Is REIT Softening?
Canadian commercial real estate companies saw positive leasing momentum, stable occupancy and strong rent collections as there was continued efforts to battle back from the pandemic in the first six months of 2022. The question now, of course, is whether they can keep that momentum going in the face of a potential recession coupled with rising inflation.
While Canada has so far been able to dodge the negative elements that have been impacting the global economy, a rather disappointing GDP report that highlighted some slowing growth in Q2 along with an early temperature check of a contraction in July hints that the country’s luck may be running out.
However, there are some market watchers suggest at least parts of the commercial real estate landscape should remain rather resilient, even if swift monetary tightening and rising prices nudge Canada into a downturn.
What do the Tea Leaves Reveal?
A report from CIBC Capital Markets in June 2022 pointed to the fact that REITs seem well-positioned to withstand rising rates well into 2026 for a few reasons, which include the way REITS tend to structure their debt (and being subjected to potentially higher rates each year) and the ongoing return to pre-pandemic operational activity.
Meanwhile, Global real estate services firm Jones Lang LaSalle Inc., in its Q2 real estate outlook, predicted that different segments of the REIT universe would hold up better than others if the economy takes a turn.
“Both industrial and retail are expected to remain resilient to softening economic conditions as the year wears on,” the report said. “Office, however, is expected to experience a delayed recovery from COVID-induced occupancy losses.”
The outlooks came after a generally strong quarter across the board.
On the retail side, as landlords continue to adapt to the realities of post-pandemic life, they are looking for new ways to bring value to their tenants, which include sharing data and offering more diverse experiences.
Companies are seeking to help retailers reconfigure their stores and environments as shopping preferences shift. This includes evolving retail spaces, drive aisles in parking lots, signage and even loading flows. With these tactics, commercial real estate companies are confident it can withstand any turbulence inflation might inflict on the retail sector.
One example of the bounce back is that RioCan saw committed occupancy improve for the sixth consecutive quarter in the second quarter, returning to a pre-pandemic level of 97.2 per cent.
“Businesses are confident about increased sales and shoppers are largely confident about spending,” the JLL report said.
The report went on to note that confidence remains high on both sides of the retail equation, auguring well for the sector.
Office Space Stumbling
Office space, unlike retail, has been the slow poke of the group, and may be most susceptible to a downturn.
After a slow rise in national vacancies over the past three quarters, the rate jumped 40 basis points in Q2, to reach 14.7 per cent.
Which area of Canada is strongest? Vancouver continued to lead the pack with the lowest vacancy rate in North America at 7.3 per cent. At the other end of the table, Calgary has a 26.8 per cent vacancy rate, although that’s still a drop from a high of 27.3 per cent experienced in late 2021.
To meet some of these challenges, landlords have offered logistical support to those tenants that are looking to reconfigure their offices to incorporate more room for collaboration and team meetings. But at the first hint of a recession, “several companies began second-guessing their real estate decisions,” according to JLL.
Overall, the REIT market experienced a net rental rate drop quarter-over-quarter, except in Montreal, which saw a 5.4-per-cent increase in overall average net rental rates. The downtown Toronto market saw the most significant decrease, dropping just over four per cent quarter over quarter to $36.92 per square foot from an average of $38.44 in Q1. The national average hit $20.22 in Q2, a 1.5 per cent decrease relative to the $20.52 average in Q1, a historical high.
Will this softening continue? Market watchers will be monitoring to see if it continues amid the economic headwinds.
Looking forward, we expect the vacancy rate to continue to rise across Canada given the current economic uncertainty, bringing balance to those markets that have been in the landlord’s favour for several years.