COVID’s impact on commercial real estate

While Canada’s commercial real estate market was challenged by the global pandemic’s emergence in early 2020, the picture looks a lot brighter this year. COVID has actually stimulated the commercial market both internationally and nationally through strong market fundamentals and robust government responses to the pandemic. Extremely low interest and mortgage rates have contributed to increasing the value of every type of property. The Canadian government has rolled out billions in financial aid to support workers and businesses and to kick-start the economy. Investors have always looked to hard assets like real estate in times of uncertainty, and the commercial real estate market in the Greater Toronto and Hamilton Area represents an attractive opportunity. Nevertheless, uncertainty continues regarding the winners and losers who will emerge this year.

Here is a topline summary of five key commercial real estate markets in Toronto and the GTHA from an investment perspective during the COVID period and beyond.

THE COMMERCIAL REAL ESTATE MARKET IN TORONTO AND THE GTHA

1) Industrial sectors are forecasted to increase

According to Fiera Real Estate, an international investment management company,  Canada’s industrial markets, already benefiting from strong fundamentals before the pandemic, have demonstrated extraordinary resilience to the current pandemic and economic downturn; and are expected to continue to do so throughout 2021. With many institutional investors experiencing pent-up capital deployment, it is likely that the industrial sector will receive the dominant share of investment volumes. Capital flows will likely continue to push valuations higher for warehouse and distribution centres, as well as industrial land for future development. Toronto recorded 1.1% vacancy at year-end 2020 and remains among the tightest industrial markets in North America. Industrial rents stabilized or continued to rise across Canada’s metro areas through 2020 and the consensus is that rents will rise through 2021. New industrial construction deliveries are forecasted to increase further in 2021 in major Canadian cities, with completions led by Toronto. It remains to be seen whether this influx of new supply will provide relief to these markets, projected to continue to have low single-digit industrial vacancy rates.

2) Downtown office vacancy rates

Fiera Real Estate points out that strong demand from tech tenants has benefitted major Canadian cities, especially Toronto, which has one of the six lowest downtown office vacancy rates in North America. This trend will likely remain in place in the long-term, possibly creating an investment opportunity. On the other hand, global real estate services firm JLL notes that there has been a troubling rise of overall vacancy rates in 2020 and 2021 as employers adapt to more flexible work-from-home (WFH) options for their office employees. Their staff have begun working from home in droves, demonstrating that flexible work is feasible, practical and increasingly desirable.

Advancements in technology and digitization have broadened how, when and where work happens. No one knows whether this “new normal” is short-term trend or will become a permanent structural change. According to the commercial real estate firm Avison Young, after the pandemic ends, portfolio strategies may start to shift from a headquarters to a hub and spoke mindset. The “hub” would be a central location where some employees work full-time, facilitating branding, culture creation, internal collaboration and engagement. The “spoke” would include flexible workspaces and partial or full-time WFH. The big question that will impact demand is whether tenants will require more, less, or the same amount of office space.

3) Retailers are either suffering or thriving during the COVID-19 pandemic

Avison Young reports that, of all commercial real estate sectors, retail is the one most impacted by the COVID-19 pandemic. This sector, which was already undergoing a rapid evolution due to changing consumer habits, will face an acceleration of those trends in 2021. Retailers across the country faced a variety of pandemic-related impacts, including mandatory closures, reduced operating hours and minimal foot traffic. Since local economies initiated phased re-openings, government financial aid and rent relief from landlords have helped many retailers remain in operation, but these measures will not be able to continue indefinitely or save every business. On the other hand, landlords do not necessarily want vacancies in their retail assets at a time when few new tenants are in the market for space – but responses vary by retailer and location as landlords assess their portfolios strategically. Enclosed malls and street-front retail continue to suffer, but strip centres anchored by food retailers and other essential services are thriving. The pandemic has resulted in some long-term changes, including encouraging Canadians (particularly in older demographics) to take up e-commerce in greater numbers. In response, many retailers and restaurants have increased their online presence and capabilities, adding online ordering and delivery options for consumers. As a result, underutilized retail and restaurant spaces are increasingly being used as “dark stores” to fulfil online orders and “ghost kitchens” to prepare food exclusively for delivery – alternative uses that may gain prominence in coming years.

4) Multifamily housing today can be a great commercial real estate investment

Although multifamily housing provides residences for tenants, they are still considered commercial property. A multifamily “house” is typically known as an apartment, townhome or condominium. With population and demand for housing constantly on the rise, multifamily housing can be a great commercial real estate investment. The long-term prospects for this property type appear to be strong as lower interest rates may continue to fuel higher Canadian home prices, leaving some with no choice but to rent, especially for newcomers. In addition, at the end of November 2020, the Canadian Real Estate Association (“CREA”) reported 2.4 months of nationwide residential inventory, the lowest measure on record, highlighting the current demand for residential products.

5) Consider storage units as a commercial real estate investment

Storage units may not sound like the most exciting investment. However, there is definitely money in the industry. When considering a storage facility as your investment, be sure to check local competition and location.  Most people don’t want to travel far to store/retrieve their items.

TO INVEST IN COMMERCIAL REAL ESTATE, OR NOT TO… THAT IS THE QUESTION

The Pro’s

The rules for becoming a landlord in Canada are much less strict for commercial than residential. With residential, there is a standardized lease, but if you want to evict a tenant you have to go through a tribunal, and there are many forms to fill out. That’s not the case with commercial. As a commercial property owner, you can use whatever commercial lease you want in Ontario; and you have more latitude regarding tenant management. If you know you’re going to run your own business out of the commercial property, it’s not just an investment. You’re the one who’s going to buy it. You pay higher interest rates for a mortgage on a commercial vs. a residential property. But the real estate appreciation these days on a commercial property, as with a residential property, is very high.

The Con’s

With COVID, if you have a commercial tenant today, you’re relying on their dime to pay your mortgage, taxes, and everything else. If COVID lockdowns continue, will they be able to continue their business and be there tomorrow? For example, COVID has destroyed 10K restaurants that are not going to reopen in the GTHA or throughout the province… With residential, you don’t have to worry about that. And if you have a tenant in an industry hard hit by COVID, like the restaurant industry, your property is set up for a restaurant. It’s going to require a major investment to change the property from a restaurant to one set up for another business, say, a retail clothing store. But retail clothing stores aren’t doing so well, either. In this industry, online ordering has jumped phenomenally. The brick and mortar stores we’re all used to, even the big box stores, are not as required any more. With online ordering, you can return something online. When shopping, you can use an app on your phone to try on clothes, or even eyeglasses, to see how you look in them… no need to go into the store.

BOTTOM LINE

The commercial tenants you could attract today might not be around tomorrow, depending on what COVID does and doesn’t do. Howard Nightingale Professional Corporation is here to help you make the right decisions about commercial real estate investment. We have extensive knowledge of all aspects of commercial real estate transactions and have represented numerous clients in the corporate and retail sectors. We can provide you with the guidance and practical legal advice you need to make the right decisions regarding commercial property acquisition and divestiture in Toronto and the GTHA. Our systemic approach ensures that your transaction is successfully and efficiently carried through to completion. To book a free initial consultation, please phone our Toronto office at 416-663-4423 or toll free at 1-877- 224-8225. We look forward to helping you sort through the details of today’s commercial real estate investment market and make smart decisions.