Morguard senior director of research outlines prospects, opportunities for Canadian real estate assets as cracks form in resilient economy
The Canadian real estate sector reflected a surprisingly resilient economy in Q3 of this year, according to Morguard’s most recent economic and market outlook. The report highlights continued growth on the rental side and, while commercial real estate has struggled in certain areas, its overall performance has remained steady. The report predicted a resumption of Canadian economic growth in either 2025 or the second half of 2024, depending on central bank policy. In the meantime, however, questions persist around the state of Canadian real estate assets as our economy appears to enter a recession.
Keith Reading, senior director of research at Morguard, explained how various real estate asset classes are set up in this economic period. He highlighted the drivers behind what will likely be ongoing strength in the residential real estate space — especially in rental apartment housing. He noted, too, that while some areas of commercial real estate appear depressed, other subsectors can offer significant opportunities. On the whole, he advocated for a ‘beds and sheds’ allocation to rental apartments and industrial real estate as a historically resilient strategy through periods of economic downturn.
“Beds and sheds have typically outperformed when you've got an economic downturn,” Reading says. “If you look at the great financial crisis, apartments were fine, relatively speaking. If you think about it, people need a place to live and renting is a cheaper way to go, and people were less likely to buy a house in that time. Similarly, industrial was stable because you still have to move goods around, grocery stories still have to store things, people still buy things. We saw lulls in office and retail, but not as much in industrial. I think that’s the way things will go again.”
Rental apartment housing has already seen rents rise by 14.6% year over year, according to Morguard’s Q3 report. Reading explained that constrained supply, growing demand, and a changing rate environment are to blame. He notes that up until very recently, Canada has not been building purpose-built rental housing. Condos were, at the time, more profitable. While there was some building over the past five or so years, the increasing cost of construction and labour, as well as the growing costs of financing, have resulted in another slowdown in purpose-built rental home construction.
At the same time, Canada’s population has expanded significantly. 1 million immigrants came in 2022, with half a million expected in 2023 and 2024. Immigrants tend to rent at first, and that pace of influx is driving rents higher. Higher borrowing costs are also keeping potential homebuyers in the rental market, who would prefer to pay less money in rent and move into ownership when rates come down again. While many retiring boomers have elected to age in place, there are still some who are foregoing the work and responsibilities of homeownership, selling their houses and becoming renters again. Finally, Reading notes that post-secondary students have entered the rental market again after COVID lockdowns kept them at home.
The end result, he says, is basic economics: low supply, high demand, and rising rental costs.
Commercial real estate is a far more mixed picture. Industrial has been the highlight and downtown office real estate has been the lowlight. The run up in industrial, Reading explains, began in the wake of the pandemic. Vacancy rates for warehouses in key locations like the GTA fell to almost zero, and rents went up in some cases as much as 500% per square foot. E-commerce, changing distribution networks, and endless business ‘pivots’ drove huge demand for industrial real estate. That has changed somewhat, Reading says, but the national vacancy rate is still around 2-3%.
Retail has also bounced back more strongly since the pandemic, Reading says, but a reliance on consumer dollars amidst inflation and higher mortgage costs will likely result in a much more challenged retail sector as the Canadian economy continues to slow.
Office real estate is “where the risk is” according to Reading. The fundamental dynamics of many jobs have changed, and while many workplaces have reopened, they’ve done so with hybrid and remote options for their workers. Reading cites vacancy rates in downtown Toronto, which were around 2% before the pandemic. Now we see vacancies in the 10-14% range. That has also more immediately impacted less desirable “B” buildings as lower rents in commercial office space have moved many businesses into more attractive “A” buildings.
When the economy begins to grow again, Reading expects growth in office real estate. However, the intervening period of relative economic weakness points to continued risk in the office real estate market.
Overall, Reading expects the Canadian economy to soften and fall into recession over the next six months. He thinks we may see unexpected negative growth from Q3 data, and expects the economy to be shrinking in Q4. Much of that comes down to interest rate increases that have potentially tripled the cost of mortgages, leaving consumers with far less disposable income. He thinks the recession should be short lived, provided the Bank of Canada is able to ease quickly enough.
“I think that the bank will do what it needs to do to stimulate economic activity, and when interest rates come down I think we’ll see some improvement,” Reading says. “The trajectory economically is that we’re going to see less than 1% growth next year.”
