Building tomorrow: Understanding Canadian real estate’s evolving landscape

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After a long run of rising asset values and increasing returns, the Canadian real estate market is undergoing a major reset. The industry has already been grappling with rising costs, labour shortages and the related impacts on affordability, particularly in residential housing, for some time. Today, those secular trends have converged with shorter-term issues to further deepen the industry’s challenges.

Although demand remains strong in many market segments owing to Canada’s strong immigration trends and stable economic outlook, the higher interest rate environment has contributed to widespread uncertainty over asset prices. While not every asset class within the real estate market is equal, many institutional investors have paused on additional investment activity, creating a general scarcity of capital. Meanwhile, the effects of the COVID-19 pandemic continue to linger, most dramatically in the office segment, where vacancy rates have hit record highs but are showing signs of improvement for transit-oriented, ESG-compliant offices with good amenities.

Investing successfully in real estate, however, is often a long-term game. That means looking beyond current overall conditions, focusing on pockets of strength or weakness and understanding the dynamics within each asset class to spot emerging opportunities.

So, a key question for real estate investors with a long-term outlook is this: Which asset classes are emerging and may be poised to influence asset allocations going forward?

Industrial real estate and beyond

That question matters now, because we are seeing investor interest beginning to shift beyond today’s (and yesterday’s) hottest market segments and into emerging growth areas.

Industrial real estate has been perhaps the hottest market for several years now, supported by the continuing expansion of e-commerce, which has forced businesses to rethink manufacturing, warehousing and distribution channels. Digital transformation as a solution to address omnichannel operations and labour shortages has also fueled the digitization of industrial spaces through adoption of robotics processes to drive operating efficiencies and improve profitability.  Near-shoring manufacturing and changes to shipping patterns to address curbside pickup are shifting the landscape of logistics and consumer behaviour. Today, demand continues to outstrip supply and vacancy rates are low. There are signs that industrial real estate’s very good run may be losing momentum, because rents are peaking, vacancy rates seem to have stabilized, and it may no longer be safe to assume that valuations will increase as rapidly as they have in the past. Some investors are beginning to take some chips off the table and looking to reallocate to parts of the market with long-term growth potential. Yet industrial real estate remains a favoured asset class.

Data centres: Real estate meets infrastructure

If artificial intelligence (AI) is going to make good on the explosion of hype it has attracted recently, then it will require a vast expansion in computing power capacity. Data centres, which process the digital activities that enable today’s connected world, are fundamental to IT infrastructure, and powering AI will require the development of huge computing hubs. Ideally, these centres can be situated in cooler locations (because mega-data processing generates a lot of heat) with easy access to an ample supply of inexpensive energy.

Are data centres real estate, or are they infrastructure? They may be a bit of both. A data centre project can go far beyond the facility itself, creating an ecosystem that involves multiple infrastructure/real estate plays. There is a natural synergy, for example, between highly power-consumptive data centres and renewable energy development, such as wind or solar, to help supply them. There can also be links between data centres, renewable energy and battery storage sites, as well as with all of these facilities’ logistics hubs to efficiently transfer goods in end-to-end industrial processes.

The growing interest in data centres reflects two broader trends—digitization and decarbonization—that are helping to blur the lines between infrastructure and real estate. In our view, real estate investors will increasingly test the waters of assets combining characteristics of both infrastructure and real estate as these megatrends evolve.

Purpose-built rental

While the single-family residential market continues to face stiff headwinds as affordability has declined, multi-family residential, including purpose-built rental properties, continues to be an area for growth. Among the factors favouring this segment of the market are rentals’ affordability relative to purchasing and the pull-back in institutional capital, which should provide solid fundamentals for private investors over the long term.

Also bolstering purpose-built rental housing is continuing high demand relative to the ongoing supply crunch. In its January 2024 rental market report, the Canada Mortgage and Housing Corp. noted the country’s rental vacancy rate fell to 1.5 per cent in 2023 from 1.9 per cent the year before. A significant contributor to the vacancy squeeze is population growth, which Statistics Canada reports was up 3.2 per cent in 2023. Fuelled in large part by immigration to Canada, that was the highest growth rate since 1957. These market trends helped to spur eight per cent average rent growth in 2023, according to CMHC, which noted that units turning over to new tenants saw even higher rental increases.

During this time of heightened concern around affordability, particularly in light of rising rents, governments at all levels are introducing policies to encourage developers to bring new rental supply to the market. The federal government announced its waiver of the goods and services tax on new purpose-built rental housing last year, and some provinces have followed suit with similar relief from provincial sales taxes. The federal government has also announced additional supports through low-cost loans under the Apartment Construction Loan Program and more recent announcements in the April 2024 budget. At the provincial level, governments have announced supportive policies as well. In Ontario, for example, the provincial government is working to reduce development charges for rental housing.

Coupled with broader efforts to speed up approvals of new housing construction and strong market fundamentals, these financial supports are starting to make the rental segment more feasible and attractive for developers and investors. To truly address the rental supply gap, more of these types of measures are needed.

Student housing

A niche asset class of particular interest is student housing, which is another example of the infrastructure-meets-real-estate trend. Unlike the U.S. or the UK, Canada’s highly fragmented student housing market offers opportunities for consolidation, as well as many characteristics, like an absence of rent control, that attract real estate investors. Supply is low, occupancy is high, there is captive demand, and margins can be very attractive if the owner maintains a good capital investment program (since student housing typically suffers more wear-and-tear than an apartment building). Add in demographic tailwinds, and there may be substantial opportunities for private capital providers to partner with government and post-secondary institutions on student housing. Also helpful is recent move by the federal government to extend its Apartment Construction Loan Program to include student residences.

Necessity-based retail

The post-COVID environment has proven difficult for retail, but there are pockets of strength within the asset class. While shopping centres continue to struggle to attract capital generally—a situation that is unlikely to reverse until interest rates decline—there is more optimism for so-called necessity-based retail. These are shopping centres anchored by a grocery or large pharmacy banner, which offer necessary goods and services that are harder for consumers to buy from their homes. They may also offer some downside protection against recession risk.

Senior housing

Like student housing, this niche of the multifamily residential market is also supported by strong fundamentals, most importantly Canada’s rapidly growing cohort of seniors. Despite the demographic tailwinds, however, senior housing has failed to attract significant investment from large capital providers, in part owing to reputational risks. Yet the opportunity remains, perhaps especially for private investors with creative approaches to managing risk.

For further analysis and discussion, download Emerging Trends in Real Estate® 2024 by PwC and the Urban Land Institute.

Fred Cassano is Partner and National Real Estate Tax Leader at PwC Canada.

Braiden Goodchild is Director, Corporate Finance, Real Estate M&A, at PwC Canada.

This story was created by Canadian Family Offices’ commercial content division on behalf of PwC Canada, which is a member and content provider of this publication.