CoStar August 2020 Market Report Ontario

With Ontario now in stage 3 of its reopening plan, social distancing measures have gradually eased and business activity is picking up. As the peak of summer has arrived, the Canadian economy is showing signs of a stronger rebound than initially expected due to nationwide business re-openings and increased consumer spending, but make no mistake, there is still a long and bumpy ride ahead. With the first wave of infections behind us and many of the new cases confined to localized outbreaks, the country is still holding its guard up as surging cases in the U.S., and even globally, provide a stark reminder of how fast things can quickly change. Latest GDP figures from May indicate that the economy was able to post another monthly gain, at 4.5% compared to April 2020, but still down 15% compared to February 2020. The rebound can be partly attributed to the $392 billion, or 17% of GDP, in fiscal aid that the federal government provided in its response to COVID-19, however, the generous stimulus package will be felt for generations to come as the federal debt load will now surpass $1.2 trillion. If there is any consolation, the Bank of Canada has indicated that interest rates will remain low for the foreseeable future, ultimately reassuring households and businesses to move ahead with major purchases or investments over the medium-term. Unfortunately, with many of these fiscal aid programs begin to wind down, the coming months will be critical for the economy as many businesses and households, who have relied on lines of credit or loans to make ends meet, will be forced to determine if they are able to continue on their own without life support.

Government officials are now faced with finding a balance between economic sustenance, personal safety and personal freedom while real estate owners and operators across every asset class are considering potential longer-term effects of the outbreak. Along with damage already inflicted, the prospect of a second wave will ultimately determine the true extent of these transformative and lasting changes in corporate and consumer behaviour. But while the full scale of human catastrophe and economic impact is yet to be seen, consumers are clearly seeking the light at the end of the tunnel. Ontarians have shown an eagerness to go out in public, often at the risk of spreading or contracting COVID-19, so it seems likely they will return to restaurants and shopping when they can. This was particularly evident as retail sales across Canada rebounded sharply after historic declines in March and April as May saw sales up almost $42 billion or 18.7% from April’s record low. Preliminary forecasts for June suggest another strong gain with a flash estimate predicting a 25% increase, which would effectively bring total sales back to February levels. As is the case with so many aspects of society during these times, the outlook for retail sales will ultimately depend on the virus trajectory and timelines surrounding the vaccine. With larger sectors of the economy reopening and lockdown restrictions being lifted, temporary relief to retailers is a welcome by-product but one that carries risk that increased social interaction could lead to a resurgence in cases and a reversion to lockdown procedures, as seen in several U.S. states.

From a fiscal point of view, municipalities across Ontario are now facing the prospect of large operating deficits due to the heightened need for municipal services and the simultaneous drop in revenue streams. Growing deficits could put provincial infrastructure investments at risk as the government may be inclined to cover these deficits using provincial capital budget, reducing funds available for new projects and necessary ongoing operations and maintenance. The alternative is for municipalities to downsize their workforces and cut costs adding to total job losses precipitated by the pandemic and further eroding services available to the public. And with large expected declines in both provincial and federal GDP, the response to this crisis will have long-term implications for growth.

Marked by peaking rental rates and record-low vacancy amidst seemingly unappeasable demand, Toronto’s office market’s pre-pandemic outlook was robust and promising. And although it is largely insulated from the recessionary effects of a pandemic, the lockdown has muted leasing levels, led to an uptick in sublease space and forced occupiers to rethink how they use their office space. Nearly all firms postponed transactions that weren’t driven by lease expiry as large-scale leasing was essentially non-existent in Q2. Complexities associated with a lower density office environment and business continuity plans have taken center stage as tenants are now turning their attention to re-entering their spaces while factoring in social distancing, symptom monitoring, availability of PPE and strict adherence to regulations. The multi-year trend toward densification has reversed sharply while public health officials may amend building codes to limit the risk of future pandemics affecting standards for HVAC, square footage per person, and enclosed space ratios. With reduced tenant competition and more options on the market for potential occupiers down the road, it is likely that rent growth will level off this year and certain submarkets could potentially see negative growth by year-end. Reduced investment activity lends credence to this expectation with acquisition capital temporarily freezing and minimal foreign investment activity entering the market.

