A sector-by-sector analysis of Canadian CRE: Altus

IMAGE: Ray Wong, vice-president of data operations for Altus Group’s Data Solutions division. (Courtesy Altus)

Ray Wong, vice-president of data operations for Altus Group’s Data Solutions division. (Courtesy Altus)

Accelerated evolution in all commercial real estate sectors, particularly in technology and work-from-home strategies, was a key theme as Altus Group offered a sector-by-sector breakdown on the impact of COVID-19.

“This pandemic has forced us to implement a lot of the changes that were sort of on the drawing board and that were discussed,” said Altus Group Data Solutions vice-president of data operations Ray Wong, who hosted the Aug. 12 webinar.

Market fundamentals remain OK and investors are coming back to the marketplace, according to Wong. He is cautiously optimistic about the next six to nine months, but said a major recovery won’t happen until mid-2021.

“There will be a very slow and gradual recovery, depending on what happens with the pandemic.”

Office

There’s a growing emphasis on employee health and wellness and more flexible work options in the office sector. While workspace per employee had been shrinking over the past 20 years, Wong said that trend was already being reversed to increase productivity even before COVID-19 made it a necessity for safety reasons.

Wong said the average square feet per office employee across Canada is about 120, and ranges from 70 to 135. He noted the lower number is more prevalent in technology firms; the higher number is more common in Alberta.

Office vacancy rates are creeping up marginally nationally, though less so in Montreal and Ottawa, which had very small decreases. The national vacancy rate went from 9.5 per cent in Q1 2020 to 9.6 per cent in Q2.

Calgary’s downtown class-A office vacancy rate is close to 30 per cent, the highest among major Canadian cities.

More than 20 million square feet of office space was under construction nationally in the second quarter and 30 per cent of it was available. Toronto accounted for about half that activity, but close to 80 per cent of its space was pre-leased.

With many tenants moving to new office spaces, Wong said there’s some concern about backfilling what they’re leaving.

Office sublet availability, as a percentage of available space nationally in Q2, was 15.7 per cent, up from 14.4 per cent in both Q1 and year-over-year.

Vancouver had the highest rate of sublet availability as a percentage of available space of any Canadian major city at 31.9 per cent.

The increases are especially prevalent in downtown areas.

Wong believes increased working from home will also lead to more of a shift from downtown offices to the suburbs, where there are fewer elevator safety and other pandemic-related concerns in smaller, less vertical buildings.

Until vacancy rates exceed six to seven per cent and sublets represent 40 to 50 per cent of the availability rate, Wong said rents shouldn’t soften much.

“I think we’re going to see a lot more sublet space come on over the next three to six months as people reassess their space and start the implementation.”

Retail

This was already going to be a make it or break it year for some retailers, and COVID-19 has only introduced new challenges. While national retail sales were up in May over April, they were still down from February.

E-commerce spending is up 110 per cent year-over-year in Canada. Wong believes this isn’t a short-term pandemic-related trend and that e-commerce growth will continue.

“It’s become more of a necessity than a choice,” he said.

Some retailers have declared bankruptcy and more could follow, while many restaurants are on the brink of closing because they can’t operate at full capacity.

Retail market rents are falling and that’s expected to continue. While some shopping centres will succeed, others will be forced to close based on a lack of traffic and loss of income.

Some retail properties put on the market over the past couple of years didn’t meet the price expectations of vendors, and Wong said that could continue. Redevelopment and intensification opportunities may improve the prospects for some properties, however.

On the bright side, Walmart Canada will invest $3.5 billion in its operations over the next five years. It will renovate 150 stores and upgrade point-of-sale technology, online ordering and distribution networks. Walmart’s online grocery order volumes have doubled or tripled in some regions.

Walmart will build new distribution centres in Vaughan, Ont., and Surrey, B.C., while renovating its Cornwall, Ont. facility.

Industrial

“I love industrial and I don’t think you can go wrong with industrial, especially along major highways,” said Wong. “Even though it’s expensive, it has safe and stable returns.”

The national industrial space availability rate was 3.1 per cent in Q2 2020, up from 2.9 per cent in the first quarter and 2.8 per cent a year earlier. Wong said the small increase in the availability rate over the past few months is reflective of small bay facilities, not larger warehouses.

More than 20 million square feet of industrial space was under construction in the second quarter.

Of that space, 34.4 per cent was available for leasing, largely due to Toronto’s 39.4 per cent and Calgary’s 77.9 per cent availability rates thanks to speculative construction.

There’s little spec industrial construction in most Canadian markets and space is often leased before building begins. There’s no reason to expect large increases in industrial availability rates, especially with the growing shift to e-commerce, said Wong.

“The change we’re seeing from just-in-time delivery to adding a little more inventory just means that warehouse distribution space is big and it’s going to get bigger as a requirement to service clients and consumers.”

Average rental rates are expected to increase for newer properties and even small-bay industrial buildings shouldn’t be hit too hard with lower rents.

Wong doesn’t envision large warehouse distribution moving into smaller markets on a large scale – even though land is cheaper – because people want fast delivery. Cities must also have a sufficient labour market to meet the needs of large warehouses, though newer buildings with more technology can help alleviate that.

While London, Ont., is affordable and attractive because of its easy access to Highway 401, it’s still a 2.5-hour drive from Toronto, which Wong said is a drawback.

Hotel

“When we went through the financial crisis, hotels repositioned themselves and created a lot of efficiencies,” said Wong. “They’re able to operate at lower occupancy levels, but probably not at where we’re seeing occupancy levels today.”

Wong believes some hotels will fail due to the impact of COVID-19, but pointed out some are looking at creative solutions to help them through the crisis — including renting rooms for the day to workers who haven’t yet returned to the office and want a break from working at home.

“Hotels are going to struggle for a little while longer, like airlines. We might see some conversions over to housing, but there’s a big cost to that. What we saw after the financial crisis was that some offices were converted to hotels, and there was a big cost in that.”

Capital markets

COVID-19 hasn’t greatly impacted most companies’ investment plans, according to Wong. Total commercial real estate investment activity was down 20 per cent through six months to $20 billion, compared to a year earlier. Wong had anticipated a drop of 30 to 40 per cent.

“Investors are returning to the market and kicking tires and looking at their assets. We anticipate for the second half of this year that there will be a continued uptick. We’re probably not going to hit the same levels as last year, but it’s better than we anticipated.”

Bid-ask gap expectations are expected to slow the market as investors seek discounts, especially in the retail sector.

Forty-four per cent of enclosed retail tenants and 37 per cent of outdoor retail tenants have been delinquent with rents. That compares with five per cent for office, six per cent for multifamily, five per cent for large-bay industrial and 11 per cent for small-bay industrial tenants.



Steve is a veteran writer, reporter, editor and communications specialist whose work has appeared in a wide variety of print and online outlets. He’s the author of the book Hot…

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Steve is a veteran writer, reporter, editor and communications specialist whose work has appeared in a wide variety of print and online outlets. He’s the author of the book Hot…

Read more




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