After roughly two years of uncertainty in the Montreal investment market, the challenge for investors and professionals alike has been trying to get a proper handle on property values in the face of a slowdown in transaction activity.
This uncertainty, always underpinned by which direction the interest rates would go at the next announcement, sometimes led to wildly differing views on value, creating a domino effect of ‘wait and see.’
You could almost say we were stuck in market inertia.
Now however, as interest rates appear to be making their downward descent, a shift is starting to take place. Buyers and sellers, and in some cases landlords and tenants, are meeting on the same page as it relates to value. A new normal is setting in.
While we don’t have a crystal ball, it’s always fair game to do some forecasting on how the market will pan out in the coming months. Here’s a snapshot of the status of each asset class in Montreal, with one prediction for each, to keep in mind as we move forward.
Industrial softens, but that’s not necessarily a bad thing
We can expect Montreal’s industrial market to show relative stability for the upcoming year.
Average industrial rental rates are still significantly higher than five years ago. For example, average asking net rents in Q2 2019 were at $6.41 per square foot. Our most recent report has average net asking rents at $15.31 for the Greater Montreal Area (GMA). That said, rental rate growth has trended downward since the start of the year.
Meanwhile, the industrial vacancy rate increased by 60 basis points quarter-over-quarter, to 3.5 per cent. This is the first time the vacancy rate has been above three per cent in over six years, according to Colliers’ Montreal Industrial Market Report for Q2. Overall availability now sits at four per cent.
Upcoming development has the potential to further impact availability. To date, there is approximately 1.3 million square feet of industrial inventory under construction across the GMA, with much of it slated for completion before the end of the year. For context, we experienced 2.8 million square feet of industrial absorption in the 12 months leading up to mid-2024.
Despite these softening indicators, cash-flow fundamentals, which help to support value stability, remain strong for good-quality industrial product. This can, in part, be attributed to favourable factors such as contractual rents operating in line with the market, in-term rent growth and healthy renewal probabilities. Values appear ready to start moving up again, though not to the extent they did in 2020-21.
Prediction: With anticipated further cuts to the key interest rate, more favourable debt conditions will help to place less pressure on the bottom line, stoking flexibility to get deals done. With that, we should expect to see greater transaction volume as buyers and sellers recognize the market is normalizing.
Lower inflation, cheaper debt haven’t spurred more retail spending
The performance of the retail sector over the coming months will really depend on the direction of a few key economic indicators.
Consumer spending is weak and expected to remain soft for the balance of the year according to a recent RBC report. The report also highlights the impact of mortgage costs on overall purchasing power.
Meanwhile, retail sales were down in June, though gains were noted for supermarkets and grocery retailers, a subcategory of ‘core retail.’
So, what does this mean for retail? The usual suspects will continue to perform well, even in the face of decreasing purchasing power and consumer confidence. Neighbourhood centres, anchored by grocery retailers and pharmacies, will remain desirable. These are tenants that typically have longer-term leases, which, when coupled with high renewal probabilities, equate to stable cash flows and values.
Prediction: Necessity-based retail properties will continue to do well, holding stable values as the softening of mortgage costs through rate cuts slowly makes its way into consumer spending habits.
Office continues to face challenges, though hybrid work will shift
In the second quarter of this year, the GMA office market saw vacancy rates rise from 16.8 per cent to 17.1 per cent, while availability increased from 18.6 per cent to 19.6 per cent. Most of that increase was driven by an oversupply in class-B buildings, according to Colliers’ Q2 Office Market Report.
The downtown submarket, however, continued to see some modest improvement, with 233,000 square feet of absorption, according to the most recent quarterly findings.
Movement on the basis of ‘flight to quality’ should continue, with more tenants shifting from class-B offices into newer towers with better amenities and services, as companies prioritize a high-quality office experience. Further, it’s possible employers in some industries — and we’re already starting to see this — will become less flexible with work-from-home arrangements.
The office sector in Montreal, like other Canadian centres, will continue to struggle over the next year. Acquisitions continue to largely be some combination of redevelopment plays, which realistically will take a large amount of time and investment.
To add, as unemployment is on the rise nationally, there is the possibility companies will start to contract under economic challenges, meaning fewer workers to accommodate.
Prediction: Long-term, we should see office market vacancy move down and shift closer to balance as more companies develop policies that require workers to be in-office for a certain number of days each week. For now, the asset class will likely see more sellers than buyers — and values will reflect that imbalance.
Why multifamily will stay healthy
Last year saw a notable slowdown in new apartment rental construction starts. This was fuelled by rising financing costs, which when coupled with heightened construction (and permitting) costs, as well as delays in project approvals, sometimes resulted in a development that was no longer feasible.
The effect of this past slowdown, which translates to fewer completed units being added to the market in the short to medium term, means we can likely expect to see a continuation of the same dynamics impacting multifamily properties today: a lack of supply, positive rental rate growth, low vacancy rates and low turnover rates.
Further, though the interest rate decreases may spell relief for some mortgage holders in the home ownership market, sale prices of single-family homes in the GMA have continued to increase, climbing five per cent year-over-year, according to the Quebec Professional Association of Real Estate Brokers’ latest report. That has translated to a continuation of the notion of a ‘seller’s market,’ keeping home ownership out of reach and maintaining the status quo for many renters.
Combining all these factors, we can expect that while demand will remain high, supply will unfortunately remain low. This, coupled with the previously mentioned cashflow dynamics and continued investor interest, will create stable yet positive value growth for existing multifamily properties.
That said, with the decline in interest rates, new development does appear to be showing some signs of recovery. According to the most recent apartment rental starts data from CMHC, starts were up in both Q1 and Q2 2024 on a year-over-year basis. Good news, despite the challenges, a willingness and strong appetite from developers to build, remains.
Prediction: Multifamily will continue to be the strongest asset class with stable values. Supply will continue to lag demand for the foreseeable future, while investor interest will remain strong, likely to accelerate into the medium term.
The numbers have to make sense regardless of market conditions
In less than five years, most of us have experienced what can only be described as two completely different real estate cycles in Montreal.
Though initially plagued by uncertainty, 2020 quickly ramped up to a market of strong investment activity, where every week seemed to bring a new benchmark. Peaking in 2022, the market then experienced a quiet that has really characterized the past two years, bringing us to where we are now.
Moving forward, I think we are likely to experience something resembling stable ground, with greater predictability and a more vibrant transaction cycle.
That assumes, however, that we’ve learned from our past experiences.
The lesson: No matter the market conditions, whether deals are everywhere or scant, the numbers have to make sense.
