Any theme for the second quarter has been overshadowed by the Bank of Canada’s rate hike that recently took place. This is the largest interest rate hike in nearly 25 years, intended to moderate inflation from the current ~8% under what governor Tiff Macklem has described as “very unusual economic circumstances.”
The higher interest rates, together with soaring construction and labor costs, speculation of a recession and ongoing supply chain disruptions are felt throughout the real estate industry. Despite these headwinds, this past quarter saw some sizeable transactions close, with individual sale prices for office and industrial assets in excess of $240 million apiece. As the market adapts to the current conditions and anticipates additional rate hikes, lenders and buyers have become much more cautious, especially in the office sector, which has historically shown greater sensitivity to economic cycles. Consequently, CBRE’s quarterly cap rate report has identified cap rate increases across most sectors and the office sector in particular reflecting the heightened investor caution. Public equity markets have been even less forgiving, with REITs trading at significant NAV discounts.
Organizations continue to implement varying degrees of their return to the office and hybrid work models as evidenced by the increased occupancy across our portfolio, now averaging 40% compared to less than 30% last quarter. Leasing tours serve as an important leading indicator of the health of the market. This quarter saw a post pandemic high in both monthly leasing tours and leases executed. Year to date, renewal leasing volume is above Crown’s 2022 budgeting for our Fund Portfolio. However, new lease transactions are slightly behind due to the slower than expected return to the office. The GTA West is the most active leasing submarket within our portfolio and suburban leasing activity is continuing to outpace downtown’s.
Touring activity has been especially high among occupiers of less than 10,000 sq. ft. These groups place an emphasis on ease of occupancy, flexibility and wellbeing. This is where Crown’s model suites program continues to facilitate leasing by presenting vacancies in their best light, especially when competing with other fully built-out options available through the sublet market. With these key themes, the distinction between high and low-quality spaces and operators continues to become more apparent.
As a best-in-class office operator, Crown continues to focus on identifying ways to differentiate our buildings and adapt to the ever-changing needs of tenants. As an active asset manager, Crown seeks to maintain a flexible mindset to navigate the various disruptions and cross currents facing today’s office market. We are confident our prudent and methodical approach will help contribute to superior risk adjusted returns.