Title: REAL ESTATE CAPITAL MARKETS AFTER THE CREDIT CRUNCH: The Canadian Experience
1REAL ESTATE CAPITAL MARKETS AFTER THE CREDIT
CRUNCHThe Canadian Experience
Carl Gomez Vice President, Research
2Outline
- The Big Picture Fundamentals
- Capital Markets - Residential Real Estate and
Outlook - Capital Markets Commercial Real Estate and
Outlook - Implications
3Canadian credit conditions key points
- Despite the recent turbulence in capital markets,
strains in Canadian credit conditions have been
less intense than in the U.S. for a few key
reasons
- Canadian financial institutions, businesses and
households have healthier balance sheets than
those in the US - Canadian banks have less exposure to the
subprime-mortgage market than the US - Canadian banks are less dependent on
securitization for the financing and on capital
markets for their revenues
4Bank Funding Costs
- Although spreads for market financing have
increased, funding costs (ie., the absolute cost
of borrowing by banks) has declined thanks to
lower Bank of Canada overnight rates
5Overall Credit Conditions
- Growth in household and business credit remains
strong and was growing well above historical
average in early 08
6- RESIDENTIAL REAL ESTATE MARKET
7Residential mortgage market
- Posted fixed rates are slightly higher but
variable rate mortgages (linked to prime) are
substantially lower net effect still positive
for consumer
8Residential mortgage market
- Canada has a smaller share of subprime mortgages
and exotic loans than the U.S. since financial
innovation is behind the U.S. Still, it wasnt
the existence of subprimes that caused the bubble
to burst in the U.S. but it did contribute to
creating the bubble
9Residential mortgage market
- Federal governments liberalization of mortgage
insurance market in 2006 (which includes 40 yr
ams 20 dp insurance for investor mortgages)
has helped to prolong Canadas housing boom
10Housing valuation metrics
- Like the U.S., speculation is causing home prices
in Canada to overshoot fundamentals like income
some correction is warranted going forward
11Regional home price trends
- Speculation runs highest in Western markets,
modest corrections already occurring in Calgary
and Edmonton, Vancouvers correction could be
more interesting!
12- COMMERCIAL REAL ESTATE MARKET
13Canadian commercial RE market
Capital appreciation has accounted for the
majority of commercial real estates recent large
returns
14Canadian commercial RE market
Global compression of cap rates provided the
valuation lift
Canada
CBRE
15Canadian commercial RE market
Compression amplified by reduction in real estate
risk premium and/or robust expectations of
strong income growth
Cap Rate Rf RP g Cap Rate Rf Rp - g
Canada
16Canadian commercial RE market
- A changing climate for borrowers lenders
seeking to ration capital for the year. Things
are tighter in the US if only because they were
much more laxed before.
17Canadian commercial RE market
Compared to the U.S., debt is less of a factor in
driving Canadian pricing
18Canadian commercial RE market
In Canada, equity investors play a far more
dominant role in providing capital for real
estate
Source Bank of Canada, RBC, Pension Fund Annual
Statements
19Canadian commercial RE market
While the cost/availability of debt has also gone
up in Canada, the significant influence of
institutional investors is the offset that should
prevent as severe an adjustment in pricing here
GROWTH IN INVESTED EQUITY - US
GROWTH IN INVESTED EQUITY - Canada
Equity
Source Pension Fund Annual Reports, RBC, CBRE
Source Emerging Trends
20Canadian commercial RE market
- Pricing is set at the margin - the adjustment in
debt markets will continue until risk is
correctly priced means the valuation effect
will likely not be at the back of real estate
investors
21Implications
- Canada has been affected by the global credit
crunch but strains in Canadian credit markets
have been less intense than US - Residential lending conditions have remained
favourable and innovations in mortgage market
have prolonged the housing boom - But affordability is being stretched and
speculation has increased, particularly in the
West therefore a correction is warranted
though not as severe as the U.S. - Commercial real estate is experiencing relatively
tighter lending conditions - But capital market structure of Canadian
commercial real estate employs less usage of debt
compared to the US not as detrimental - A leveling out of cap rates (or a modest increase
for some properties) as risk is re-priced
suggests that the valuation effect will no
longer be at the back of commercial real estate
investors