BMO Real Estate Forum: Quebec Outlook
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When looking at the last 18 months, the commercial real estate industry has fared far better than anyone expected. The industrial and multifamily sectors weren’t hit as hard as retail and office, but we’re optimistic that the sectors impacted the most will eventually find a new balance. The recent BMO Real Estate Forum featured a series of presentations and discussions about the outlook for Quebec.
Robert Kavcic, Director and Senior Economist at BMO, provided a high-level economic update.
Maxime Hamel, Director, Real Estate and Land Development at Altus Group, discussed the state of the residential market and the impacts of the current crisis.
Charles Trudel, BMO’s Regional Market Leader for Quebec, moderated a roundtable discussion covering key topics, including industry challenges.
Watch the video above for the full event.
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Mike Beg: [Greeting in French] Greetings, everyone. I'm Mike Beg, head of BMO's Canadian commercial real estate finance team. Thank you all for joining us today. I think we can all agree the past year has been a time like we've never seen. Banks entered COVID bracing for deeper impacts in their commercial real estate books. We were deferring mortgage payments to ease cash flow pressures for our clients. We were monitoring income property, rent collections, and housing market trends while continuing to support large development and financing demand by the industry.
I'm not trying to steal our speakers' thunder, but to say the commercial real estate segment has done better than expected since last summer would be an understatement. The payment deferral programs served their purposes and largely wound down last fall across all the banks. We have not had any losses or defaults in our commercial real estate loan book that can be attributed to the pandemic or COVID. Availability of capital across the segment is strong, and we have a veritable Z, or near Z-shaped recovery, because employment impacts were largely service sector, representing about 4% of GDP.
There is pain and ongoing adjustment in retail and office but this is not your parents' or even our own prior commercial real estate recession experience, but a unique pandemic one where low rates and strong demand and continuing undersupply trends are driving borrowing and housing market activity. We expect that to continue through 2021 and 2022 and beyond. We have a lot to cover over the next hour. I'll walk through the agenda quickly and then we'll get started.
We'll start with Robert Kavcic who will kick us off with an economic update. Robert has been with BMO since 2006 and plays a key role in analyzing Canadian regional economic, fiscal and real estate trends. Following Robert, we'll be joined by Maxime Hamel, director, real estate and land development at Altus. Maxime works primarily in the area of residential market research, launch price lists, and potential market value reports for large condominium projects, as well as developing automated tools and web-database of all condominium projects in the greater Montreal area.
We will then have a roundtable covering the key topics and answer questions that were submitted. Moderating that discussion is BMO's, Charles Trudel. My team leader for Quebec, based in Montreal, and heading that Quebec region. He brings over 13 years of experience in commercial lending in various industries, including real estate, services, manufacturing, and other diversified industries.
One last thing before we get started, if you are watching the events on a desktop or a laptop, you will see a chat box next to the video screen. Please feel free to use that at any time during the presentation to submit questions to panelists. Thank you all for the questions we received during the registration as well. We will address as many of those as possible during the roundtable discussion. With that, I'll now turn it over to you, Robert.
[00:03:21] Robert Kavcic: Great. Thank you very much, Mike, and thank you, everybody, for joining us today. To start us off, I'm going to look at the higher-level economic outlook and then focus a little bit on real estate as well before we turn it over and dig more deeply into the real estate sector. From an economic perspective, it still is all about COVID. When you look at Canada, the good news is that cases do appear to have peaked, just based on some of the restrictions we're seeing across various parts of the country, and that would be true in Quebec as well.
Our economic outlook right now assumes that this third wave that we are experiencing is cresting. As we go through this summer, we're going to see a more widespread rollout of vaccines and therefore allowing the economy to open up on a more sustained basis. The good news here is that Canada-wide, we're looking at about 40% to 50% of the population vaccinated now. Quebec actually leads the provinces in terms of the vaccine rollout, which is good news for the local economy.
At the rate we're going, most projections now suggest that by around Canada Day, sometime in June or July, we should see about 70% to 80% of the population vaccinated. Our forecast builds off of that and does expect a very strong expansion through the second half of this year and into the first part of 2022. The second quarter is going to look pretty weak because some provinces have rolled out more restrictions. We could see about flat growth in the second quarter. Keep in mind that the economy even through the turn of the year, as some provinces were rolling out containment measures, the economy actually held up very well. Part of the reason is that businesses and households and individuals, I think have more or less learned how to adapt and operate under these conditions. We didn't get nearly the same shock over the winter as we saw last spring when COVID first hit us. That's good news.
The real good news here is that if we are right, and that the economy is able to open on a more sustained basis, by around the middle of the year, the third and the fourth quarter look very strong. We could see 5 to 10% annualized growth later this year and into the early stages of 2022. On an annual basis, that leaves us at 6% growth this year, 4.5% growth next year for Canada overall, those are very, very strong growth rates, obviously, coming off of a very challenged 2020.
