Strong market, rising interest rates raise market correction fears

Sober first thoughts

When the elder statesmen of the real estate industry speak to younger generations, the sky-high interest rates of the early 1980s stand out as one of the defining moments in their careers. The upheavals of the early 2000s, a time when the millennium bug was debunked but the dot-com bubble burst, office vacancies soared and the terrorist attacks on New York and Washington (not to mention the SARS outbreak) discouraged business travel, seldom warrant a mention. Cocooning and economic stimulus sparked a residential real estate boom until the subprime crisis sounded the end of the cycle. A year later, Lehman Bros. was collapsing and a global financial crisis ensued.

But for real estate assets, it was merely “a blip,” according to Doug Pearce, the founding (now former) CEO of BC Investment Management Corp. (BCIMC), who spoke candidly about his career to members and guests of commercial real estate association NAIOP.

With a career spanning the interest rate highs of the 1980s and the lows of the 2010s, Pearce said there’s reason to worry.

“We’re 10 years into a bull market,” he said. “Where does this all end? I think we’re due for a correction. And when was the last time we saw a correction in the real estate market? It’s been a while.”

Key concerns for Pearce are rising wages, rising prices and the nod this will give bankers to raise interest rates in an effort to halt inflation.

“And that’s not even going into the politics of trade wars or other issues that could have a triggering effect,” he added. “It’s clear to me that we’re in for a bit of trouble.”

The antidote to financial stress, Pearce indicated, is a certain detachment.

Headquartered in Victoria, BCIMC wasn’t distracted by the financial fads dazzling investment teams in the larger centres of Montreal and Toronto.

“We didn’t understand some of the instruments,” he said. “We were far enough away that we could think, assess things differently and not get swept away by fads. But it was stressful.”

Second blush

CBRE Ltd. was first to market two weeks ago with its report on Metro Vancouver investment sales in the first half of 2018, pegging them at $5.6 billion.

Now, several more have appeared with their own tallies, reinforcing the generally strong trend.

Avison Young, looking at the whole province, identifies 102 deals worth more than $5 million in the first half of the year. The aggregate value of the transactions is $3 billion.

Colliers International, tapping data from RealNet, pegs the value in Metro Vancouver at $4 billion on a volume of 644 transactions. Altus Group, meanwhile, tallies 1,033 transactions worth more than $1 million, totalling $6.6 billion.

Drilling into the figures, Colliers highlighted the generally strong pricing, a point Paul Richter of Altus Group echoed even as average transaction value in the first half of 2018 declined 2.5% from a year earlier. Redevelopment prospects linked to infrastructure buoyed investor hopes, though Avison Young sounded a note of caution.

“Can these prices continue?” Pearce mused during his recent reflections at NAIOP, and Avison Young’s answer appears to be “No.”

While cheap debt and short land supplies have helped boost deal values across the board, uncertainties are creeping in.

“A pause in the residential land market connected to heightened political uncertainty, rising construction costs and affordability issues is starting to foster a more cautious approach from buyers and lenders alike,” Avison Young said.

One-third decline

Real Estate Board of Greater Vancouver (REBGV) president Phil Moore observes that commercial real estate transactions followed the general downward trend of residential real estate in the first half of 2018.

The numbers from Sotheby’s International Realty Canada for the city of Vancouver show the residential market is taking a harder hit.

Sales in excess of $4 million dropped by a third in the second quarter, while sales over $1 million fell 25% versus the same period last year. This compares with a 16.3% drop in commercial volumes in the REBGV area over the same period.