Economic Update: $50 Oil

With the slide in WTI and Brent crude prices since September 2014, there are many anxious people out there reading headlines and consulting with their peers about what all this means and what is coming next. For Alberta, it is the lifeline that provides the economic foundation for our quality of life and it is difficult to try and reason that your business or job is not related (directly or indirectly) to the health of the industry.  The wealth that is provided comes from two sources: conventional oil production and the oil sands. The former has been well established for multiple decades and the companies that participate in this form are global industry leaders who have laid extensive infrastructure across the province. The latter is a growing behemoth that is seeing technology, money, jobs and resources allocated to it at a speed and scale that is difficult to put into perspective and is epitomized from the numbers coming out of Fort McMurray. So you can understand that when this commodity loses 50% of its value in 6 months it gets people talking. From the various anecdotal evidence gathered over this period, this is the author’s humble attempt to provide a crystal ball and make sense of it all.

ATB Financial just released their second quarter economic outlook for Alberta (click here for the full report), they and almost every other analyst/economist are predicting either very slow growth (0.8% real GDP growth for 2015 in ATB’s report) or minor contraction. This comes from a previous estimate of close to 2.0% growth  in real GDP before oil prices dipped to their current rates. The fallout from low oil has started to show; all you need to do is drive around Edgar Industrial Park in Red Deer and the decrease in traffic is quite noticeable. As was expected, spring break-up is bringing in layoffs in the oil sector and the resulting impact will trickle down into other sectors. The papers are quite keen to print as much as they can when any statistics are released regarding home prices and sales, especially in Calgary. However, it is not all doom and gloom. The closing paragraph in ATB’s report sums it up:

Despite the severe challenges in the energy sector, many other industries in the province face much brighter prospects in 2015. Agriculture, forestry and tourism all benefit from lower fuel prices. The lower Canadian dollar will also help commodity exporters and tourism operators.

Impact on Industrial Real Estate

So what does this mean for commercial real estate? First off, activity has slowed, especially in the industrial sector, there is no questioning that. But the reason is mostly because nobody is quite sure what is going to happen. Not too many people are willing to go out on a limb and make a major decision such as purchasing or leasing a large facility until there is some confidence back in the economy and oil prices. This is not 2009 all over again, companies and individuals are not leveraged like they were back then and we are not suffering from a debt crisis; money is still available and companies have far better balance sheets then they did. Another reason why activity has slowed is because everybody is expecting a pullback in pricing and lease rates. If you believe that a property you are interested in is going to come down in price, why wouldn’t you wait?

This situation has created an environment where buyers, sellers, landlord, and tenants do not have aligned expectations on both price and value. The buyers and tenants are expecting deals, they obviously do not want to pay what the going rate was pre-2015. Sellers and landlords are reluctant to lower rates or prices, and why should they? Interest rates are the lowest they have ever been meaning if cash is ever needed a quick refinance can solve that problem. Yields and cap rates are also linked to this so valuations shouldn’t change drastically either. Landlords and sellers are not in the business of losing money, they are trying to maximize their gains just like the tenants and buyers. Of course there will be some companies/individuals who have come into hardship and there will be the odd deal but there are so many buyers and tenants out there looking for this that I do not expect prices to drop significantly. A metaphor I like to use is that the vultures are circling and waiting for the first victim to appear. The problem is there are a lot of vultures circling right now.

Impact on Other Sectors

In the previous paragraphs, I have been broadly speaking about the industrial market and to some extent the investment market. The other sectors are still moving along like it is business as usual, most notably the retail market. Retail lease rates have been rising over the past couple of years and they have most likely peaked but this is mainly due to the fact that the demand for higher quality retail space has outstripped the demand, not because of the state of the economy. There has been a push to build a significant amount of retail space in Red Deer over the past few years (such as Clearview Market Square) and many other projects are in the pipeline in Red Deer and Gasoline Alley. Soon the supply will have caught up to the demand and retail lease rates shouldn’t be going much higher.

Land values do not appear to be dropping anytime soon either. The demand for commercial land far exceeds the supply and there is a significant amount of international and local players out there looking for this. Gasoline Alley continues to be built out and prices out there have been steadily rising. Industrial land has stabilized but I don’t expect it to lose ground anytime soon, certainly not like in 2009.

Conclusion

In conclusion, contrary to what the newspapers will have you believe, we are not in a state of panic. It is a waiting game to see where things go on a global, national and regional scale.  Until we have a prolonged period of the current situation, the sellers and landlords will be reluctant to lower prices. Likewise, until there is some indication that the economy is picking up or there is a significant drop in prices, tenants and buyers will be reluctant to put forward any cash. Everyone is trying to time the bottom and nobody likes buying before that point. I often look at charts (as I’m sure a lot of people do also) and think why I didn’t buy more back in 2009. This might just be an appropriate time to test the waters if you are a buyer or tenant.

~Brett Salomons