The underlying story here is that we think there's quite a bit of pent-up demand for things like services and face-to-face activities, travel tourism that are going to continue to drive growth over the course of the next few years and that's going to look quite strong. For the monetary policy backdrop, as much as the growth numbers do look very strong right now, the Bank of Canada has been pretty clear that they're going to be very patient raising interest rates.
A few weeks ago, they did come out and say that, yes, growth is outperforming our expectations, inflation is probably outperforming our expectations a little bit, we're probably going to look at raising interest rates a little bit earlier than we previously thought. Even still, that is probably a late 2022 story before we start seeing interest rate hikes in Canada. Our official forecast is that the Bank of Canada starts to raise rates in January of 2023, which is why you don't actually see a rate hike on the left side forecast there on the left chart.
I would say that the risk with what we're seeing right now, in that growth is running stronger, inflation is running stronger, housing markets are running still very, very, very strong. The reality is that the Bank of Canada by the time where we get through this period, maybe we actually do start to see some rate hikes in 2022. That's not our forecast today, I would just say that that's where the risk lies with respect to that forecast earlier rather than later.
When you look at longer-term interest rates, the market is already very much sensing a recovery. If you look at 10-year interest rates on the right side of this chart, we already pretty well back into the rings that we saw pre-COVID and we do expect gradual increases from here over the course of the next few years, where long term interest rates settle in around levels we saw over the course of the past cycle.
For mortgage rates, we do think that there still is some upward momentum in say, the five-year fixed space for example. Over the next couple of years, we've already seen five year fixed rates back up about 30 or 40 basis points off of the lows, and there's probably a little bit more upside to go on that front end, of course, variable rates would start to move with the Bank of Canada, sometime in late 2022 or early 2023.
Then, looking at the regional perspective, the thing we'll say about Quebec is that yes, 2020 was a challenge because early on in the pandemic, Quebec was hit harder than most from a healthcare perspective. Therefore, they were a little bit earlier and a little bit more aggressive with restrictions, things like a full shutdown of the construction sector for a period last year that we did not have in provinces, even Ontario as tough as the pandemic has been here in this province. Some of the restrictions in Quebec were that much tougher.
We saw a decline in growth about 5.3% last year. The flipside is that the province looks like it's going to recover a lot faster than most this year, we could see almost 6% growth in 2021. I would say more importantly if you look out beyond this year into 2022 and 2023 and beyond, we do think Quebec is a leader in Canada, still from a growth perspective. If you remember before the pandemic for three to four years, Quebec was seeing some of the strongest economic growth the province saw in 15 or 20 years. It was one of the real drivers of economic growth in Canada.
We think that when this pandemic eventually does pass, that Quebec is going to reassert itself at or near the top of the provincial pack. Some of the fundamentals just like the improved fiscal backdrop, a better business confidence, a little bit of a decrease in the tax burden, all of those factors we think are going to continue to support the longer-term story in Quebec even if there are some structural challenges on the demographic side.
With respect to the housing market, what we're seeing here is just dramatic strength through the second half of last year and into the first part of this year, 2021. It really has been demand-driven. You can see sales on the left side here, are running at well beyond record levels versus anything we've seen in Canada going back and a similar story in Quebec. There are a lot of factors on the demand side.
At the end of the day, what we have said is that a lot of the demographic and fundamental drivers of housing demand in this country that were coming down the road over the next two, three, four, five years, things like growth and millennial households or demand for single-detached housing and it's movement out of the major cities towards areas with more space, a lot of these trends were in place anyway.
What the pandemic did was it pulled a lot of that activity forward into a very short window and magnified a lot of activity to make it look a lot more dramatic. In a sense, we're getting a number of years of activity compressed into a very small window, hence why the sales gains and the price gains all look so very dramatic. The other thing I would point out here is that this is not just a Toronto, Montreal, Vancouver story like it was before the pandemic, but you can see the price growth we're seeing across the country.
It is literally everywhere in Canada has seen market strengthened and price growth accelerating. Of course in Montreal, we're seeing 20% plus year over year price growth right now, which is historically strong for that market, even stronger than we were pre COVID, which itself was a very tight market. As for the demand side of the story, a few things that are driving housing. First of all, the labor market has improved very quickly.
You can see the jobless rate in Quebec has already come down to about 6.5%. It's actually the lowest unemployment rate in Canada right now, believe it or not. It just highlights how the recovery has actually been very quick. Even though there are still some pockets of weakness out there. Employment is still down about 3% from where it was pre-COVID, but we think that those losses are going to start to come back very quickly through the second half of the year.
In fact, some provinces that haven't faced quite the same restrictions as Quebec have, has already seen employment pushed back to pre-COVID levels. This is going to be a pretty quick recovery once some of those sectors are allowed to open back up on a more full basis. Another takeaway here is that if you look at where the job declines have been, or still are across the economy, they're very much in lower-wage industries, and this is important for the housing market story.
