Ottawa’s Commercial Real Estate Market in 2017: What should we expect in the year ahead?

June 22nd, 2017 InvestCRE Magazine No Comment yet

Alan Whitten is the founding partner of Huntington Property Group Inc.

Will Ottawa’s economy boom or bust, or offer more of the same boring, steady growth in the coming months?

Now that 2017 has dawned, the year ahead is expected to be somewhat exceptional in Ottawa, if only because it’s Canada’s 150th birthday, which offers much promise for the tourism and entertainment sector.

For the commercial real estate market (CRE)—which is defined as office, retail, industrial and mid-to-large multi-family dwellings and apartments—it will likely be just more of the same, which is a good thing. Due to the presence of the federal government, Ottawa has rarely set records for price changes, up or down, and that won’t change this year. This region will, however, continue to be a slow and steady opportunity for those looking to invest in CRE—or probably any other kind of real estate, for that matter.

One of the main drivers of this forecast is the basic macroeconomic principle of supply and demand. The supply of good-quality CRE assets is limited here, especially when considering the area bounded by the National Capital Commission’s Greenbelt.

There are a finite number of properties that can be bought or sold—or even become available— inside that boundary, and a very high majority of them are owned by those who intend to keep them indefinitely, resulting in very little supply. Influencing the demand side of that principle is the presence of the federal government, which provides a continuous trickle-down effect that ensures a basic level of demand for goods and services in the National Capital Region. This point can be debated (no city will ever empty out of residents willing to do business with one another); however, the recent example of Calgary’s downturn illustrates how a local economy can slow due to external events and other potential risks. Nevertheless, provided its main economic driver remains in place, Ottawa should always be stable, which makes for a healthy (if somewhat boring) environment for CRE.

While supply may be particularly limited inside the Greenbelt, most of the factors influencing supply and demand apply to the entire city of Ottawa. Its urban area is well defined, and unrestrained growth is very unlikely anywhere, as Ottawa already has one of the largest geographic boundaries of any city in Canada.

Other factors driving demand include the increasingly diversified economy, specifically Ottawa’s excellent tourism activity and its dynamic tech sector. That sector, particularly in Kanata North, has been undergoing a rebirth of sorts in recent years, and it’s no secret as to why. From the beginning, Ottawa’s tech sector has been based on telecommunications and software, and does anyone believe that smartphones and the Internet will be obsolete any time soon?

Look around at any exciting new technology product or service, and it’s safe to say that telecommunications and software are key components. Ottawa’s long history of expertise in these areas provides an advantage. Although the demise of Nortel Networks was indeed unfortunate, there is a silver lining: the collapse of Nortel attracted a host of international companies to fill the gap, such as Ericsson, Nokia and Ciena, each of which has a large presence in Kanata North.

BlackBerry, another example of a prosperous Canadian company whose fortunes appeared to be headed south, pivoted into a success story in Ottawa by way of its acquisition of software company QNX, a market leader in the development of autonomous vehicles. Now, Ottawa is poised to become a major research and development centre in that field. Even if you doubt you will ever travel a long distance in a self-driving car, that’s where the future is headed, and Ottawa will be at the forefront in the design and testing of this new technology. (Ironically, Apple, the multi-billion-dollar company that has achieved supremacy over all other smartphone companies, including BlackBerry, has also set up shop in Kanata.)

Today, Ottawa has the highest proportion of technology employment in Canada, higher than any major city—including tech hub Kitchener–Waterloo—and that translates into higher demand for commercial real estate.

Of course, tourism is not to be ignored. Sure, Canada’s 150th birthday doesn’t come along every year, but Ottawa is well situated to continue attracting people and events every year. To start with, Canadians will always be drawn to their capital to bask in Canadian culture and experience our country’s history. In addition to the natural advantage of being centrally located between Toronto and Montreal, Canada’s two largest cities, Ottawa is within a day’s drive of the huge population base on the eastern seaboard of the US. Those facts, combined with the presence of dozens of international embassies and consulates that draw visitors from around the globe, make the National Capital Region a significant catch basin for tourism.

