Canadian commercial real estate owners and managers have plenty of potential pain points these days as the pandemic continues, but an Altus Group survey indicates they are increasingly concerned about office leasing rates over the near and mid terms.
“Landlords are worried about near-term lease rollover,” said Colin Johnston, president of research, valuation and advisory at Altus Group, in an interview with RENX. “So if you’ve got a great building and you don’t have any lease expiries coming up in the next few years, you’re feeling pretty good.
“But if you’ve got some near-term expiries, couple that with this work-from-home phenomenon (and) there’s some questions as to how strong the rental rate market is going to be going forward.”
Layoffs and rising unemployment, small business bankruptcies, more stringent financing conditions and a decline in consumer confidence were all identified by respondents as factors which could significantly impact the commercial real estate market in Canada.
Work from home: “This is working”
However, the Altus Key Assumptions Survey of 115 Canadian CRE executives from pension funds and life companies, publicly traded corporations (REITs), private companies and brokerages highlighted another, more concerning trend in the office sector – the long-term adoption of remote working.
The June survey, following on an initial survey conducted in April, also found concerns over recession, government debt, oil prices (a particularly strong concern in Alberta) and bankruptcies have intensified.
The surveys asked the executives which risks might have the most lasting impacts on the commercial real estate market.
“Layoffs and rising unemployment and small business bankruptcies have consistently been there for office,” said Johnston..
“But what happened with this June survey, a bunch of people said ‘Hey you forgot something else. Forget financing. Let’s talk about this whole-work-from home phenomena and how that is going to lead to a significant change’.”
When the initial survey was taken, the focus was on getting people out of the office and setting them up to maintain productivity from home work environments. Two months later, that has shifted.
“Now office landlords are saying ‘Hhey people are being pretty productive. This is working’ ,” Johnston observed. “This work from home is really, really significant going forward.”
Factors affecting office leasing
That is leading more executives to worry about rent sustainability and office leasing going forward.
“These trends are here to stay,” added Johnston. “The longer it goes on, I think we’re going to fundamentally change and if you ask me if we’re going to have a hybrid working (environment), I think that’s what’s going to happen.
“You’re going to have a bunch of people either on flex hours, because they can’t commute in on the GO Train or the subway, and we’re going to have flex days in the office as well.”
In the survey, Johnston said several respondents suggested the suburban office market could become popular again. Perhaps in the major markets because of COVID, fewer employees will want to use the public transit systems to head downtown.
Johnston said managing cash flows and balance sheets is also a prime consideration.
“When we asked the question to landlords if they are going to defer their cap-ex or reduce the scope of their capital expenditures on their office buildings, that’s growing as well,” he said.
“Naturally people are trying to protect their balance sheets, so they’re going to defer a little bit there and not spend as much on their buildings because they’re going to have to spend a bunch on cleaning their buildings.”
Strong office market pre-COVID
Johnston said owners of downtown office space in major urban markets may not be experiencing major rent collection issues, but with fewer people in the buildings parking revenue is certainly impacted and the health of food court tenants and other services will be severely challenged.
“In Canada, we had a very, very strong office market going into this. We had historically low vacancy rates, we had increasing rental rates,” Johnston noted. “We were in a good position.
“I don’t in any way want to say that the office market is going to crater, because it’s not, but I do think this work from home is going to create some uncertainty and it’s going to play out over the next six to 18 months.
“After layoffs and unemployment and small business bankruptcies, I think work from home is right up there.”
Survey respondents said over the longer term, a rise in vacancy from bankruptcies and rationalization of space will also exert downward pressure on net effective rents and increase the risk of bad debts.
Cash flow may be affected by longer periods of absorption for some premises, in addition to loss of base rent, loss of recovery from operating costs and other revenues.