While America is getting a taste of its first-rate cut in four years, Canadian real estate professionals who have welcomed three straight reductions in the overnight lending rate this year still hanker for more.
That's because higher interest rates in Canada since 2022 put a damper on that country's investor enthusiasm in projects. And increased borrowing costs contributed to a decline in publicly traded real estate investment trust values, while some of the country's largest pension funds posted weak returns from their property holdings.
So with higher rates also curbing deals in the United States over the past couple of years, the reaction of Canada's property industry to its three cuts since June could provide a sense of what may be ahead for industry counterparts in the world's biggest economy after the Federal Reserve cut rates for the first time in four years Wednesday, lowering the federal funds rate by 0.5% to a range of 4.75% to 5% and holding open the possibility of further cuts.
Brett Miller, CEO of Montreal-based Canderel, a Canadian property giant with more than $20 billion in acquisitions, development and management projects, said the latest Bank of Canada cut was welcome news for the real estate industry — but he remains cautious.
"It will take a number of successive cuts to impact market velocity," Miller told CoStar News in an email. "Fund managers have been holding cash in short-term instruments that have been yielding +5% returns with little to no risk."
As the returns from those investments decrease those same fund managers will have to start to deploy capital elsewhere, and we are already starting to see movement in the multifamily investment asset class, Miller said.
"In Canada, we need lower rates in order to spur badly needed residential development," he said. "The investor condo buyer needs to have confidence that a pre-build purchase of a condo makes sense." Miller also said he expects the market to start moving in six to nine months after two or even three additional interest rate cuts.
Rate Effects
Today's rate environment for real estate contrasts 2020 and the couple of years after the COVID outbreak was declared, said Mark Goodman, a principal of Vancouver-based Goodman Commercial. That period was an "explosive time" for the market, he said.
"In 2021, we did 39 transactions and over half of a billion dollars in sales from office on Zoom. Then it started to slow down when interest rates started to creep up in 2022, and we started feeling this impact," Goodman said during a panel discussion at the Canadian Apartment Investment Conference this month. "We weren't quite sure how bad it was going to be."
That's when Goodman noticed an interesting trend.
"I'm watching all the open rates, and everybody is looking, and no one is calling or emailing. I thought there was a problem with the system," said Goodman, recalling he was on the same stage two years ago. "I was trying to be optimistic speaking, but I think I coined the phrase, 'We were going into a long dark winter,' and that is exactly what happened. It was brutal."
Goodman said things started to look up when the Bank of Canada started pausing on rate hikes in 2023 at 5%.
"I can safely say things are looking pretty good," he said. "If we look at the first six months of this year, we have had a 69% increase in volume and a 59% increase in transactions compared to the same period of last year."
The interest cut by the Fed in the United States is also expected to be felt in Canada because the Bank of Canada monitors the difference between the countries' overnight lending rates.
Bank of Canada Governor Tiff Macklem told journalists this month the Bank of Canada takes "monetary policy decisions in Canada in the best interests of Canadians," said Macklem. "Interest rates between Canada and the United States can diverge. There are limits on how much they can diverge but those limits have not become a constraint on Canadian monetary policy."
He said the policy rate in Canada never went as high as the United States, and the Bank of Canada lowered the overnight lending rate three times, for a total of 75 basis points, during the past several months without the Fed making a single cut.
"Markets are now expecting the Fed will now be easing, and the divergence does not look it is getting bigger, and we are not seeing a big impact on our exchange rate," said Macklem. He also said the gap should not be a concern as the rates move closer to together.
Cuts priced into borrowing rates
Benjamin Tal, deputy chief economist with the Canadian Imperial Bank of Commerce said the real estate industry might not want to celebrate too early because there is no guarantee about the impact on long-term borrowing rates.
"The market has already priced in" cuts, Tal said. "This is why I say the Bank of Canada should go even below what the market is expecting."
The economist said by going to 2.25% for Canada's overnight lending rate, above the approximate 2.5% to 2.75% priced in by the market, long-term yields will drop even further.
"There just isn't much room for long-term rates to go down much further, and real estate professionals will just have to get used to the new reality, Tal said.
"There were days when we said everything below 5% was good, and people have to get used to this," Tal said. "We were too spoiled. If you can't make money in this environment, something is wrong with your model."
For now, some real estate executives are satisfied with what they are seeing on the interest rate front and say the impact is already being felt.
"Decreasing rates are having a positive impact on our business as we are seeing better spreads between interest rates and capitalization rates, which will translate into higher deal volume," said Kevin Henley, chief executive of Montreal-based Canadian Net REIT, told CoStar.