What this chart shows you as you go left to right, that's the change in employment from pre-COVID levels. Down 30% still from last February, you see an industry like accommodation and food, but as you go up the chart, you move up the wage scale. Accommodation and food services just so happens to also be the lowest paying industry in Canada. The takeaway here is if you look up in the top right corner that the five or six highest paying industries in this country have all seen employment rebound well above where we were before the pandemic started.
From a housing demand perspective, those of a higher income industries that is where you find more home buyers, obviously, as opposed to renters, which are lower down the pay scale. Recovery in that area was very quick and very strong hence why we've seen a big rebound in housing demand very early on. On the demographic side, we have fundamental strength as well. It's just been interrupted temporarily during the pandemic. International immigration flows, pre-COVID were running extremely strong. Immigration targets going back to 2016 have been steadily increased.
We think that as the pandemic passes, Ottawa is going to be very quick to increase those immigration targets and that source of population growth will rebound, similar in Quebec. Migration flows have been a positive for Quebec as well, province to province, which you don't hear as much about, but historically going back over the last 10 or 20 years, Quebec would lose a significant number of households to other provinces in Canada. Ontario or Alberta, where the job market was historically much stronger.
Now, because on a relative basis, Quebec's economy is actually performing well versus the rest of Canada, w're not losing nearly as many people as we were before. In fact, those migration flows are very close to balancing out, and we're not drawing people in from other parts of Canada, but the fact that we're retaining people and not seeing big outflows on net is a big improvement for Quebec. That's been driving housing demand as well and then the millennial group is another big one that gets overlooked.
The millennial group is the biggest chunk of the Canadian population. The leading edge of that population is about 38 to 40 years old right now. Of course, as you get to that age, you start creating households. You start having first or second or third kid, you start looking for single-detached houses so you have all these factors compressing into the housing market, especially for single-detached housing that are driving demand higher.
Again, this is not new. These demographics have been in place for the better part of a decade, and we've been watching them slowly creep up on us, but the pandemic really put a spotlight and really pulled a lot of this demand forward into a small window so hence the demand we're seeing for housing right now. We don't think it's going to turn overnight, look at the market balance today. The sales to new listings is the blue line. That's just a quick measure of the market balance in Quebec and the average home price obviously rises as the market tightens up.
Right now, we're seeing historically tight market. I suspect that over the next year or two, the conditions are going to settle down a little bit. I think we've already probably seen peak momentum for sales and just month over month price growth. The fact that the Bank of Canada actually started to finally talk about maybe raising rates at some point has helped change the psychology a little bit.
Over the course of the next year or so as the economy goes back to normal, it might actually almost be an opposite recession from a housing perspective where housing is strong through the downturn, but as the pandemic lifts, and people are able to travel again, and go back to work in the big cities, again, the demand for housing, this acute demand for housing might actually dial itself back down a little bit.
It still looks like a very strong market going forward over the next two years or so, but hopefully, as as the psychology turns down a little bit, the market will start to look something that looks a little bit more reasonable because of the pace we're going right now, I think policymakers are in fact getting worried about it. By later in 2022, early 2023, when the bank can realistically start talking, or actually raising interest rates, I think even a small incremental move there would pretty quickly put the market back into a more sustainable balance.
On the supply side, I think that's the short story on the demand side. On the supply side, what we're seeing here is just a lack of inventory across markets like Montreal.
When absorbed inventory, bouncing around historic lows, we always talk about needing more supply in the market, needing more supply and it may not just be that we need more of it, it might be the composition of it.
It would be more single detached homes and it might be the elasticity of that supply which is a real issue where we know builders are constantly complaining about too much red tape and too much time to bring projects to market and that for sure is an issue if we can over time see policy work towards increasing the elasticity and the speed at which supply can come to market to respond to demand shocks like we're seeing right now, that could help keep the market a little bit more well behaved going forward, but the bottom line here is that supply is obviously very tight on both the new and the resale side.
The other story on the supply side is building costs. This is a question that we seem to get every day on the inflation side. Yesterday, the volume got turned up by about 10 notches. In the US, we saw the strongest month-over-month increase in core CPI since the late 1980s and there's quite a bit of underlying inflation momentum in the North American economy right now. On the good side, there's tremendous demand for physical goods and in housing specifically a tremendous demand for lumber and steel and anything that goes into new construction or renovation activity, but on the supply side, we're still very constrained.
It's probably the same thing around Montreal and parts of Quebec, but here in Toronto, you can hardly get the lumber to build the fence in your backyard, even if you wanted to pay up for it. That's where we are. We're seeing quite a bit of pressure on building costs and because of that, we're looking at 10% to 12% year over year increases in residential building construction prices. The other issue is that the availability of labor seems to be pretty constrained.
We're hearing anecdotes in the US where firms are having to pay bonuses to higher minimum wage workers just simply to get them back into the labor force, and it's a similar story in Canada here where we have very generous federal benefit programs that are still flowing and at this stage are probably disincenting the movement back into the labor force for a lot of workers. That's limiting supply and again, just kind of constraining what we're able to do and pushing prices higher.
