Solid pre-pandemic fundamentals and timely fortifications should position Canadian real estate to navigate and rebound from the sudden shock of COVID-19, market and economic analysts conclude. However, it’s considered too early to gauge precisely what that journey will entail. During a recent online discussion, Benjamin Tal, deputy chief economist with CIBC Capital Markets, and Paul Morassutti, vice chair, valuation and advisory, at CBRE, concurred momentum is more stalled than trending downward.
“It is still murky,” Morassutti acknowledged. “What all the uncertainty has done is effectively pause large parts of the market.”
As businesses tentatively begin to resume operations, Tal splits projections into two eras: pre and post-vaccine. Until a vaccine or suppressive treatments for COVID-19 symptoms are in place, he maintains the economy can’t even be characterized as recessionary, but, rather, will be in “zigzag” mode with the potential for subsequent waves of outbreak to dampen progress.
“But it will be much better than it is now, which is frozen,” Tal submitted.
While expressing optimism that effective vaccines and/or treatments will emerge to help fuel a recovery by 2022, he also foresees volatile months ahead. “We will have a year-and-a-half of very interesting times,” he said.
Divergent trends for office, industrial and retail
Breaking it down by asset class, Morassutti reports: investment transactions largely at a standstill; limited, but not necessarily unsettling office leasing activity; intensification of the industrial-retail dichotomy; and relative stability in the multifamily sector.
Thus far, in most markets, there’s been no spurt of office sublets or rent discounts that conventionally signify an economic downturn, but there has been a flurry of conjecture about the forces COVID-19 may have unleashed. Morassutti summarized the two prevalent hypotheses — that large portions of the workforce will permanently shift to home offices and that space-per-worker ratios in office buildings will have to expand to allow for social distancing — noting that, together, they amount to the status quo.
“This is not an either-or. Both these dynamics will play out,” he said. “Our advice would be to take a breath. It’s too early to know the long-term trends.”
Meanwhile, the Toronto market hasn’t shown much evidence of faltering. “Deals are getting done,” Morassutti affirmed. “Sublets are up, but not to a significant degree, and rents seem to be holding up.”
For retail, COVID-19 delivers a serious blow to an already downcast sector. For industrial, it brings the uncertainty of supply chain disruptions and threat of general economic destabilization, but also opens up the possibilities of rapidly growing demand for warehousing/distribution and last-mile delivery facilities. Comparably higher transportation costs underpin the business case for food and goods retailers to invest in real estate closer to their customer base as they increasingly shift to e-commerce.
“Retail is hurting. Industrial is doing very well,” Morassutti reiterated.
Beyond logistics, spinoff industrial real estate opportunities may lie in the growth and resurgence of domestic manufacturing. Tal projects a pullback from globalization, in which nations and corporations look for insurance from the potential vagaries of international supply chains, and begin to prioritize resilience over profit maximization.
“Everybody is in a self-preservation mode,” he said. “Anything that was exposed by this crisis will come closer to home.”
Looking to the downside of the industrial-retail equation, Morassutti tallied a list of faltering department stores — Neiman Marcus, JCPenney, Nordstrom — and characterized COVID-19 as just another contributing factor to their struggles.
“This is not particularly surprising. The department store model has been in decline for 15 years,” he asserted. “More and more, the COVID crisis is accelerating existing trends rather than triggering new ones.”
Relief measures influence residential stability
Turning to residential, Morassutti sees relatively few immediate concerns in the rental sector after the vast majority of tenants paid rent in April and May. “This is one sector where, so far, the federal programs have had a very real stabilizing implication,” he observed.
Tal further expects some COVID-19 relief measures could morph into long-term deliverables that would bolster stability for some renters and, ultimately, their landlords.
“We (the Canadian government) are establishing, building infrastructure and planning for Canada’s future social assistance programs,” he predicted. “After the fog clears, we will see that we have de facto established a guaranteed income program. It will be around for a long time.”
Meanwhile he cautions against making assumptions about housing price trends. With the market “basically frozen”, he separates out current vendors and house-hunters from the majority of decision-makers.
“If you’re conducting a transaction now (it’s because) you need to do that,” Tal reasoned. “So the signal we are getting now is a very biased signal.”
In contrast, he points to a pool of prospective buyers now watching for opportunities to buy secondary or income properties at somewhat discounted prices as evidence of continued confidence. “I don’t see the market collapsing. The fundamentals are very, very strong,” Tal said.
Policy response factors in bullish outlook
Morassutti offers a similar reading of the commercial real estate market, based on its pre-pandemic status and the federal government’s and Bank of Canada’s subsequent moves to ensure that all players along the chain, from tenant to lender, continue to have room to manoeuvre. Tal adds Canada is well placed to take on the resulting debt from those actions given the low-interest environment and a debt-to-GDP ratio that was well below the Organization for Economic Cooperation and Development’s (OECD) recommended threshold heading into the crisis — an enviable position compared to the United States and most of the European Union.
“Our starting point (for repayment) will be fantastic,” he said. “GDP will be rising four or five times faster than interest rates.”
The stock market appears to align with that confidence.
“There is a disconnect between the stock market and the economy, for sure. However, the stock market is not disconnected from the policy underpinnings,” Tal maintained. “The market is looking at the response of the authorities and realizing it’s not over. The stock market is focusing on what’s happening in the future, not what’s happening now.”
The observation circles back to Morassutti’s earlier recitation of Wayne Gretzky’s classic advice: “Skate to where the puck is going, not to where it is.” And he expects the future won’t stray too far from the recent past with pre-pandemic fundamentals “still there underpinning the market”.
“We do remain more bullish than bearish on overall real estate health,” Morassutti reported.