CoStar June 2020 Market Report Ontario

MARKET SUMMARY

After almost three months since the onset of the COVID-19 pandemic, ‘phase two’ seems to be well underway with signs of a calculated return to a semblance of normalcy and widespread discussions around how that ‘new normal’ will shape up, albeit under a lingering cloud of economic uncertainty. And while the full scale of human catastrophe and economic impact is yet to be seen, consumers are not surprisingly seeking the light at the end of the tunnel. As officials around the globe begin weighing easing lockdown restrictions, they are now faced with finding a balance between personal safety and personal freedom. Real estate owners and operators across every asset class are considering potential longer-term effects of the outbreak and the implications that these fundamental shifts are likely to bring. Beyond the immediate challenges, the severity and duration of the pandemic will ultimately determine the true extent of these transformative and lasting changes in corporate and consumer behaviour.

Ontario’s commercial real estate industry is also evolving with assets previously generating steady cash flow and returns now being hit hard across the value chain. Service providers are struggling and spending to mitigate health risks for their employees and customers. Many developers can’t obtain permits and face construction delays, stoppages, and potentially shrinking rates of return. Meanwhile, owners and operators face drastically reduced operating income and anxiety about how their tenants are struggling to make lease payments. Although the Canada Emergency Commercial Rent Assistance program is now up and running, it is unknown at this time how many landlords are actually applying for this program on behalf of their tenants. This program could prove crucial in curbing the effects of the pandemic on small to medium sized businesses that are a significant economic driver. The program is essentially a forgivable loan to qualifying commercial property owners to cover 50% of rent payments by eligible small business tenants experiencing financial hardship in April, May and June. The loans will be forgiven if the owner agrees to reduce the eligible small business tenants’ rent by at least 75% for the three corresponding months under a rent forgiveness agreement, which includes a pledge not to evict the tenant while the agreement is in place. Given the rapid evolution of COVID-19, the speed at which the economy and financial markets are evolving, and the unprecedented uncertainty surrounding the potential severity and duration of the pandemic, economic outlooks are now subject to considerable volatility.

Social distancing and the largest work-from-home experiment in history has drastically changed the way people occupy and interact with commercial real estate. Companies are now rethinking their office footprints and warehouse needs on a daily basis. Consumers forced to shop online because of closed malls and shopping centers may permanently adjust their buying habits toward e-commerce. Before the pandemic, consumers were already shifting their spending habits away from physical stores, and this long-term trend is expected to accelerate after the crisis, especially as many previously struggling brands are tipped over the edge into bankruptcy or forced to radically reduce their footprints. Assets that have greater human density seem to have been the hardest hit, with demand in regional malls, hospitality, healthcare facilities and student housing down. By contrast, self-storage facilities, industrial properties, data centres, and even streetfront retail have faced less-significant declines. Within office space, the multi-year trend toward densification and open-plan layouts may reverse sharply. Public-health officials may increasingly amend building codes to limit the risk of future pandemics, potentially affecting standards for HVAC, square footage per person, and amount of enclosed space. And while the retail sector has had its share of challenges over the past few years, they pale in comparison to what it’s facing now. The virus and corresponding shutdown are threatening the entire retail ecosystem, from supply chains to the retailers themselves, their landlords and their lenders.

The Greater Toronto Area’s (GTA) office market was thriving prior to the emergence of the coronavirus, with historically-low vacancy and unemployment, robust rental growth, well-capitalized owners, diversified tenant bases and new product slated to deliver over the next few years. However, the ensuing slowdown carried significant weight, as tenants with expected Q2 move-in dates saw their occupancy timelines pushed farther out. Many tenants have requested rent deferrals, with landlords requesting extensions on their lease terms in response. In the near-term, expect heightened pressure on certain industries, such as coworking or physical-product-based businesses, and landlords with exposure to short-term leases. Announcements from tech giants the likes of Google, Facebook, Twitter and Microsoft for long-term adoption of work-from-home policies could influence the entire office sector to incorporate remote working as a pillar of the ‘new normal’. Considering the fluidity of the situation, the implications on the office market going ahead remain to be seen. Overall demand is expected to lessen, with rental rates likely to either adjust downward or level off. In the coming months, many new construction projects that were nearing delivery will see their completion dates pushed out or their plans amended to brace for potential fallouts. GTA’s diverse economy coupled with federal and provincial government’s actions providing economic aid could potentially mitigate some risk as we navigate through the crisis.

2020 started off exceptionally strong in Greater Toronto’s industrial market with historically tight market conditions characterized by pent up demand and rapidly rising rents. And while the trickle-down effect initiated by China’s supply chain shutdown has caused disruptions, the industrial sector could be the least affected by the global pandemic. 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. Short-term leases are expected to gain traction while companies look for temporary space to fulfill online orders and store product overflows. Additionally, delays to the estimated 9 million SF of industrial space currently classified as under construction and expected to come online in 2020 combined with continued demand for space will result in an expected continued shortage of available space over the coming years. On the other hand, 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. Entire retail ecosystems are now in peril with new bankruptcies, store and restaurant closures and layoffs announced daily. The retail industry might have effectively reached a tipping point with the coronavirus pandemic.

Ottawa was experiencing slow-but-steady growth entering COVID-19 with strong economic and office market fundamentals. The launch of the Confederation LRT Line last year combined with historically low unemployment, low vacancy and a diverse tenant mix will provide some buffer to the uncertainty surrounding the pandemic. Tenants may choose to temporarily vacate or sublease out space to reduce costs, pushing vacancies up in Q2. Apart from the office component in several mixed use developments, such as Zibi and the upcoming 900 Albert development, and some previously announced design builds, office construction is largely on hold as institutional landlords look for significant pre-leasing in place and large tenants hesitate to commit to space in developments that could be years from completion. As always, Ottawa’s office sector will benefit from a significant federal government presence providing a soft landing from the adverse effects of the crisis. The industrial market in the National Capital Region has entered a period of unprecedented uncertainty. Some degree of vacancy increase is likely, along with an easing of rental rates. The lack of big box space available for lease in the past 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 very unlikely in this already risk-averse market. For large users, built-to-suit is the only option in this market. 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. 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. The long-term impact of COVID-19 on retail will largely depend on how soon retailers and restaurants can reopen, the capacity at which they can reopen, and the willingness for the consumer to open their wallets.

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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