This is something that's probably-- As an economist, I always kind of say when these trends start to break out, they tend to run stronger and they tend to run longer than anybody first thinks, and everybody is saying and including policymakers that this inflation scares transitory. It's going to go away, it's just base effects from last year. I suspect that we could very well be in for a period where we have two or three years where inflation is running pretty firm.
We're going to have to deal with that as builders and as consumers before the market, ultimately, readjusts because you guys, this is a massive shock on a global scale that can't just fix itself overnight. This will be with us for some time going forward, I think. Then finally on the rental side, I won't get too deep into the weeds here, but as strong as the housing market has been on the resale side, the rental side has been a little bit softer partly because within the rental market and within the job market, most of the declines have been in those lower-wage industries.
Of course, that disproportionately hits the rental side. The flip side is that yes, there has been serve and various other federal measures to keep tenants paying and keep them solve it through this downturn. We haven't seen a big wave of insolvencies. The decline that we've seen in non-permitted immigration flows has been pretty significant and those flows tend to fall directly onto the rental market. Those flows are on hold right now.
That is probably opened up some more vacancies. I think we're still probably a year or two away before we actually see those flows rebound, but we do think that eventually they will come back to Canada. The other thing we've seen in the bigger markets too, is this shift out of shorter-term rentals into the longer-term rental stock, just simply because there's not a lot of travel going on and investors in condos, for example, going back over the last few years would be putting their units onto the short-term rental market just because the cash flow is better.
With that market now effectively drawn or effectively closed off, a lot of those units have been flipped back onto the long-term market. That's just brought more supply and put a lid on rents in some cities and put some downward pressure in some cities as well. The key takeaway here though is again that a lot of this is temporary and once the restrictions lift on a more sustained basis, and this is probably 2022, 2023, these very acute short-term factors should eventually nullify themselves.
We should go back to a world that looks more like the one we saw before the pandemic. That's the macroeconomic story. Just to summarize quickly, I think obviously we've all seen real estate booming. I think we're probably already seeing peak momentum in the market and we should see the market's settled down. It's still going to look very strong through the rest of this year and probably through 2022. Eventually, there'll be a little bit of a natural payback for the fact that we have pulled demand forward, and eventually, the Bank of Canada is going to talk more seriously about raising rates and then actually go ahead and raise rates.
That should help balance the market out and put us onto a more sustained path going forward. With respect to the province itself, I think as I said at the outset, we're still very bullish on Quebec on a relative basis. First other parts of Canada. We were before the pandemic, the pandemic shock has obviously hit Quebec in a pretty unique way.
Post-COVID, I think it's safe to assume that Quebec is going to remain one of the drivers of economic growth in Canada. For that reason, I think we'd be quite bullish still on prospects for housing longer-term in the province. I will leave it at that. I guess I'll flip it back to you, Mike, and we can do some Q$A at the end.
[00:23:33] Mike: Thank you, Robert, for your insights and update. I'd now like to hand it over to Maxime who will be giving an update on Quebec regional market trends. Over to you, Maxime.
[00:23:50] Maxime Hamel: Thank you for the introduction. It is my pleasure to be here today to discuss with you the state of the residential market and the impacts of the current crisis. My name is Maxime Hamel, I'm director of the real estate development and land team at Altus Group, Montreal. Our team is specialized in all consulting and reporting services to assist developers from the land acquisition, to the operation of the assets.
We're also following all-new condominium and rental projects over 20 units at the Montreal CMA in order to produce their condo and rental tools, a subscription-based product for developers and lenders. For this session, I propose the following topics. First, we will explore the residential market context before COVID-19. Then we will see the different COVID-19 impacts on the residential markets and figures.
After that, we will discuss what expectation we can have for the future and lastly, we will come through the presentation. The Montreal market before COVID-19 for condos and rental was absolutely booming. We'll see a few starts showing how much. Let's begin with a condominium market. First, let's take a look at the resale market. We can see the two charts that at the end of 2019, the annual sales for condominium was at its highest since 2005, with close to 19,000 transactions.
The supply on the market and the total number of listing was the second-lowest in 15 years, therefore, very strong demand and low supply. This relation between the strong demand and the low supplies were represented in this chart, which shows the resale market conditions over time as per the Quebec Professional Association of Real Estate Brokers. The vertical axis shows the required numbers of months to dispose of the inventory while the horizontal axis represent the different quarters.
As [unintelligible 00:25:40], a balanced market is comprised between 8 and 10 months of inventory, more than 10 months represent the buyer's market while less than eight months of inventory is a seller's market. There's been a strong market tightening from a market strongly at the advantage of buyers in 2015 to a market strongly at the advantage of the sellers at the end of 2019, that sums up the inventory under resale market for a condominium. What about the new ones?
