Retail landlords anticipate social distancing protocols will pose a challenge as stores and malls reopen following lengthy COVID-19-triggered shutdowns. Recovery from the sudden and dramatic economic hit could be an even longer term and more daunting prospect.
Recently released results of a wide-ranging survey conducted by Altus Group reveal many major Canadian commercial real estate players braced for the erosion of consumer confidence, tenant solvency and their own investment returns. Questions were posed during the mid-April height of the pandemic to 115 industry professionals affiliated with private owners, REITs, pension funds, life insurance companies and brokerage firms, including 35 involved in the oversight of national portfolios. Ninety respondents, or 78 per cent, own or manage retail properties, making it the most commonly represented sector in the survey base, followed by office, industrial and multi-residential respectively. Some of those with a particularly prominent presence in Canada’s retail landscape include Cadillac Fairview, First Capital, Oxford Properties Group, Ivanhoé Cambridge, Morguard and BentallGreenOak.
“We intend to conduct this survey on a regular basis for the duration of this crisis,” reports Colin Johnston, president, research, valuation and advisory, with Altus Group.
To begin, survey respondents indicated they expect that duration to be marked with climbing vacancies, declining rents, diminished tenant retention and rising cap rates. Most have also put their own acquisition plans on hold. Despite the general view that there will be capital in play for opportunistic property deals, a fairly modest portion of respondents expressed an interest in deploying it in the retail sector. Unemployment, slumping consumer spending and confidence and small business bankruptcies were tagged the biggest threats to real estate fundamentals with less emphasis placed on financing constraints, stock market volatility or rising government debt.
“Even with government aid, people will focus more on their day-to-day expenses, try to make ends meet, and keep up with other necessities such as mortgage payments and rent,” observes Kruti Desai, manager, national research insights, with Altus Group. “Leisure and entertainment stand at the forefront of this crisis. The travel industry has been strongly impacted and has declined drastically. Brick-and-mortar retail is following in its step.”
Rent relief requirements emerge early
Survey respondents with retail interests are highly illustrative of efforts to devise rent deferral arrangements with tenants, even ahead of the introduction of Canada Emergency Commercial Rent Assistance (CECRA). While some critics have chided commercial landlords for a perceived reluctance to sign up for the federal-provincial subsidy covering to 50 per cent of qualifying tenants’ rent, survey results show that upwards of 80 per cent had already agreed to a retail rent deferral and more than 30 per cent had offered some form of rent abatement by April 23 — one day before Prime Minister Justin Trudeau announced the early details of CECRA.
“Many retail owners proactively designed and allocated rental relief programs based on retailers’ risk profile and exposure to dramatic impact of being forced to shut down,” Johnston reiterates. “Retail tenants were more likely to obtain rent abatement or reduction from their landlord than office tenants (19%) or industrial tenants (10%). Only one respondent reported no plans for rental relief measures.”
At that point, most respondents envisioned a two- to three-month rent deferral period. More than 50 per cent of private companies also expressed willingness to negotiate for an extended term in some cases, while pension funds and REITs appeared more reluctant. Most respondents calculated they would need six to 18 months to fill vacancies, but with some variations depending on the region and asset quality.
Centrally located core assets in Ontario, Quebec and British Columbia were flagged as more likely to retain tenants, lease somewhat expeditiously and hold rent values, with more mixed prospects foreseen in suburban malls and all throughout the prairies. Overall, rental rate forecasts were much more pessimistic for suburban secondary assets, with 48 per cent of respondents projecting decreases of more 10 per cent, while 21 per cent of those surveyed expected prime urban rents would drop to the same degree.
A clear majority were readying for at least 70 per cent tenant retention in top-quality malls. There was much less certainty in other locations, where almost an even number of landlords expected 30 per cent to upwards of 50 per cent of tenants would not renew leases. While there were expectations that vacancies in top-quality malls could still be filled in three to six months across Quebec, Ontario and western Canada, survey respondents were more likely to budget at least 12 months to lease empty spaces in secondary properties.
Johnston concludes this all flows through to respondents’ approach to rent relief. “Owners prioritize short-term relief for retailers who can get through this crisis. COVID-19 is accelerating the bifurcation of weaker/stronger retail concepts that had started before the pandemic hit,” he maintains.
Acquisitions on hold, but investment strategies endure
Although the largest share of those owners stated they have no short-term plans to acquire retail properties beyond deals that were already in progress when the pandemic hit, fewer than half characterized their retail investment strategy as on hold. Pension funds, insurance companies and private companies were more likely to be pressing forward than were REITs.
A majority of respondents expect retail cap rates will rise, with British Columbia identified as the one market where there is some potential for them to compress. Top-quality properties are deemed more likely to hold their value than secondary malls. That said, community plazas with grocery store anchors and/or a mix of other services that remained open through the lockdown period are at more favourable juncture.
“Essential-service retail will be fine,” Johnston affirms.
Meanwhile, social distancing imperatives have arguably struck the cruelest blow to experiential retail — the market segment previously tapped as an antidote to e-commerce and a gaining mainstay of flourishing regional malls and competitive high-street shopping. Its post-pandemic prospects are still unclear
“The retail industry will continue to boost e-commerce capacities, which may prompt landlords to focus more on entertainment-type tenants as some of their other tenants exit,” Desai suggests. “Retailers could, in fact, see an opportunity in appealing to and tethering their entertainment strategies to consumer post-outbreak behaviours and habits, as people eagerly wait to socialize and interact in public space.”