Multifamily outlook 2025: More capital ready to deploy as cap rates soften

• What Institutional investors are expected to be more active in the multifamily market
• Why Compressing cap rates, stabilized financing and for-sale distressed sites all present opportunities
• What next Interest in rental development is expected to remain high as the condominium market continues to deflate

Canada’s multifamily real estate market saw an onslaught of changes in 2024. Private investor activity surged as institutional investors took a back seat, interest in rental development soared to new highs and climbing rental rates came to a halt, even dropping in some markets.

As institutional investors start to reconsider their options with the hope of financing stabilizing in the immediate future, here’s what experts say to expect from the multifamily market in 2025.

Plenty of rental interest, but a challenging pivot

Widespread interest in rental development disappeared in Canada several decades ago, but 2024 saw the pendulum come swinging back.

More investors and developers were inclined to focus on rental opportunities as tax cuts on developing rental units took effect, rental rates remained strong, and the condo market took a nosedive.

Some are even changing already-in-the-works condo developments to have a rental tenure.

“I’m actually encouraged by that,” said Glen Hirsh, chief operating officer at Starlight Investments. “I believe it’s a positive trend because it means that you have many players at the table, particularly condo developers, that are recognizing this urgent need for every type of housing across the country.”

Though interest is high, some question how many condo developers will actually take the plunge into rental development.

“There are a lot of developers talking about pivoting to rental, but I think the reality is the economics are relatively light if you’re not vertically integrated,” said Adrian Rocca, chief executive at Fitzrovia. “It’s a really specialized asset class.”

Pivoting as a residential condo developer isn’t easy, Rocca added. Features like smaller unit sizes and cheaper finishings that are often found in condo developments simply don’t work for rental projects.

“If the building system wasn’t chosen or inspected correctly, or the right flooring or doors installed, you’re going to see wear and tear pretty quickly in your building. That’s now your liability,” Rocca said.

Lower immigration leading to less demand

Short-term softening in rental demand is expected as Canada pumps the brakes on immigration and a small wave of recently completed condo buildings adds investor-owned units to the rental market.

“I think that will be reflected in where we see rental rates for the smaller suites,” Hirsh said. “We are anticipating that the larger suites, being the two bedrooms, the three bedrooms, will stay quite stable.”

Tenant turnover remained relatively low earlier in the year, limiting the ability of operators with rent-controlled units to increase prices. The recent influx in inventory, however short-lived it may be, offers renters more options, and turnover is starting to creep up in certain market segments.

“Increased turnover is happening at the moment because there’s lots of choice with the significant condo inventory that’s hitting the market,” Rocca said. “Maybe you’re seeing turnover on older product go down. On newer product, we are actually seeing it increase. That said, we believe it will be short-lived given the minimal new starts over the last three years.”

Until that future supply deficit is felt, rent prices are expected to remain relatively flat.

“I don’t expect we’ll see the same strength in rental growth in 2025 as we’ve seen in previous years,” Hirsh said. “But at some point, what’s going to happen is the supply that’s coming online is going to abate as well.

Even slower development

With the low levels of development seen in recent years, it’s hard to imagine it dropping any further. But after years of projects being put on hold as financial viability came into question, that’s precisely what brokers and developers are bracing for.

Hirsh notes that Starlight is in the fortunate position of pursuing infill developments, allowing the company to mitigate land costs.

“That is a real competitive advantage for Starlight,” Hirsh said. “We also see an increase in construction costs like everybody does, but it helps that we’re focused on developing underutilized land that already exists in our portfolio.”

Unsurprisingly, interest in development sites has waned, posing a challenge for brokers tasked with offloading these assets.

“Rental rates are coming down, interest rates are still higher and something’s got to give in the pro forma and that’s got to be the land value,” said Sim Waraich, a transaction manager at CBRE’s national apartment group.

“Pricing isn’t where it used to be back in 2021 or 2022, so navigating those bid-ask spreads has been challenging, but there are opportunities out there that make sense from a developer standpoint.”

Rocca agreed that there are opportunities to be had as a developer, namely the ability to be choosier about what land deals to pursue.

“Land prices are off 50% to 60%, so we think there’s an attractive opportunity to be selective,” Rocca said. “We want to make sure our margins are protected, so we’re being really thoughtful around the types of deals that we look at. In 2024, we underwrote maybe 100 deals and transacted on one.”

The number of multifamily development sites being placed under receivership grew exponentially in 2024, providing even more options to buyers at typically more attractive price points. Rocca notes, however, that the sites coming to market thus far have not been in central, desirable locations.

“Up and down the mass transit lines in downtown or midtown Toronto is really our core focus, but we’re not seeing receiverships in those locations yet,” Rocca said. “We think that’ll eventually come to fruition in 2025.”

Expect cap rate compression

Capitalization rates across various asset classes are expected to compress next year, and the multifamily market is no exception.

“Cap rates are peaking [across the board],” Waraich said. “We jumped on a call with all our multifamily specialists across the country, and what they’re seeing across the board in Halifax and Toronto and Calgary and Edmonton, we are expecting that in 2025 cap rates are going to start to compress again.

“I’m not saying that they’re going to come down by 50 basis points or 1 point, but the expectation is they will start to compress.”

Rocca agreed that cap rates will continue to drop, noting that with bond yields trending downward, the overall cost of capital is likely to come down.

“I think with confidence we will see 3.5% cap rates in 2025 for Class-A product in Toronto,” he said.

More activity as financing stabilizes

High financing costs in recent year sent investors and private capital groups to the sidelines, hoping to weather the storm until conditions improved. But the series of rate cuts seen in 2024 offered some market optimism that is expected to carry into 2025.

“As financing rates start to stabilize in 2025, I think we are going to start to see a little more deal activity, hence why a lot of this sideline capital has been looking in 2024 and the feeling that we get is that they’re looking to deploy in 2025,” Waraich said.

“Groups are circling back on listings that have been on the market and they’re getting their head back into it and we have seen some deals starting to close.”

Waraich pointed to the metropolitan Vancouver and Greater Victoria markets as examples of successes amid falling interest rates. Once all deals are totaled, both are on track to see their 2024 deal volume exceed the previous year.

Rocca has similarly observed more institutional investors wanting to jump back into the multifamily market, but with a discerning eye.

“I believe there’ll be some new entrants in the market on the capital side, which is positive, both in terms of income-producing and ground-up development,” Rocca said. “But the theme is going to be economic viability.”