On this slide? We can see the intentory for the Montreal CMA as per counter tool. We're talking here only about unsold units. There's been a 21% decrease in the inventory of unit under construction and an 87% decrease of inventory for built units over the last five years. As a result, there were only 272 new condos available for immediate occupancy in the old Montreal CMA. For the downtown area, it was only 23 units. Was this decrease in the inventory simply caused by a lack of supply? No, it was not. As we can see in the following slide.
They are in the same period. There has been records volume of unit in newly launched project in the Montreal CMA. Indeed, while the quarterly average was around 1,100 units launched per quarter, we saw five quarters, mostly Q2s and Q4s with between 2,503,000 new units launch from the end of 2017, to the end of 2019. The majority of which were located in downtown Montreal and always demand during those years, demand was extremely strong.
We saw in the years 2017 to 2019, they showed 7,000 to 8,200 units sold per year. The evolution of sales were therefore sustained since the volume observed in the year 2014 to 2016 were around 5,000 units sold annually, and around 40% of historical sales are from downtown projects. In those great market conditions, downtown Montreal has seen the launch of record phases in terms of scale, height, number of stories, and number of units.
The appetite of investors for the Montreal market greatly helped the absorption of such major projects. If we take a look at the prices, they were evolving relatively slowly in between 2013 and 2015, not surprising, the inventory on the new condominium market was so large. Then once the excess supply was clear in 2016, prices started to rise rapidly. In fact, from 2016, to the end of 2019, we saw a 30% increase. We're talking about 10% to 15% price increases per year.
I remind you that the quality of Montreal project were also evolving. Let's now go through the rental market condition before COVID. We have witnessed a period of significant transformation that is definitely changing the game for rental. A strong ideological change has began in the United States following the real estate crash of 2008, renting has regained its popularity. It's no longer a bad thing to be a renter.
Montrealers are now also renting by choice. This phenomenon is mainly oriented around three-axis. Millennials wants a lifestyle and a quality condo, but with the flexibility of rental, then there's boomers wants less maintenance and to free up the [unintelligible 00:29:15] single-family home and in the downtown area, the professionals and the student clientele are also very present.
Therefore, rental market was also on fire. This can be seen by observing the number of housing starts in the greater Montreal area. Rental is popular and developers have understood this. Rental housing starts have exploded going from 4,000 starts in 2014 to more than 13,000 rental sites in 2019. It has therefore more than tripled. The proportion of housing starts in the Montreal CMA followed the same trend and went from 11% in 2012 to 53% of housing starts in 2019. May I remind you that the new condominium market was slowly booming during this period, and it still decreased in terms of start proportions versus rental product.
It shows how much the rental market was crazy in those years. A few moments ago, I mentioned the interest in the lifecycle condo but the desire for the rental flexibility. In addition to the rental starts shown earlier, what we see here is the evolution in the number of condos for rental in the greater Montreal area. In 10 years, the number of rental condos as almost credible. It shows 35,000 units in 2019. Of course, this growth is also caused by the strong investors present in the new condominium market.
The vacancy rates were also in line with the very strong market. Indeed, the vacancy rate in the Montreal CMA was cut for more than half between 2016 and 2019 to be at its lowest since 2010. 2019 showed 1.5% of vacancy, while the equilibrium level is normally at 3% and vacancy level is of less than 1% is considered as a housing crisis. We saw in the previous segment that the market was amazing before COVID-19. Let's now continue with the impacts of the pandemic.
Under condominium resale market, the territory that was the most affected was a downtown area, Ville Marie. It is the only district that saw a decrease in its sales volume with a 21% drop over the last 12 months. The district also saw an increase of 42% in its average number of listing. The number of months of inventory for the Marie went from six months in Q1 2020 to 10.7 months in Q1 '21. The district is now in a buyer's market.
Downtown Montreal saw a slight market deviation from 3.6 months to 4.3 months, but the territory is still deep in a seller's market. All suburbs territories experienced market tightening with listing decreases and increases in sales volume. What about the condominium market, the new condominium market? Montreal CMA has experienced a decrease of 37% in its annual sales volume based on our condo tool.
The downtown territory was the most affected with 58% sales decrease in 2020 versus 2019. North Shore saw a decrease of 48%, South Shore shows a 33% decrease. The Island Montreal and Laval were the less affected territories with sales decrease of 15% and 11%, respectively. Why was the downtown market more effective? Let's have a look at the downtown area data more precisely. As you can see in the following charts, the biggest effect of the pandemic or the sales volume were on Q2 2020 and Q4 2020 when the confinement was affected.
It is also as we saw earlier, the quarter in which there is normally the most project launch. Therefore, is it simply a lack of demand or is it something else? This chart shows the strong correlation between the number of new launch units and the quality sales. It does make sense as the downtown market sales strategy is mostly event-oriented. We have observed in the past that in Q2 and Q4s, where the project launch are concentrated that 65% of the quarterly sales come from projects in their launch phase.
