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By Keith Reading

Canada’s rental apartment investment sector continued to register healthy market characteristics over the last year. Investors enjoyed attractive yield results and stable income performance. This year’s solid returns were reflective of the sector’s long-term history. The healthy return performance was, in large part driven, by the strength of national rental market trends.

The solid return generated over the last year coupled with ongoing income stability, attracted a broad range of investors to the sector, on top of the already healthy demand-base. A range of public and private investor groups either expanded their existing investment holdings or entered the sector for the first time. This trend was driven in large part by access to relatively inexpensive debt capital either through the capital markets or the Canada Mortgage and Housing Corporation (CMHC).

Access to inexpensive capital and the promise of stable and attractive yields boosted liquidity levels, beginning in late 2009, after a rather sharp slowing trend emerged in 2008. As demand for apartment acquisitions increased and bested supply this year, pricing recovered to almost pre-recession levels.  In short, Canada’s rental apartment property sector continued to build on already healthy investment market fundamentals over the last year, as the sector remained a preferred real estate property class with investors.    

The Canadian rental apartment property sector generated a solid total return over the last year, after a bullish performance characterized the asset class during the previous 12 month investment horizon. The national property class posted a solid annual rolling return of 5.9 per cent for the 12 months ending on June 30th, 2010, according to the Investment Property Databank Index (IPD). The index tracks return performance for Canadian rental market property with a capital value of approximately $5.2 billion.

This result represented a sharp recovery from the bullish result of 0.2 per cent in the previous year. The poor showing was driven in large part by the correction in capital value that was observed across the various asset classes in the real estate sector. The previous year saw a cumulative capital decline in the index of 5.5 per cent, as a result of the unwinding of unprecedented capital growth prior to the credit crisis. However, the correction paled in comparison to the other major asset groupings, which saw deeper declines in capital value. This year’s return was supported by continued income strength, one of the sector’s trademarks for several years. The combination of the stabilizing capital trend and income stability drove this year’s positive return result, which placed the sector in a favourable light with investors.  

Healthy Canadian rental apartment market fundamentals resulted in strong income returns over the last year, which in turn, drove the solid total return performance. Average rents remain at peak levels in most major markets. Average same sample rents increased by 1.8 per cent year over year as of spring 2010. Though not as sharp as the previous year’s 2.7 per cent increase, the upward trend for rents supported stable and positive income returns in the last year, which has characterized the sector for several years.

Upward pressure on average rents was supported by healthy occupancy characteristics in the Canada rental apartment sector. National occupancy rested slightly above the 97.0 per cent barrier throughout the past 12 months, resulting in continued limited supply for potential renters. Occupancy levels this year reflected the long-term trend that saw national occupancy of 96.8 per cent or lower, dating back over a decade.

Average rent increases and strong occupancy trends were driven by healthy demand over the last year. Recent immigration trends have boosted demand for rental accommodation. In the Greater Toronto Area, for example, where the majority of new arrivals locate, net international immigration will have reached slightly more than 90 thousand in 2010. This is up 9.8 per cent from year ago. The majority of new arrivals to the country tend to rent in their first year of residency.

Healthy rental apartment demand was also driven by housing trends. Prices continue to rest at close to peak levels, despite the recent slowing trend in the sector. Consequently many potential buyers have been forced to continue to rent. The continued strength of Canada’s rental apartment market in driving income performance and, in turn, total returns attracted a range of investors to the sector.     

A range of public and private groups actively acquired assets in the Canadian rental apartment sector over the last year. Publicly-traded groups were active in the highest price ranges over the last year, given their ability to raise relatively inexpensive funds through the capital markets. The Canadian Apartment (CAP) REIT, for example, acquired a cumulative total of 668 Canadian apartment units in 2010, up to the close of the third quarter.
The most significant of these was the acquisition of: a 307-unit portfolio in Victoria for $47.2 million, 199 units in Mississauga for $31.7 million and a 162-unit luxury property in Vancouver for $38.4 million. In addition, CAP REIT was in the process of finalizing the acquisition of another 1,300 units in Vancouver and Montreal from two separate vendors for a combined cost of $142 million in December.

Private groups, typically the dominant group in the sector, were also active acquirers of premium assets in the last year. These included: Homestead, Skyline REIT, and Sun Life. Further, private buyers dominated acquisition activity in most other pricing levels, a trend that has characterized the sector throughout its history. While a variety of investor types acquired assets in order to meet their investment objectives this year, a few ventured into previously unchartered territory. 

The diversification efforts of a number of purchasers resulted in their entry into new markets and ownership arrangements in the last year. In April of this year, Killam Properties announced its entry into a joint venture with The Kuwait Financial House, in order to acquire $450 million in Canadian apartment property over the next few years, with an allocation of $250 slated in the next 12 months. 

In order to facilitate diversification in a portfolio that was previously dominated by holdings in eastern Canada, Killam made its first foray into the Ontario market, with acquisitions in Cambridge and London for a combined acquisition cost of $79.7 million in spring.

In August, a private equity partnership group, led by Greystone Managed Investments, acquired Timbercreek REIT, comprised of 5,112 units in 62 buildings in Manitoba, Ontario, Quebec and Nova Scotia for $182 million. To some degree, this type of activity helped boost recovery in the Canadian rental apartment sector.

The strength of Canadian rental apartment property investment fundamentals in the last year resulted in a fairly healthy recovery. Purchaser depth increased to the point where values firmed and increased for select assets. Through the credit crisis, many investors retreated to the sidelines awaiting market stability. This year the in-flow of relatively inexpensive funds into the sector not only boosted represented investor confidence, but also drove increased liquidity levels.

At the three-quarter mark of 2010, approximately $2.1 billion in sales of rental apartment investment property were completed, which reflected a marked increase from the previous year’s pace. Increased demand produced multiple bid scenarios, which resulted in downward cap rate pressure. Yield-hungry investors, both within the sector and from without, who had grown weary of poor returns generated with risk-free investment instruments, increasingly looked to the rental apartment sector to meet their investment needs.