This is an HTML version of an article that ran in the April 2014 issue of Real Estate Forum. To see the story in its original format, click here. 

Although an all-out merger between the US and Canada is not likely, Canadians are taking a bigger chunk of the US commercial real estate market.

Call it an invasion from the Great White North. Commercial real estate investors and developers—even Canadian banks—have a growing appetite to buy, build or lend against all asset classes in many US markets. Yes, what started out long ago with individuals scooping up residential properties in warmer US climates has become a full-blown CRE trend that's gaining momentum faster than the winter snow melts across the border in springtime. Some Canadians are even jokingly referring to the US as “the 11th province.”

Canada is the number one foreign investor in US real estate, putting nearly $12 billion to work in 2013, according to Avison Young. One of the biggest deals last year was Canada-based Brookfield Property Partners' $1.1-billion acquisition of Atlanta's Industrial Developments International. But GlobeSt.com headlines tell a broader story of deals large and small: Canadian REIT Buys Virginia Hotel Portfolio for $37M; Canadian Developer Proposes Hotel; Canadian Buyer Grabs Publix Retail Center; Amazon.com Fulfillment Center Purchased by Canadian Investment Firm; Canadian Developer to Build Dallas Res Tower; Canadian Fund Acquires 50 Rental Homes—and the list goes on.

“For several years now, Canadian investors—both institutional and private—have been gobbling up US commercial properties at break-neck speed,” says Dan Carlo, principal with Avison Young and managing director of the Toronto-based firm's Miami office. “Canadians, as a whole, have been the most active foreign investors in US real estate every year since 2010, and were never far behind before that. In fact, Canadian investors represented nearly one-third of the aggregate $90.6 billion that international buyers invested in US real estate during 2010 to 2013.”

What's Driving the Invasion?

Headlines out of Canada suggest a myriad of factors is driving the invasion from the Great White North. The Toronto Globe and Mail reported that Canada's commercial real estate market is softening after outperforming expectations over the past five years. Financial Times reports Canadian pension funds may be overexposed in the sector as the market faces big declines.

Ciro DeCiantis, a partner in Deloitte's Toronto office who leads the firm's Canadian real estate practice, confirms that yields in Canada have compressed and there is the perception that income growth in the near term will be flat. “The thought is that the US market is undervalued, there are strong markets and even secondary markets with good returns and potentials for income growth in the US,” DeCiantis says. “The projected decline of the Canadian dollar to around $0.80-$0.85 is a strong motivator. Also, there is almost no product available in Canada.”

As Brian Ward, president of Colliers International's Capital Markets group in the Americas, sees it, capital flows and the demand for prudent real estate investments are driving Canadian investors' appetites. “There may be some additional motivations, such as a recognition that the US dollar may continue to strengthen against the Canadian dollar over the next few years as we move into the next phase of our monetary policy,” he says. “The US also appears to be showing more strong positive trends with employment growth and wage stability.”

Avison's Carlo warns that it's risky to generalize the motivation of Canadian investors because there are innumerable types of investors—insurance companies, pension funds, high-net-worth investors, REITs, etc.—pursuing a plethora of investment strategies. With that caveat, and in general, he says Canadian investors have a “very favorable” view of real estate and the US is an attractive, familiar market which still offers liquidity gaps. He says Canadians can fill these needs and “obtain a premium” over similar investments in Canada.

Mark Stapp, executive director of the Master of Real Estate Development and Fred E. Taylor professor in real estate in the W. P. Carey School of Business at Arizona State University, offers a good reminder: It's not just Canadians that are taking interest in US commercial real estate. That, he says, is because the US has some of the best-defined, protected property rights in the world, and there are very few barriers to entry. Indeed, just about anyone can buy US real estate, and stable political and monetary systems make it a safe harbor location.

“Canadians see this as an easy place to invest in a culture essentially the same as their own, with ease of access,” Stapp says. “The strength of the loonie to the dollar had made US real estate a very good value for Canadians. The loonie has lost strength compared to the dollar over the past six months, but Canadian real estate is also expensive by comparison, so the values found in the United States are good. The combination makes this a good place to invest. Plus, they get to winter here. Also, I believe that Canadians have some favorable tax policies regarding investment properties.”

Canada Picks Its CRE Darlings

Canadians are hungry for US real estate for many reasons—and investors have their favorite product types. In today's market, multifamily is the darling but a close watch on Canadian commercial real estate investments shows that the appetite runs the gamut from office to industrial to retail and beyond.

Colliers' Ward still sees multifamily leading the way. He points out a noteworthy market dynamic. When you compare Vancouver to Seattle, or Toronto to Boston in terms of the number of people living in the city, he says, the US has a ways to go—but it appears there is a strong trend in that direction. He also believes Canadian investors are looking for stronger yields in relation to risk.

“Multifamily pricing has become very aggressive, and may start to cause investors to pause without a clear sense of rent growth,” Ward says. “However, the data suggests that even with current new supply, there is not enough product to meeting coming demand. For those that feel multifamily is too expensive, I would expect them to move toward yield opportunities in office, industrial, retail and hotels, to the extent value in those asset classes exists.”

Indeed, Anthony Cocuzzo, a partner from Deloitte's Toronto office who leads the company's Americas regional real estate practice, insists multifamily is no longer the commercial real estate darling among Canadian investors. As he sees it, multifamily was the safer play in a tumultuous market but investment is flowing to opportunities with higher capital appreciation and income growth in a recovering market.

“Multifamily has seen significant upward pressure on valuations as investment has poured into that asset class during the uncertainty of the last several years,” Cocuzzo says. “Canadian investors are looking at office and retail to capture rebound in the US economy, as well as industrial—primarily logistics and distribution—assets located near major transportation hubs or adjacent to metropolitan areas to capitalize on continued rise of online retail and the repatriation of manufacturing.”