Therefore, the low sales volume seems to be attributed to the lack of new supply on the market, especially when the number of units available for purchase is low. This is the case for downtown Montreal, which sales level over around 85% for the last year. The slowdown in activity did not impact considerably the inventory. There's been an increase of 14% of the run for inventory over a year. We're still very far from the kind of inventory seen in 2013 to 2015 though.
Now, for rental properties. We will first went through the vacancy rate as per the CMHC rental market report. The Montreal CMA showed an increase of 1.2% in the vacancy rate to show 2.7% which is still under the equilibrium level of 2%. Without surprise, downtown Montreal was the most effective district with a rise of 7.6% in a year to show 10.2% of vacancy in 2020. Downtown Montreal is back around an equilibrium level from 1.6% to 3.2%.
The suburbs territory is still much in demand. Laval is at 2% vacancy while north and south shore are around 1% of vacancy, which is close to the housing price level. This slide shows the vacancy rate for new delivered rental projects that are open for more than a year as for our Q1 2021 rental tool. Indeed, if you want to compare the vacancy versus the existing product, we have to take into consideration the stabilization process for new projects.
Therefore, the effective vacancy rate for stabilized products are 6% for downtown Montreal, as of Q1 2021. In Q2 2021, is actually around 10% due to renewal, 5% for the Island of Montreal excluding downtown, 5% for Laval, 10% for North Shore and 2% for South Shore. As for market rents, downtown Montreal shows average rent of 290 per square foot, $2.90 per square foot. Down in Montreal, excluding downtown Montreal shows average rent of $2.18 per square foot.
Montreal suburbs shows average rent of 185 per square foot and based on our rental tool, market rents globally either remain stable or experience slight growth in all territories. Instead of decreasing face rent, we're seeing promotion or incentive. It is most of the time, one to three months rent-free and it does make sense that the prices and rent can only go up in the new construction and here is why. Land values are increasing. The construction costs also increasing with the price of materials and the rarity of labor.
Fees and taxes are also going up with the addition of rent taxes. 20-20-20 regulation adopted by the city of Montreal. Therefore, the developers have two options, either raise the price and rents for the project to be economically feasible or accept a lower profit margin. It can be a mix of both but we can easily conclude which option makes the most sense for the developer. What is expected for the future? There are some major condominium projects that will be launched in 2021, [unintelligible 00:37:18].
Developers still have confidence in the downtown Montreal market, and I do as well. We saw the correlation between use supply and demand earlier. In my opinion, downtown remains the economy are the Montreal and the province of Quebec. The live-work-play-learn lifestyle of downtown Montreal is only on pause. Following the vaccination process, the sanitary measures should ease which will bring us back to a more normal context and the return of activity in downtown Montreal.
The return of students in some university is already scheduled for September. We expect a gradual market recovery during the year and a return to normal in 2022. Therefore, in 2021, in my opinion, there will be a better sales volume for new condominium than what we saw in 2020 since there will be some new supply. However, we will have to wait for 2022 to see similar sales volume to what we saw from 2017 to 2019.
We expect vacancy rate at downtown to return closer to the equilibrium level, as well with the return of students and downtown professionals. We're confident that the market will return to the growth we experienced before the pandemic. If you want to follow the residential and land markets in the future, our developers to expert tools are available online for our subscriber. If you have any questions on today's presentation, or you want to learn more about our expert services and tools, feel free to reach me. This concludes my part of the presentation. Thank you all for your attention and I will pass it on to Charles.
[00:39:08] Charles Trudel: Thank you very much, Maxime. Now, we will move into a round table to answer some of your question. As a reminder, if you have not had a chance to submit a question yet, and you would like to please submit using the chat and Q&A box found next to the deal screen. Let's get started. The first question that we have received is more toward Robert and Mike. The question is what are the post-pandemic long-term effects on Office towers and commercial real estate?
[00:39:50] Mike: You want to go first, Robert? Yes, go first Robert.
[00:39:53] Robert: Sure. I'll start off with a higher level of luck. We think that and very consistent with Maxime's comments. We think the cities are going to come back quite strongly, and Montreal included. It might be a 2022 and beyond story, but we think that there's going to be still a very strong demand for the core of the big cities.
For the office segments, specifically, what we're seeing right now is that tenants are retooling the way they're going to be using those offices. If we are working from home more post-COVID, maybe the footprint can be smaller than in the past but we're still going to be in there at least a couple of times per week. I suspect that will be more or less the norm for most industries going forward. In theory, that could put more space back onto the market, but we're seeing anecdotes that other industries like technology and things like that are picking up some of that office space and using this as an opportunity to move in and get into the downtown market.
Maybe rents are a little bit stagnant for a while. Maybe cap rates are a little bit higher, but I think that the big cities and the office spaces in those big cities are going to hold up very well once this pandemic is over, at least from a high level and look at where the job creation is. It's in industries like technology, professional services, science, finance, those are all industries that typically are based out of the core of the big cities in this country. I think longer-term that's where the growth is going to remain.
