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Canada: Further cap rate compression as interest rates begin to rise

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The desire to own trophy office assets, fueled by strengthening fundamentals in growth markets, continued to nudge CBD office cap rates downwards in Toronto, Ottawa and the Waterloo region during the second quarter of 2017.

Modest cap rate compression in downtown Toronto was driven in part by upward pressure on Class A rental rates within a very tight CBD market and expectations of more of the same. Tenants will see little relief until 81 Bay Street and 16 York Street open for business in late 2020.

Until 2017, rising rental rates have been kept at bay by the expectation of a healthy amount of new supply arriving at market. However, strong demand has absorbed the lion’s share of this space in downtown Toronto, including the space displaced by tenants moving into the new towers. Consequently, availability is expected to remain near record lows until 2020. Upward rate pressure on Class A space should lead to higher IRR’s which supports the notion of further cap rate compression.

We don’t often see top-tier office product trade in downtown Ottawa. A 50% interest in Minto Place sold during the quarter, offering shared ownership of a three-building complex in the financial core. In addition, the pending sale of Constitution Square, a top-tier, three-building complex also located in downtown Ottawa, is anticipated to provide further evidence of cap rate compression for core investment assets. With the federal government starting to expand again after years of austerity, fundamentals are strengthening in the Ottawa market.

Canadian interest rates began creeping up in July 2017, though the 25-basis point increase has had little effect on investor interest. Continued rate increases would ultimately dampen the red-hot demand by owner/users and investors for lower-priced commercial real estate. For now, this segment continues to sell near or at record prices.

Source : Cushman & Wakefield

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