Monday Market Minute | Sep 5, 2022

Commercial real estate valuations begin adjusting as cap rates expand and transaction volumes drop

What Moved

Canadian commercial real estate transaction volumes fell sharply through the summer as buyer-seller expectations diverged. With the BoC overnight rate at 2.50% and heading higher, capitalization rates on commercial properties — which had been compressed to historic lows — began expanding. Institutional buyers demanded higher returns to compensate for the increased cost of financing, while sellers anchored to 2021 appraisals. The office sector faced additional headwinds from persistent hybrid work patterns, while industrial and multi-family assets held up better due to structural demand.

Why It Matters

For private real estate fund investors, the cap rate expansion represented a meaningful markdown on existing portfolio values. Funds that had acquired assets at sub-4% cap rates now faced a reality where equivalent properties traded at 5% or higher. Open-ended real estate funds faced the challenge of managing redemptions while asset values declined. Closed-end funds with current-vintage deployments, however, could access better-priced opportunities than at any point since the pandemic recovery.

Signal to Watch

CMHC rental market data — tight vacancy rates and rising rents provided a partial offset to rising cap rates in the multi-family sector, making it the most resilient commercial real estate segment.

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