[00:41:32] Mike: I'll add some other perspective to that too. At the beginning of the pandemic, some of you may have seen Cushman & Wakefield's report early last summer, I think, where all their property managers and office owners, something like 40,000 data points of feedback. expected 95% of people to return to the office. The big variable was not really knowing how many days per week people were going to return to the office.
This last week I saw an updated report from Cushman & Wakefield that year-over-year occupancy in the US had dropped only 3%, but it was interesting because it wasn't really uniform. The US is at least as far as office is concerned, not so much housing market's very different, but office not so different. Suburban office tenants in that survey, they've been renewing almost at 100% levels across the US whereas larger downtown tenants are giving up space, averaging something close to 20%.
That ladder start we're seeing as well with subletting of larger tenant spaces in the downtown cores of Canada for office. Cushman & Wakefield felt it was a complex task trying to estimate office lease square foot per employee going forward as there's some competing forces like social distancing requires more space, but that will offset to some extent, but not all the impacts of working from home some of which are here to stay for some folks.
What if people coming in three days a week decide to come in all during Tuesday to Thursday, can you really reduce your space much if they're all showing up on the same days? You still need most of your current space for that. Based on this, BMO Economics and Robert's team have said that the impact on downtown office occupancy would be less than 20%.
I'd estimate something in the range of 10 to 20% depending on how this all washes out. No one really knows.
That's an educated guess. If you add suburban office with less impact, it feels more like the 10%, but again, I'm not going to say anyone has a perfect line of inside of that. We'll probably take a couple of years to sort out. My view is that that's a reset over the next couple of years and after which office demand would track their economic growth as it did before the pandemic.
Certainly, office isn't going away because work from home has its limitations. I noted JP Morgan CEO, Jamie Dimon in the last couple of weeks made a fairly strong statement. At least as far as financial sector goes in urban centers. About wanting to see more people in the office more often and not less just for both internal team, as well as clients synergies. Back to you, Charles.
[00:44:19] Charles: Thank you, Mike and Robert, for those interesting insight. The other question that we have received for the audience is for Maxime. Maxime, where do you see the cap rate going on different asset type in greater Montreal area in a year or two?
[00:44:39] Maxime: That is a very good question. Nobody has a crystal ball, but we can see the following trends. If we start with [unintelligible 00:44:47] family, we have to take two step backs to look at the long-term evolution, and we can realize that we are on the cap rate compression trend for the last 20 years. We're are now under 4% cap rates. The question remains, how further down could it get?
Is it possible that on a short term there will still be compression in the cap rate? It could be the case, especially for the suburbs where there's so much strong demand. For downtown Montreal, we foresee stability. We have to be cautious though because since the cap rates are correlated to the obligation and the policy interest rates, and we are seeing concerns about inflation from the Federal Reserve, the interest rates could gradually be increased and it could have a small impact on the cap rates.
I'm not saying for every point of percentage, there will be exactly the same impact on cap rates, but it's possible that there's going to be a small impact. For commercial, we have seen slight increase in the cap rates. However, for all commercials strips comprising essential services, they show stability and even slight compressions of cap rates. For office, we have seen stability and we project stability as well.
It is a wait-and-see context. As we're waiting for the workers to return to office, we can see slight increases in the future, but it's depending on the quality of the asset and the impact of the remote working and the availability of the office spaces. Industrial, I think the compression in cap rates that we saw for industrial properties this year will continue on the short term and stabilize on the midterm. This type of asset is really in demand especially for distribution centers in this area of e-commerce and data centers. Back to you, Charles.
[00:47:01] Charles: Thank you, Maxime. The other question that we have from the audience is maybe more toward Robert and Mike again. The question is, with the crazy residential market, people are bidding and sometimes overbidding on properties, hence, market prices are going crazy like we saw in other markets in Canada a few years ago. Where do we seem to be heading to and how should the government address the problem of affordability in Montreal?
[00:47:36] Robert: Well, I can start. We published a report on this couple of weeks ago or a couple of months ago now saying that the government probably needs to step in and do something because we are concerned that just very strong fundamental supply and demand conditions were starting to breed a lot more speculative activity and we saw demand actually really take off the chart since last fall. It doesn't sound like we're going to see too much done on this.
OSFI came out and tightened up their lending guidelines incrementally. I say incrementally because those lending guidelines are already relatively strict and I don't think the measure they recently announced taking the qualifying rate up another 20 or 30 basis points from an already high level is going to do too much. It's certainly not going to change the psychology in the market. We saw their federal budget, where Ottawa was rumored to be considering some measures like taxing principal residences or changing the capital gains inclusion rate, none of which we agreed with for the record. Thankfully, they did not do that.
