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Photo: Bernard Spragg. NZ/Flickr

Rising interest rates “could be the number one risk” to Canada’s commercial real estate segment moving forward, TD Economics says in a new report.

“Developments of the past several weeks have highlighted what could be the number one risk facing Canada’s [commercial real estate] outlook over the coming years — the possibility of higher interest rates,” the TD Bank’s research department said in its Canadian Commercial Real Estate Outlook, published today.

TD Economics noted Canadian 10-year bond yields and US Treasuries have been on the upswing since November 2016, when Donald Trump won the US presidential election.

TD’s economists aren’t the first to suggest higher interest rates may be on the rise due to President Trump’s actions. Late last year, BMO Senior Economist Robert Kavcic said US tax cuts as well as protectionist policies, such as higher tariffs, may cause more rapid inflation stateside, leading to higher interest rates north of the border.

Commercial property investors’ returns already took a hit from rising interest rates last year as real estate prices soared while rents remained stable. At the time, most commercial segments “had enough cushion to absorb” the effects of rising interest rates.

But now investors, especially those in Toronto and Vancouver, will feel the impact of trimmer margins if rates continue to push higher. “Spreads in the office sector are now estimated to be below historical averages,” says TD Economics.

There are other possible headwinds on the horizon. “A housing slowdown will ultimately spill over to demand for office and retail space through reduced employment and household spending,” TD Economics adds.

“Housing markets are likely to lose steam over the next several quarters on the back of recent increases in borrowing rates and tightening in federal mortgage regulations,” the bank adds.

So far, however, Canada’s hottest housing markets have bolstered investor interest in commercial real estate assets.

For instance, real estate jobs in Toronto have contributed to demand for office space there. And BC’s foreign-buyer tax, which applies to residential properties anywhere in Metro Vancouver, compelled non-resident investors to put their money elsewhere.

Non-residents were responsible for about 30 per cent of all Canadian commercial real estate investment in 2016, far above the 5 per cent historical norm, says TD Economics, citing recent CBRE figures. A third of that foreign investment was Vancouver bound.

“Anecdotal evidence suggests that the… tax… encouraged foreign investors to shift their focus from housing to commercial real estate,” says TD Economics.

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