Industrial, multifamily continue to lead commercial real estate as pandemic impacts economy for foreseeable future
Commercial real estate investors should expect the pandemic’s impact – already accelerating trends in e-commerce and remote work – to continue to affect all segments into 2022 and beyond.
“‘Sheds and beds’ is the best way describe the market in 2021,” says Scott Addison, president of brokerage services at Colliers Canada.
In the months ahead and even next few years, warehouse – “sheds” – demand will still drive industrial, he adds, fueled by population growth and e-commerce. Some return of manufacturing to Canada will also be a minor factor.
With the demand for industrial space outpacing supply, the expectation is for vacancy rates to remain low, rent growth to stay strong and land prices to keep rising for years to come.
Major markets such as Toronto, Vancouver and Montreal, are all seeing record-low industrial vacancy rates, all at 1 per cent or below.
Additionally, “beds” – the multifamily rental segment – has been “a very hot segment” for institutional investors and will remain so as immigration expands beyond prepandemic levels, Addison says.
Yet retail and office, under siege during COVID-19, should not be written off, says Peter Cuthbert, partner with Colliers’ strategy and consulting arm.
“Office and retail are not dead, contrary to some broader sentiment,” he says. “While functionally obsolete assets will have to be repurposed or redeveloped, modern, well-located office and retail will continue to play a significant role in the economy.
“No one should underestimate the power of a major shopping centre as a community hub and the act of shopping as a leisure activity, nor the value of face-to-face interaction as a driver of ideation and a key element in intellectual, office-oriented businesses.”
High-quality retail and office will remain strong assets. “Functionally and technologically obsolete assets are often in primary locations next to major long-term infrastructure. While the built form of the asset may not be fit for purpose, the potential value of the land for other uses may equal, or in some cases, exceed that of the existing use.”
There’s also an evolutionary shift in use of space, says Cuthbert. “Economic activity is being dispersed across a broader geographic grid, with the trend being driven by remote working and direct-to-consumer goods delivery.”
Residential and industrial logistics have benefited, he explains, while office and retail have been suffering to some degree.
“In effect, the supply chain is now operating under a different set of roofs.”
In the immediate term, pandemic conditions have stung the office sector, some regions more than others.
Vacancies were up from 2019 through to 2021 nationally, with Calgary and Edmonton approaching 28.6 and 19.4 per cent respectively in Q3. By comparison, Toronto office vacancy ranged from about 5 to just under 9 per cent, Colliers data show.
Downtown office space remains highly prized in major cities, according to Benjamin Tal, deputy chief economist with CIBC World Markets Inc.
Even so, Colliers forecasts that office vacancies will rise, peaking nationally at about 14 per cent in 2023, according to its latest National Office Outlook.
Many top properties will remain occupied, but companies will be cautious about expansion, given the possibility of downsizing and the risk of making the wrong move, Addison says.
Reorganization is more likely with “new collaborative areas for creation,” he says, as well as lounge-like spaces for clients to have a coffee, relax and experience an organization’s brand.
Retail space saw lower vacancies than office, but major markets are forecast to see vacancies rise gradually to the end of 2024, ranging from a low of about 5 per cent in Vancouver to a high of about 16 per cent in Victoria, according to Colliers.
Tal notes declining conditions are due to e-commerce. “Demand will go down as we go back to normal, but e-commerce demand will be higher than the previous normal.”
Still, in-person shopping will be “exotic after COVID,” he adds.
E-commerce will continue to pressure industrial. Already, the Greater Toronto Area rents have doubled in the last 24 months, Cuthbert says. Some space now features $15 per square foot rents, similar to big box retail, indicating further blurring between warehouse and retail.
“It’s conceivable that big box retailers could move their back walls forward to accommodate logistics and e-commerce fulfillment,” he says.
Moreover, industrial cannot be built fast enough in Vancouver and Toronto, Addison adds. “A healthy market is about a 4 to 6 per cent vacancy, and right now it’s 1 per cent.”
What is left is often “dysfunctional,” he adds.
Therein lies opportunity, as these assets often have good infrastructure access, ideal for repurposing.
Anything close to transit will do well for multifamily,” he says. “Anything close to good labour and power will pay off for industrial.”
The challenge remains uncertainty, Tal says. “We were under the impression when we were young and innocent a few months ago that the vaccine is an end game.”
“With no definitive answers or direction coming out of the pandemic, companies are choosing not to downsize their office space,” says Addison.
Even with the status quo, investors should be cautious, for instance, about paying too much for industrial.
“With going in yields at historically low levels, investors need to look carefully at the assumptions backing their pricing” Cuthbert says. “It may be a mistake to straight line the recent rising rental rate trend too far into the future.”
The low yields on standing assets are causing investors to move up the risk curve to achieve outperformance, Cuthbert notes. “They are increasingly investing in higher yielding/higher risk assets that require follow on capital investment for repositioning or full development.”