Soaring Capital Growth Defines 2011 Market
April 12, 2012
Office and Retail Cycles Move Closer Together
Investors, fund managers and researchers use the REALpac/IPD Canada Property Index to track and compare the performance of funds, monitor risk and identify cost saving opportunities. The following is an overview of the 2011 annual results, with historical context from 12 years of data – Editor.
Total returns on standing investment assets in Canada rose to 15.9% in 2011 from 11.2% in 2010 according to the REALpac/IPD Canada Property Index. The results were taken from IPD Canada’s database of 2,140 properties with a total capital value of $95.2 billion at year-end 2011.
In comparison to other property markets around the world, Canada appears to have performed favourably in 2011, at least when set against the UK and US markets, with returns being strongest for each of the office, retail and industrial sectors. Over the last five years, annualized, Canadian returns have outpaced the US by a factor of two, and the UK still further.
The substantial increase in returns in 2011 occurred despite income returns slipping from 6.9% in 2010 to 6.4% in 2011, predominantly as a result of the denominator effect. Capital growth, which stood at 4% in 2010, soared to 9% in 2011, providing the major part of the annual total return.
IPD is a global information business dedicated to the objective measurement of commercial real estate performance. Returns for 2011 were the third highest measured in the 12 years since IPD began covering the Canadian property market. Only in 2005 and 2006 were returns higher. The pattern was identical for capital growth: 2011 was the third highest year on record, following the 2005 and 2006 boom years.
Over the past 12 years, income returns have ranged from a high of 8.9% in 2002 to a low of 6.2% in 2008 when the global financial crisis first struck. Income returns of 6.4% in 2011 were the second lowest on record.
Long run total returns averaged an annualized 8.7% over the past three years, 9% over five years and 11.2% over the past decade. A year ago in 2010, total returns were in line with the 10-year annualized average. In 2011, performance exceeded all historical averages by a relatively wide margin.
Income returns have provided the stable component in total returns, and ensured that overall performance has never strayed far into negative territory, even in the depths of the recent global financial crisis.
SALES OUTPACE ACQUISITIONS
Net investment on the 42 portfolios IPD measures – which measures the difference between total capital expenditures receipts – continued to narrow in 2011, falling for the fourth consecutive year to $775 million. In 2011, net investment reached its lowest level since 2003 when it had dipped to just $361 million, and stood at about half the $1.5 billion level recorded in 2010.
The decline in net investment can be traced to a robust deal market where sales have been more widespread than acquisitions for the funds covered by IPD. Net sales receipts of $5 billion in 2011 were second only to the previous year’s record of $6.1 billion.
Gross purchase expenditure of $3.4 billion fell substantially below net sales receipts, and also represented a sizable decline from $5.1 billion in 2010. Furthermore there has been a significant decline in development expenditure since the financial crisis started in 2008, standing at $500 million compared to more than $2 billion in 2008.
Net income growth rose for the second year in a row to 3.7% in 2011, but net operating income (NOI) yield compressed to 6%. The yield in 2011 was the tightest on record, narrowly eclipsing 2007’s previous minimum of 6.1%, when values peaked after a period of considerable yield compression. The yield decompression that occurred in 2008 and 2009 has been erased by the recovery of the past two years.
Although capital growth was substantial in 2011, relative pricing between real estate and long-term bonds reached its widest gap in the past decade at year-end 2011. This occurred as the spread between the NOI yield and the long-term bond rate widened to nearly 4.1%. In Q2 2007, the spread was only 1.7%, the narrowest margin of the decade.
Improving fundamentals contributed to the impressive total returns of 2011. Over the course of the year, the vacancy rate tightened in three of the four most heavily weighted property types in IPD’s Canadian database (super regional retail, high-rise office and warehousing) and stabilized in the fourth (regional retail).
Overall, the vacancy rate improved in seven of the 13 single-use property types tracked by IPD. It was the first year since 2007 when the majority of the 13 single-use property types showed improving vacancy rates.
Canada’s eight major census metropolitan areas (CMAs) turned in double-digit returns in 2011, but Calgary was in a class of its own, with capital growth of 13.7% pushing total returns to 21.6%. This exceptional capital growth even exceeded Ottawa’s 2011 total returns of 12.8%, and was driven by all major asset types, with offices delivering the highest return (25.1%), followed by retail (18.6%) and industrial (17.1%).
The epicentre of Alberta’s boom lies in the oil sands of Fort McMurray, but the impact can be felt a few hundred miles away in Calgary where many national energy companies maintain head offices. The broker Avison Young reported a vacancy rate in downtown Calgary of just 4.5% at year-end 2011, including a 2.5% vacancy rate for Class A space and a mere 0.3% for Class AA.
Calgary’s performance dynamics echo similar patterns seen abroad. Property markets in key cities of other resource-rich countries have also outperformed in recent years. Comparable trends have been noted in Australia, South Africa and Norway, among others.
Alberta’s boom and its effect on Calgary’s property markets have dominated national headlines and attracted international media attention, but it is important to note, that resource-related booms sometimes end quickly. Property returns in these markets can be volatile, as veterans of the 1980s real estate markets would no doubt testify.
Five of the eight major CMAs provided five-year annualized returns to 2011 exceeding the Canadian all-property average. All four western CMAs outperformed over the last five years, but Halifax was the only major CMA in the east to do so.
VARIATION BY PROPERTY TYPE
Total returns in the retail sector peaked in 2005 ahead of office returns. From 2005 onward, the timing of the office sector’s property cycle lagged the retail sector.
The next cyclical turn came in 2008 when retail returns bottomed out. Again, office returns lagged the retail cycle and did not hit bottom until 2009.
In 2011, the cycles for the two property sectors moved closer together, with total returns in the office sector (16.4%) coming very close to retail (16.8%). This was a spectacular escalation for the office sector, following as it did total returns of 8.5% in 2010. Retail returns also rose in 2011, but from a much higher starting point of 15.6% in 2010.
Total returns varied significantly across property types within the office sector. In the retail sector, returns were more consistent across property types.
The four single-use property types most strongly weighted in the IPD database are high-rise offices, super regional retail, regional retail and warehousing. Total returns rose in 2011 for all of these property types except super regional, which slipped from 17.3% in 2010 to 16.8% in 2011 – but this was still higher than the market total return of 15.9%.
The sharp improvement in returns for high-rise office properties from 8.5% in 2010 to 16.6% in 2011 came as vacancies continued to improve and the demand for space in Canadian urban centres increased.
Capital value in IPD’s database is fairly evenly distributed across the two major sectors, with retail accounting for 42% and offices 38%. Of the individual property types, high-rise offices represent the largest category with $32.2 billion out of a total value of $95.2 billion. Industrial properties account for about 10% of the overall database, and the majority of these are warehouses.
The three single-use property types with the highest total returns over the last five years (super regional retail, regional retail, and high-rise offices) are the three most heavily weighted property types in the IPD database by value. In general, all office properties and most retail properties have outperformed industrial properties over the past five years on an annualized basis.
DIVERSITY & STRENGTH
In 2011 the 42 Canadian portfolios that IPD monitors delivered income returns ranging by 1.8 percentage points, once again demonstrating the diversity of the funds in the dataset.
Compared to other domestic asset classes, Canadian private real estate also performed favourably in 2011, outperforming all other investment classes. Over the past 10 years, both private real estate as measured by IPD and public real estate (REITs) have outperformed traditional equities and bonds asset classes by a wide spread.
The preceding article was supplied by the Real Property Association of Canada (REALpac) and IPD. For more information, see www.realpac.ca or www.ipd.com/news.