Except for retail properties, the Canadian commercial real estate market was on firm footing heading into the COVID-19-triggered lockdown. Driven by an insatiable appetite for logistics and warehousing space, the industrial market was setting historical benchmarks in availability, rental rates and new construction. The downtown office market was experiencing robust demand from a thriving tech sector, while leasing activity in transit-oriented suburban markets was strong.
The strength of the labour market, eroding home ownership affordability and robust immigration were key drivers of multi-residential demand. Retail was already undergoing a significant transformation which will only be accelerated by COVID. While the death of retail is greatly exaggerated, ongoing challenges will continue to reprice the sector.
The extent of the impact on these demand drivers is just beginning to unfold, but a fundamentally sound commercial real estate market is well positioned to withstand the economic shock without any major dislocation. Growth drivers are most evident in large corporate and population centres such as Vancouver, Toronto and Montreal. Given their economic and social diversity, these major Canadian markets should lead the recovery and continue to thrive over the long term.
To date, rent collection has surprised to the upside with most of the stress occurring in retail, particularly enclosed shopping malls. This suggests that government support programs are working and that perhaps businesses were more resilient than business sentiment surveys indicated.
Nevertheless, there is plenty of uncertainty and little consensus on the economic outlook for Canada and the United States. It is becoming clear that it will not be a V-shaped recovery, and it is more likely to be uneven and prolonged.
Household consumption drives both countries’ economies and will play an important role in the recovery phase. Absent a vaccine, many service-oriented sectors are likely to face both capacity and demand challenges. Elevated household debt in Canada will weigh on consumer spending, particularly for discretionary items.
The Canadian economy is also more dependent on trade, especially with the U.S. with respect to commodity and manufacturing exports. This poses additional challenges if U.S. and global demand remains weak.
Employment loss and fortitude varies across sectors
The labour market has lost approximately 2.6 million jobs since February, pushing the unemployment rate to an all-time high of 13.7 per cent. This understates the full impact on the labour market as Statistics Canada estimates that one third of the labour market is either out of work or working less than 50 per cent of their regular hours.
May’s figures were encouraging with a net gain of almost 300,000 jobs. This suggests that many are being hired back as a result of the economy reopening and/or government programs working effectively to preserve payrolls.
The shape of the recovery will depend on how swiftly the economy reopens, workers are rehired and demand rebounds. Additionally, the current massive government stimulus may be distorting the underlying economic reality. This raises questions. Will sustainable demand return by the time government programs expire in the fall? Will there be an enduring shock to consumer and business confidence?
Compared to prior employment downturns, the COVID-19 lockdown has disproportionately impacted people-facing industries. Office-using sectors such as finance, insurance, and real estate (FIRE) and professional/scientific/technical have held up much better to date, but there is risk to these jobs the longer the economy takes to restart. Meanwhile, industrial-oriented sectors such as construction and manufacturing experienced sizable job losses in March and April but experienced a mild recovery in June as plants reopened and development projects ramped up again.
The longer the downturn, the greater risk of a second wave of job losses that could spread to other sectors, including white collar professions. The extent of job losses will depend primarily on an individual firm’s financial health. Aggregate sector financial positions offer a glimpse of where stress is more likely to materialize.
From a liquidity, solvency and profitability standpoint, office-using sectors such as FIRE and other professional and technical services are better positioned to withstand the current shock. These sectors are also more responsive to work-from-home arrangements and face fewer operational disruptions.
The accommodation/food services sector is highly leveraged and tends to operate with slim working capital and profit margins, while wholesale/retail trade is much more liquid and solvent. Meanwhile, the financial position for industrial-oriented sectors is rather mixed.
There have been a few notable retail bankruptcies in Canada to date, including retailers Reitmans and Sail Outdoors and we expect more insolvency issues across both small business and larger enterprises.
Vulnerabilities and strengths in Montreal, Toronto and Vancouver
The impact of the job losses varies across metros, with larger cities such as Montreal, Toronto and Vancouver among the hardest hit. Collectively, the three metro regions have lost more than 900,000 jobs combined this year, representing more than 50 per cent of the national total.
These metros saw the their labour forces shrink by 13-15 per cent and have nearly given back all the jobs that had been gained since the global financial crisis within the span of five months. Energy dependent economies in Alberta also experienced significant job loss as they have been ravaged not only by COVID-19 but a plunge in oil prices.
As the main economic and corporate hubs in Canada, Montreal, Toronto and Vancouver are well positioned to bounce back, especially if tourism and consumer demand recover quicker than anticipated. However, given their density, these metros are particularly vulnerable to a second wave and a more prolonged economic downturn. Montreal and Toronto have been COVID-19 hot spots and the interconnectedness across their metropolitan areas, along with a greater propensity for global travel, are vulnerabilities.
The three metros’ economies are also dependent on trade and more exposed global economic conditions. Any material disruptions in the supply chains of intermediary goods will negatively impact the manufacturing sector in Montreal and Toronto. Meanwhile, weak global demand for commodities will weigh on Vancouver’s resources sectors. On the upside, these markets continue to be premier destinations for the tech sector, and this will be a key driver of economic growth over the longer term.
The preceding article is excerpted and adapted from the BentallGreenOak Canada Perspective Midyear 2020 Update.
