Real estate sentiment drops to lowest level since late 2009, respondents reporting modest improvement in market conditions

Results from the recently released Fourth Quarter 2011 REALpac / FPL Canadian Real Estate Sentiment Survey, produced by the Real Property Association of Canada (REALpac) and FPL Advisory Group, indicate that the fourth quarter of 2011 brought a material change in views on the health of the real estate sector. The overall real estate sentiment index has dropped to its lowest level since late 2009 and respondents are reporting a modest improvement in market conditions but few (30 per cent) expect any further improvement in the coming year. However, it is important to note that the Sentiment Index measures the market trajectory and is scored from 0-100, meaning scores above 50 reflect positive trends and score below 50 reflect negative trends. This quarter is the ninth straight quarter in which the Index has been above 50.

This quarter, the Current Index has dropped to 64 (from 71) and the Future Index has fallen to 55 (from 61) reflecting respondent perspectives that market conditions, while still positive, are not expected to improve materially in the coming year. Notably, many respondents felt that while the Canadian market has weathered recent events in the US and EU they are not immune from global economic events.

When the Overall Sentiment Index for Canada is compared to that of the United States, there remain similarities, though the Canadian Current Index reflects slightly stronger fundamentals while the Future Index is slightly lower than its U.S. peer. The Overall U.S. Sentiment Index registered a 59 this quarter (down from 69 last quarter and 77 in the second quarter), reflecting a continued decline.

As the indices have dropped, interviewees also reported a sense of caution in the marketplace. As one interviewee noted, “There is certainly more perceived risk today in world financial markets. The fallout from that uncertainty is a slower pace of transaction activity, more difficulty in obtaining new financing, and hesitancy on the part of users. To me that implies slower growth in strong price markets.” Another felt the market conditions were worse for small players, “General market conditions are tough, especially for smaller players. There is lots of caution out there and it is definitely not a bull view.” 

Asset Prices

Real estate asset values have continued to trend upwards, with a vast majority of respondents (90 per cent) reporting increased asset values over the past year.  However, most (58 per cent) expect flat pricing going forward and an increasing group (now 18 per cent) is expecting a small decline in asset values. However, we see an increasing bifurcation between top tier and second tier assets, one respondent noted, “Good quality, institutional grade pricing is still on the rise and we are still experiencing some cap rate compression; however, with regard to the second tier assets, the market is not as deep.” 

Debt Markets 

Availability of debt capital continues to be widely available, although several respondents noted that a tightening of underwriting standards has continued to limit LTV ratios. As one respondent noted, “Because most of our [residential and multi-family] stuff is CMHC insured, [debt availability] is a slam dunk, I don’t see this changing; however, the CMHC is being more conservative with their underwriting. Now you can only get 70 per cent financing whereas you used to be able to get 75 per cent in certain markets.” Respondents are slightly less positive than last quarter in terms of overall availability, 42 per cent (v. 46 per cent last quarter) felt debt availability was somewhat better than a year ago.  Most respondents (65 per cent) expect conditions to remain the same over the next year. 

Equity Markets

Although slightly less positive than last quarter, the equity market still appears to be strong, with little room for improvement over the next year.  However, as with asset pricing we are seeing a bifurcation of availability; smaller firms are having slightly more trouble accessing capital when compared to large REITs with the large amount of capital on hand that is necessary to purchase the top tier institutional grade assets.  Albeit at slightly higher discounts, capital raising has continued in the REIT sector, as one interviewee noted, “Canadian REITs are still doing capital raising; the discount has increased somewhat, but we are still seeing reasonable fund flows.”  Again this quarter, respondents were almost equally split on expectations of future equity availability, with the majority (55 per cent) expecting conditions to remain the same over the coming year. 

The Q4 2011 survey captured the thoughts of 50 leading real estate executives, including CEOs, presidents, board members, and other leading executives from a broad set of real estate sectors including owners and asset managers, financial services providers, and building operators and related service providers. Survey respondents represent income producing real estate including office buildings, retail shopping centres, industrial buildings, hotels, multi-family residential (apartment buildings), and seniors’ residences.

This quarterly economic survey serves as a gauge of senior real estate executives’ confidence in financial and real estate markets in Canada. The REALpac/FPL Canadian Real Estate Sentiment Survey measures executives’ current and future outlook in three areas including overall real estate conditions, real estate asset values, and availability of capital. Three Sentiment Indices comprise the survey including a Current Conditions, Future Conditions and Overall Conditions Index. The “REALpac/FPL Canadian Real Estate Sentiment Survey” is directly comparable to the “Real Estate Roundtable Sentiment Survey” in the U.S. (also conducted by FPL Advisory Group, using an identical methodology).