It does not take real estate expertise to see that something significant is taking place in the property market of Toronto, Canada’s largest city. Visitors to the city cannot fail to be struck by the construction activity in the downtown district, which promises to radically transform the skyline through the addition of potentially two dozen skyscrapers. No other city in North America is adding as many high-rise condominiums and office towers.

Set against the backdrop of lacklustre growth that forecasters predict for the Canadian economy, the building boom is a response to a chronic shortage of prime office stock following historically low levels of development since the last major wave of two decades ago.

Broker Cushman & Wakefield estimates that around 5m sqft of space is under construction in the central business district alone. Many of the new towers under construction are condominiums, reflecting the growing appeal of city-centre living, which offers easy access to work and the main transportation hubs.

In the investment market, transactions for standing office assets has slowed and the shortage of stock and keen pricing have deterred overseas real estate investors. For the past two years, Toronto’s office investment market has been dominated by large domestic pension funds and real estate investment trusts. Looking at RCA’s transaction database we can see there was a 38% decline in the value of Toronto’s office transaction volume to $2.8bn (€2.04bn) last year. The city’s two largest transactions, PSP Investments’ purchase of a 50% stake in the TD Canada Trust Tower and the acquisition of Bay Adelaide Centre East by Brookfield, accounted for over one-third of the city’s entire office investment volume in 2013.

The low supply has been a boon to investors by depressing vacancy rates by around 5% in the downtown central business district and in supporting rental growth. These positive office market fundamentals powered the surge in investment activity, which peaked in mid-2012 to over $5.1bn of transactions invested over 12 months, the highest rolling annual total on record. Although transaction activity has fallen since 2012, average office prices have continued to improve, doubling to almost $500/sqft since 2010.

Such attractive pricing persuaded international investors to become net sellers during the past two years, with GE Capital of the US, Union Investment Real Estate of Germany and the UK’s HSBC and Standard Life Investments all selling office properties in the CBD district.

The supply pipeline threatens to lift vacancy rates and weigh on rents, while the patchy outlook for Canada’s economy also overshadows the occupational market in Toronto. High household indebtedness is acting as a brake on consumption and recent indicators suggest that manufacturing and exports, particularly to the US, are not translating into more jobs, even if Toronto is dominated by the banking and financial services sectors.

This year is shaping up to be like last year for the investment market as investors wait to see how Toronto absorbs the space under development and for a clearer perspective on rents and capital values.

In such an environment, it is unlikely that cross-border investment into Toronto’s office market will pick up any time soon.

Joseph Kelly is director of market analysis at Real Capital Analytics

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