids in the pre-purchase planning of furniture through augmented reality. Customers with the app can now pick a product they want to visualize in their home, their smartphone and app will then digitally place selected furniture in the house and match the scale and lighting to the surrounding environment. The expectation is that this preliminary use will only serve to promote further growth, as retailers increasingly understand the technology and identify other additional applications to drive traffic to their stores.

Not to be forgotten, 2017 was the year that the term blockchain made its way into the mainstream. As we start 2018, the number of planned initial coin offerings has increased into the hundreds, and includes old economy companies such as Kodak, as well as governments. While not clear where this technology is going, and if many of its proposed uses even require a blockchain network, real estate is one of the industries in which an open ledger has very practical uses, in particular as it relates to the reduction of fees and speeding up transactions. An open ledger for keeping property records would also add transparency, and could streamline due diligence for market participants. This could be particularly beneficial in countries with weaker institutions.

One asset class set to continue benefiting from blockchain, as well as Artificial Intelligence (AI) and cloud computing are data centres. Beyond the demand for Bitcoin and Ethereum mining, blockchain and AI are set to infuse most, if not all, industries with real world applications. One example is the recent blockchain logistics initiative between Maersk and IBM. The amount of data being generated in the world is only expected to increase, and both these technologies provide strong secular tailwinds that are set to drive demand for data centres, both from end users as well as investors. Summit Industrial REIT recently announced a joint venture to develop and own data centres in Canada. We expect additional investors to add exposure to this sector.

CRAFT BEER’S METEORIC RISE

Lastly, shifting our focus slightly, craft beer has seen a meteoric rise in popularity over the last number of years, particularly in British Columbia, where market share doubled from 2010 to 2014 with no signs of slowing down. A few decades ago, only one craft brewery existed in Canada: Horseshoe Bay Brewing, which opened in Vancouver in 1982. The beer industry in Canada, although still dominated by large foreign-owned brewers such as Molson Coors and ABInBev, has begun to reverse the trend of consolidation seen in the 1980s and 1990s. With new opportunities in an emerging market, new craft breweries flocked to industrial areas throughout Metro Vancouver, bringing with them a specific set of requirements for their space. In particular, drainage and floor support for complex and heavy brewery equipment often meant upgrades to existing space. Considerable power supply, ventilation and water supply also factor into making precise real estate decisions for brewers when selecting their space. Not wanting to be left out, Alberta is starting to make itself a major presence in the national microbrewery scene. In early 2013, Alberta was home to only 13 small brewers, one more than Nova Scotia, which has a quarter of the population. By 2016, that number has roughly tripled. New craft breweries are flocking to Calgary’s eastern industrial areas due to the availability of appropriate facilities. The southeast and northeast areas of Calgary consist of light and heavy industrial facilities that offer infrastructure to support brewery capacity requirements and operations.

THE CANNABIS INFLUENCE

2018 will be the site of a similar story for Canada’s industrial markets, as companies race to acquire space for not yet legalized marijuana. Aurora Cannabis is nearing completion on an 800,000 square foot facility near Edmonton’s International Airport, while Canopy Growth recently completed a similar deal for 160,000 square feet in south Edmonton, and Freedom Cannabis is retrofitting a 110,000 square foot facility in Acheson, just west of Edmonton. At this time, little is known about the direction that will be taken by the various provinces, territories and municipalities across the country. What is known is that cannabis legalization will have a profound effect on commercial real estate, including as it relates to the landlord/tenant relationship, and environmental and municipal matters. Much like the rise of craft breweries, careful thought must be given to leasing or purchasing space within the industrial market, but also on the retail side of the industry; where questions exist surrounding location in multi-tenant buildings, safety and security, and, ultimately, who bears the responsibility for required upgrades to properties. Cannabis operations require huge amounts of municipal water, considerable power and extensive ventilation, as well as lighting and air conditioning to moderate the heat generated by the significant lighting required. Landlords will have to take into consideration the costs associated with accommodating this tenancy and weigh those costs against rental rates they are able to achieve. Data will be king, as this market continues to expand and assert its influence on the commercial real estate sectors.

Overall, the Canadian commercial real estate market will continue to be dominated by increasing demand outpacing market supply, particularly as Canada remains a consistent and stable destination for investment. This hyper-competitive market will be premised on a make-or-break mentality largely driven by the rise of data and technology. Forward-thinking investors, developers and real estate professionals, who are likely to embrace this shift will be better positioned to engage with their end-users. Through 2018, flexibility, understanding and acceptance to change will fuel growth in Canada’s commercial real estate sector.

End notes

[1] https://renx.ca/piret-acquired-blackstone-3-8b-deal/

2 https://renx.ca/choice-properties-acquire-creit-6b-transaction/

3 http://www.ikea.com/us/en/about_ikea/newsitem/091217_IKEA_Launches_IKEA_Place

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