Broad-Based Slowdown Paves Way for Rate Cuts,
Suggesting Investment Recovery in 2024
GDP surprised on the downside. Weaker than expected, Canada’s economy shrank at a 1.1 per cent annualized rate in the third quarter. An outright contraction in non-residential investment, inventory and goods exports was the most prominent contributor for the soft economic activity from July to September. While a large rise in government spending aided a 2.1 per cent gain in total consumption, household consumption flatlined, which suggests that consumer spending per capita continued to contract amid strong population growth. Although a significant upward revision for the second-quarter GDP helped Canada avoid a technical recession, or two consecutive quarters of decreasing output, softening labour market conditions and consumer spending, as well as declining manufacturing sales, all indicate that the nation’s GDP is facing further downward pressure in the final months of 2023.
Increasing evidence the Bank of Canada may turn dovish. Weak economic growth in the third quarter — alongside easing inflationary pressures, an upward-trending unemployment rate and waning home resales — should be sufficient to keep the BoC sidelined for the remainder of 2023. With inflation expected to fall within the BoC’s target range, coupled with further downward pressure for the economy continuing over the near-term, the monetary authority will likely communicate winding down its tightening policy toward the second half of 2024. The Bank may feel compelled to act earlier, possibly with rate cuts beyond current market expectations, if the economic slowdown proves to be worse than anticipated.
Commercial Real Estate Outlook
Hospitality and industrial remain top-performing asset classes. Despite broad weakness in production, output in accommodation and food services, as well as the transportation and warehousing industries, exceeded total GDP growth by 560 and 490 basis points, respectively, on a year-over-year basis during the first three quarters of 2023. This outperformance aided strong fundamentals in the industrial and hospitality sectors in Canada. In the hospitality sector, leisure travel is still a priority for many consumers, which is expected to lead the next leg of recovery in occupancy rates and key revenue metrics beyond 2023. In the industrial sector, the national vacancy rate remains below 2.0 per cent, but is currently inching up to a more balanced level due to elevated construction activity and milder demand growth.
Recovery in investment activity taking shape in 2024. Restrictive financial conditions were the dominant reason for declining investment activity this year, as potential buyers faced increasing scrutiny from lenders amid elevated debt-servicing liabilities. In 2024, however, possible rate cuts and a positive outlook for select commercial asset classes will likely create a conducive environment for investors to stage a comeback. Top-performing properties — such as hotels in tourist areas, suburban grocery-anchored retail centres, rent-control-exempt apartment buildings and large distribution centres in extremely low-vacancy markets — will likely be on investors’ radars once interest rates begin to fall. These asset types have the potential to maintain healthy fundamentals even in the worst-case scenario, in which the economy falls into a deeper recession.
* Through 3Q
Sources: Marcus & Millichap Research Services; Bank of Canada; CoStar Group, Inc.; Statistics Canada