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Status quo for now as bank rate cut has investors watching

While the outlook is clearer, don't expect a surge in deal-making
encor-place-calgary
Encor Place in Calgary sold in May for $21.5 million, one of two office towers Cadillac Fairview brought to market prior to interest rates starting to ease.

Two consecutive rate cuts has Canada’s real estate investors rockin’ like it’s 2023.

The Bank of Canada’s second cut to its policy rate on July 24, following on an initial 25-basis point cut on June 5, has pared the policy rate to 4.5 per cent, exactly where it was until June 7, 2023.

The market was in a funk at the time, with initial hopes for a stable rate environment dashed by lingering inflation fears that triggered two more rate hikes.

Today, investors are still waiting on clarity before leaping back in.

“It won’t give commercial real estate investors too much juice,” says Carl Gomez, chief economist and head of market analytics with CoStar Group. “For the most part it’s still status quo for actually lending rates as far as commercial real estate goes.”

Gomez says the sharp rise in interest rates from March 2022 till last summer means the Bank of Canada is now trying to normalize rates, with CoStar anticipating the policy rate to reach 3 per cent by the end of 2025.

“At 3 per cent, 10-year Government of Canada bond yields at 3.25 make sense because there is some spread there from a yield-curve perspective,” Gomez said.

In the meantime, investors who have keeping their powder dry are likely to jump in because they’re less reliant on debt.

“It will give those who have been on the sidelines a little bit more confidence and ease to start deploying capital again, knowing we’re on the other end of the rate hikes,” he said. “If you’re an equity investor and you’ve got lots of equity parked on the sidelines, now may be the time to come out and start looking for deals.”

In an environment of rising interest rates, no one knew how to value properties or what the terminal cap rate would be. That uncertainty is gone now.

While the impact will be felt differently in different markets across the West, Susan Thompson, associate director of research with Colliers Canada in Vancouver, expects some of the hesitancy seen as late as this spring is gone.

The hesitancy is illustrated by Cadillac Fairview’s decision to list two office towers in Calgary – Encor Place at 645 7 Avenue SW, and 635 8th Avenue SW – as part of a rebalancing of its portfolio, something many institutional investors have been doing in the face of shifting asset values over the past year.

“They were shifting more towards different types of assets,” Thompson said. “But there’s the ‘can we find a buyer for these,’ and everyone’s trying to weigh what income is in place, what’s the price per square foot.”

The period of price discovery was complicated by a lack of comparables due to the lack of transactions.

“Because there hasn’t been a lot of activity in the market, it’s very hard to benchmark what those prices should be,” she said.

To date, only Encor Place has sold, trading May 2 for $21.5 million.

While there was a flurry of activity prior to the change in the capital gains tax regime on June 25, some of those deals may simply have been pulled forward due to the change in tax policy.

“We won’t know for a few months yet, were these deals going to happen anyway later in the year?” Thompson said. “Will that in turn slow down things for the next few months?”

Other investors may want to see a more significant improvement in rates before acting.

“It’s a bit of a wait-and-see game to when this really does start to unlock activity, because this is not the end of the cuts, this is just cut No. 2 in what could be a long series of cuts,” she said. “Some are going to be more willing to move now, and some are going to want to see rates come down further.”

The most immediate beneficiary is likely to be the residential market, Gomez said.

“You’re going to have a lot of sellers who’ve been itching to list their homes but felt they couldn’t get a buyer,” he said. “Realtors will use this to coax those guys were thinking about selling into the market.”

An increase in listings will give buyers more options, but also create a more competitive market tilted in favour of buyers with access to better financing rates.

“Paradoxically, what we might see is a surge in listings relative to modest sales and all that’s going to do is put more pressure on pricing,” Gomez said.