Toronto’s industrial sector seems poised for sustenance through the pandemic as well as potential late-year growth. Manufacturing, production, maintenance and supply chains are still among the most essential services and provide an opportunity for revenue during a time of uncertainty. E-commerce sales have spiked driven by demand for the delivery of essential items and groceries while there is renewed demand for dark kitchens and order fulfillment warehouses. Owners and tenants alike will need to coordinate closely with the public sector to forge plans that are essential to both public safety and the solvency of their workforce, while keeping the lights on in their operations. This will be particularly relevant to manufacturers of critically important components, parts and finished goods, especially those involved in critical infrastructures such as energy and power, transport, communications and food and agriculture.

The deterioration of Toronto’s retail sector has been swift and the true extent of the damage to the economy could be widespread. The shutdown of all but essential stores added further strain to several years of weak retail sales, rising property taxes and the shift to e-commerce. Even with the increases in May and June, Q2 2020 will go into the books as among the worst ever for retailers. The key consideration is whether the sharp rebound will be sustained in the coming months or the pace of spending growth will slow with millions of Canadians still out of work, government aid winding down, and restrictions on some businesses likely to linger. The retail industry might have effectively reached a tipping point with the pandemic, allowing e-commerce to emerge as the logical successor to traditional brick-and-mortar models. Due to the lockdown and warnings to avoid high-traffic indoor areas and places without proper ventilation, many shopping malls and underground pathways have seen a large reduction in shoppers. Depending on the governmental decrees, neighbourhood streetfront retailers may actually find their foot traffic not significantly reduced, as the perception of safety is higher within this retail subtype. Assets in retail nodes with necessity-based retailers, primarily grocery and pharmacy, will likely find that their consumer traffic remains relatively high. Notwithstanding that, tech giants like Amazon and Shopify continue digitalizing the industry and driving consumer behavior to e-commerce channels, further diminishing hope of a recovery for traditional retail performance.

Ottawa’s office market showed strong fundamentals in Q1 and the launch of the Confederation LRT line last year will provide some buffer to the uncertainty surrounding the pandemic. That being said, leasing activity slowed significantly in Q2 with overall market activity expected to stay stagnant over the short term. Businesses are putting major decisions on hold with many tenants expected to lean towards shorter-term extensions rather than committing to a long-term renewals on leases that are set to expire. Some may choose to vacate or attempt to sublease out space to reduce costs associated with their existing real estate obligations. The pre-existing disconnect between potential demand from the office sector and existing supply will be interesting to monitor; a key driver being whether the government divests some of their real estate in favour of longer leases with the private sector to spur economic development or chooses to renovate their current inventory. This all points to office vacancy climbing for the rest of the year although the market’s reliance on the federal government could mean Ottawa could fare better than other markets.

The National Capital Region’s industrial market has entered a period of unprecedented uncertainty. Some further degree of vacancy increase is expected in the coming quarters, along with an easing of rental rates. In the past, the lack of big box space available for lease meant that built-to-suit was the only viable option for most large occupiers. Now, with the looming economic impact of COVID-19, new speculative construction is unlikely in this already risk-averse market. For large users, built-to-suit may continue to be the best option if the market softens. However, the industrial sector is expected to be fare better than others as the importance of online shopping and other elements of distribution and supply chain have seen a spike in demand. Although overall activity has declined and vacancies have edged up, prospects for the Ottawa industrial market remain strong. With a strategic location to service both Ontario and Quebec, Amazon and Shopify have shown their interest in establishing a presence in the region, prompting several transportation and logistics users to follow suit and pursue large industrial footprints.

Ottawa’s retail market is experiencing catastrophic declines similar to those seen in Toronto and cities across the globe. Retailers were struggling before the coronavirus pandemic began and the impact has simply lessened their chances for survival. With consumer shopping habits bound to change and retailers needing to adapt to remain financially viable, focusing on consumer needs and building loyalty has never been more important. Retailers with modest or no online presence are moving quickly to change their business trajectories. The pandemic has accelerated the rise of e-commerce and with risks of a potential second wave, consumer loyalty to e-commerce is likely to continue rising. As a result, brands are increasingly pivoting to a direct-to-consumer business model and many e-commerce businesses are experiencing sizable growth. The long-term impact of COVID-19 on the retail sector will largely depend on the potential emergence of a second wave as well as the duration and severity of the outbreak going forward.

These insights are made possible through CoStar, the largest commercial real estate source for property listings for sale or lease in Canada.

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