The next plank is really monetary policy. At the end of the day, it's the Bank of Canada sitting on its hands and telling the market that we're not going to see rate hikes for a very long period of time. I think that is the biggest factor that breeds the speculation and that is where we're going to have to see policy change, be it with a very strong economy or with inflation that continues to run above their target. It's ultimately at the end of the day interest rates that can dictate when this market calms itself down.
In the past, we've seen some measures at the more local level to address speculation in non-resident investment in Vancouver and Ontario, it doesn't seem there's a big appetite for that. Then on the supply side, there's an argument to be made that even if we don't necessarily need more units overall, we need an increased elasticity, we need the response of supply to be faster. We need to take red tape off and get units to market faster.
The problem is that a lot of these things they take a long time to play out and it's not going to help us over the next six months or so. At the end of the day, I think it comes down to the Bank of Canada and whether or not they want to go ahead and move on rates or change the guidance even more.
[00:50:06] Mike: Thanks, Robert. That gives me a chance to say a couple more words on this topic. I'd say that as Robert noted in his recent publication offered 10 demand cooling suggestions to policymakers, and it really does illustrate the leavers available, but it also illustrates the limitations of those leavers because there's limits on monetary policy options and mortgage rule tightening.
We're seeing evidence of low rise, residential reaching affordability limits that would shift that demand surge back towards condo and away from detached, just because of the price movements in detach are leading us to believe that at some point FOMO or fear of missing out is going to give away to FOOP, fear of overpaying. We certainly saw that following the corrections in Vancouver and Toronto in 2016 and 2017 and we fully expect that at some point that's going to happen with these surges that we're seeing now across Canada.
We do think that that's happening already in Toronto. For example, there is that shift is already underway and being evidenced in some of the data that I'm seeing here. I would expect that to happen in Montreal as well. As to the question, how government should address affordability. I'm really glad that this question was asked. It's the reason I joined our local billboard where I live to be a strong advocate for a national housing policy that guides provincial and city housing supply, strategy and policy.
In short, we need to improve residential density as of right to avoid long drawn-out appeals and delays. That zoning should be really favored towards logically suitable locations like transit corridors and nodes, and specifically something like a subway location or a rail station. Those shouldn't be areas where we're debating about density much. We should increase that appropriately because that's what people want to live to access transit to employment. We should also try and do something about the approval processes.
It used to be that you could get a project, a larger scale project approved in three years. These days in some of the major cities, it can be five years or even more in some cases for a new condo project. Clearly, this is the trend of demand. To have such a deterioration in the actual, as Robert put it elasticity of supply linked to these two factors of density, being slow to be released and approval timeframes being slower than they should be. A national provincial city coordinated housing strategy to fix those things probably is in order.
This does require those standards and it would help mitigate the strong demand that really we're creating by design. With a great immigration policy that's driving great economic growth, we just need to come up with the right supply policies. Back over to you, Charles.
[00:53:08] Charles: Hey, thank you, Mike and Robert. I don't think we have more questions from the audience as we speak. On that, thank you again for joining us. We hope that you enjoyed today's session and I want to thank you again for taking the time of your busy day to spend the time with us today. On behalf of BMO, we want to know that we are taking of you, your families and your businesses. We are here to help. We have been through uncertain times over our 200-year history and we have a strong capital position and we are well prepared to serve our client.
We hope that BMO's commitment to the real estate industry and our commitment to you, our client has been discernible. As a reminder, today's call was recorded and is available for playback. You will receive detail on how to access that in an email later this week. Additionally, if you submitted a question that wasn't answer, we will be in touch to provide additional information. This conclude our call today. Thank you. Be safe. Take care. [foreign language].
Mike Beg
Head, Real Estate Finance
Mike Beg as Head, Real Estate Finance, Canada is responsible for management of BMO’s Commercial Real Estate Finance group and its client relationships across …(..)
View Full Profile >When looking at the last 18 months, the commercial real estate industry has fared far better than anyone expected. The industrial and multifamily sectors weren’t hit as hard as retail and office, but we’re optimistic that the sectors impacted the most will eventually find a new balance. The recent BMO Real Estate Forum featured a series of presentations and discussions about the outlook for Quebec.
Robert Kavcic, Director and Senior Economist at BMO, provided a high-level economic update.
Maxime Hamel, Director, Real Estate and Land Development at Altus Group, discussed the state of the residential market and the impacts of the current crisis.
Charles Trudel, BMO’s Regional Market Leader for Quebec, moderated a roundtable discussion covering key topics, including industry challenges.
Watch the video above for the full event.
This is part 3
of a
3-part series on
BMO Real Estate Forum
PART 1
BMO Real Estate Forum: National Outlook
Mike Beg | March 22, 2021 Commercial Real Estate
The past year has been a rollercoaster ride like no other, but the commercial real estate industry staged a dramatic recovery beginning last summer. …
PART 2
BMO Real Estate Forum: Atlantic Outlook
Mike Beg | May 11, 2021 Commercial Real Estate
This past year has been one for the books, and to say the commercial real estate industry has done better than expected since last summer would be an…
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