From Carlo's perspective, Canadian investors often look to the US for opportunities unavailable to them back home. Very large, “fortress” malls are a good example of that. He says the few such malls that do exist in Canada are owned by a very small group of players. For his part, Stapp has a simple answer to the question about what product types are satisfying Canadian investor hunger: all types. “There are larger investors buying everything from land to hotels, and small investors buying single-family homes,” Stapp says. “In a market like Phoenix, Canadians accounted for more than 90% of the foreign buyers of single-family homes over the past several years.”

Canadian Investors Span the US

Although Canadian snowbirds flock to condo investments in warmer climates, the bigger picture of Canadian capital flowing into US commercial real estate seems to have no boundaries. Carlo suggests Canadian investors are, in some measure, US geography agnostic.

“We see them active in virtually every NFL city, in coastal markets, and even in such places as the Dakota flatlands, where they are investing in development spurred by the success of fracking there,” Carlo says. “Also, we have seen them actively pursuing demographic trends in the US population. For example, following the aging Baby Boomer population by investing in senior housing and medical office buildings or following the large age cohort now making its way through college by investing in student housing.”

Deloitte's DeCiantis tends to agree. He's not sure if one region stands out more than others, but he has noticed large institutions focusing on core markets like New York. Of course, that's nothing new. “I think yield is the first filter, then evaluated against local economic fundamentals compared to long term economic performance in that region,” he says. “I also think Canadian investors are more willing to look at secondary US markets—primarily the REITs—because there is more potential for upside and some secondary US markets have similar economic fundamentals to major Canadian cities.”

At the end of the day, Ward says Canadians are no different than any other sophisticated global investors. They want markets in geographic proximity to their home turf—such as Seattle, Chicago, Boston and New York. They also look for coastal markets that offer the best opportunities for strong real wage growth and demonstrated multiple exit strategies, such as San Francisco, Southern California, Washington, DC, and South Florida. “I am seeing more Canadian investors going global like many US private equity funds,” he says, “and are now aggressively competing for product in the UK and Western Europe.”

The Canadian Investment Impact

Beyond the big dollars Canadian investors are making into US commercial real estate, what's the big picture impact? And is there a downside? According to Ward, it's clear that Canadian investors are creating more competition for US buyers—but so are other foreign investors.

“This is not a foreign capital issue,” Ward says. “It is a global capital issue, including both domestic and offshore resources. The mentality for commercial real estate investment has changed fundamentally, even with the 2009 market correction, and global investors now see real estate as a core component of their overall investment strategy into all asset classes.”

Carlo sees no downside in the rush from Canadian investors. By and large, he says, Canadians are stable, patient, and sophisticated investors. He looks at the surge of Canadian capital as a reaffirmation that—notwithstanding the issues our country faces—the US remains a global beacon for investment safety and stability. Carlo does admit Canadians are driving competition but feels it has helped buoy prices on existing properties and spur new opportunities.

“The US real estate market is of such a size that there is ample space—if not a need—or foreign capital to play a meaningful role,” Carlo says. “Foreign capital has been a market stabilizer. Similar concerns of being too dependent on foreign capital were raised in the 1980s when Japanese investors were taking major positions in prominent US properties such as Rockefeller Center in New York. We seem to have come out from that 'over-dependence' just fine.”

How Long Will the Invasion Last?

According to Royal Bank of Canada, Canadians purchased, on average, between $15 billion to $19 billion each year worth of US commercial real estate property in the last five years. Alain Forget, vice president of sales at RBC, says Canadians are taking advantage of the perfect storm.

“We've seen strong Canadian currency versus the US dollar, low interest rates, a soft real estate market, and a strong Canadian economy,” Forget says. “Canadians own now more than $50 billion in real estate assets in the state of Florida alone.”

Most commercial real estate industry watchers see the Canadian capital invasion as a long-term trend—one that has existed for a long time and one that will continue. In terms of the current level of elevated investment activity, DeCiantis says it should also continue, but he notes a few caveats.

“It should continue as long as yield differential exists between Canada and the US, and as long as there continues to be a lack of product available in Canada,” DeCiantis says. “It should continue as long as there is an expectation that there will be a softening of the Canadian dollar, creating impetus to acquire now and increase US holdings.”

Ward agrees that this is a long-term trend—unless. He predicts that a shake-up in the global capital markets could cause investors to shift to alternative investment strategies or rebalance their portfolios. As he sees it, the potential for misalignment between real estate, which has traditionally been a long-term investment class, and the need to generate returns that are not consistent with that fundamental, remains an issue for all global investors.

“As long as global investors understand that real estate generally involves a long-term investment thesis, I see little near term change in strategy,” Ward says. “Also, keep in mind that much of the capital driving this market is equity, and not necessarily higher-leveraged debt. When there is a correction, the ramifications for—and reaction by—equity will be different than if it were debt.”

Avison's Carlo sees Canadian demand in US real estate remaining strong for the foreseeable future. He notes an X factor: how quickly US real estate prices recover from the Great Recession troughs and return to replacement-cost levels. At that point, he says, we can reasonably expect Canadian capital—as well as that from other global players—to taper its US allocation and reallocate elsewhere. He predicts that emerging markets such as Mexico and Brazil should be the beneficiaries of such a potential pivot.

“The reality for Canadian investors is that their domestic market is highly concentrated in a few industries and, for the most part, in the hands of the largest domestic players,” Carlo says. “So, foreign investment is a portfolio imperative. The US offers the largest and most familiar investment alternative and, as such, can reasonably be expected to continually receive large amounts of investment across all real estate asset classes from Canadian investors.”