Ottawa is not only rich in tourism assets such as Parliament Hill and other historical buildings, it also boasts an amazing array of world-class museums, music and arts festivals and sporting events, as well as proximity to outdoor phenomena such as Gatineau Park, the Ottawa River and the world’s largest skating rink! If those responsible for Ottawa’s many attractions promote these assets widely, both nationally and internationally, our tourism sector will continue to flourish beyond 2017. You may be able to guess my point: Tourism creates employment and opportunity, and translates into higher demand for commercial real estate.

So, the fundamentals of Ottawa CRE clearly favour strong demand for goods and services—meaning more buyers not only for accommodation, but also for everything from coffee and clothing to entertainment, which means that more businesses will be created to cater to this demand.

But Ottawa CRE is an asset class that demands capital. Despite those ridiculous advertising claims we’ve all seen (Buy real estate with no down payment!), CRE is a capital-intensive business, and buyers need both debt (in most cases) and equity (in all cases). Fortunately, Canadian banks and other lenders are unlikely to turn off the taps when it comes to financing what is perceived as among the lowest-risk assets in Canada—that’s a given.

And once you’ve acquired your asset, the future horizon appears promising for liquidity. Brookfield, a global company that currently manages more than $250 billion in real estate assets, published a report in 2013 predicting that institutional investors will increase their investments in real assets (such as CRE). The report noted that this trend is expected to “accelerate materially over the course of the next decade, with allocations to real assets reaching 20% to 30% of portfolios by 2030.”

And what about demand for Ottawa CRE assets? In 2016, Altus, a national commercial real estate consulting company, conducted a survey of Canadian real estate executives that found there were an estimated 17 buyers for every seller of good-quality industrial assets. Yes, there is demand for Ottawa CRE!

CRE is an asset that creates a rate of return, which is kind of important, as no one who invests money in anything wants it to sit idle.

Some may view the Ottawa market with skepticism due to the lowered rates of capitalization and rising price tags associated with CRE assets in recent years. However, interest rates have dropped in tandem with capitalization rates, mitigating these market changes. Your rate of return is most important when compared with inflation, and the rates of return for Ottawa CRE assets are still performing well compared with most inflation rates in the industrialized world.

Whether you are a sophisticated money manager or a family with money to invest, you don’t want to stick your money in a mattress and watch it erode in value due to inflation. In Canada, the inflation rate has stayed at or below 2% for the majority of the past decade, and many experts predict it will remain at a manageable level. Well-located and properly managed CRE investments will allow you to beat inflation on your assets.

While rate of return is important, capital growth is also a critical aspect of investing in CRE. The investment objective should extend beyond simply beating inflation, as you should expect your assets to grow in value as well. In many CRE sectors, it’s still cheaper to rent or buy something that already exists, given the current cost of buying land and building new. In 2017, this “discount” on buying existing assets should be in the range of 20% to 40%, depending on the asset.

There are reasons why new assets cost more, and the biggest one is that users who need a distinct feature will pay more for something they can’t find elsewhere. But most users, whether they are a corporation or a shop owner, will likely opt to take the cheaper route, rather than breaking the bank to buy the “shiny new toy.”

As an owner of CRE, buying a property that is already there, with a value you can measure, protects you from the risk that someone down the street will build something new and steal your tenants. This discount is also a way of shielding yourself to some extent from future development, because the cost base of existing assets is lower than it is for newly completed properties. Plus, there is good reason to expect this “discounted” initial purchase price will translate into capital growth sometime in the future.

These are some of the “macro” reasons why Ottawa is a good place to invest, but one still needs to be smart about what to buy. Do your research, negotiate hard, and be prepared when a good opportunity presents itself.

Huntington Properties was established in 1996 because we believed there are good CRE investment opportunities in Ottawa. Our subsequent growth has confirmed that it was true then, and it is still true in 2017.