How will the recession brought about by government measures to combat COVID-19 impact commercial real estate valuations?
While it’s still too early to know long-term repercussions, companies are currently carrying out stress tests, forecasts, analyses and covenant-checks of assets to try to avoid surprises later.
Theoretically, property values should be moving lower as risks have increased and cash flow has likely weakened. However, as long as companies and high-net-worth investors seek to deploy large amounts of capital to buy real estate, the trend of high property valuations could continue.
- The retail sector has been challenged in recent years
- While trophy assets such as CF Toronto Eaton Centre and Yorkdale Shopping Centre should still be very strong, there will be a widening gap between good and bad malls.
- Enclosed malls in secondary and tertiary markets that were already ripe for redevelopment opportunities may have those plans hastened.
- Grocery and pharmacy-anchored retail strips have generally performed well, as those stores have remained open to provide essential goods. However, those locations often also feature small businesses such as salons, bakeries and dry cleaners that may be in for tough times.
- Migration to online shopping isn’t likely to end.
- “Multifamily real estate has historically been the most resilient asset class and we think that continues today,” said Anna Kennedy, chief operating officer of KingSett Capital, a private equity real estate firm with $13 billion of assets under management.
- Kennedy cited low vacancy rates, upward pressure on rents and an existing need for more rental apartments in key Canadian urban markets, which she believes portend continued strong performance.
- Sender said people who are renting typically don’t have a lot of alternatives, and need to live somewhere, so “it makes sense that multifamily will be more resilient than commercial asset classes.”
- The majority of office workers across Canada have been working from home for about two months, and Kennedy said it’s been “quite remarkable” how they’ve adapted.
- However, the consensus of the panel members was people still long for human interaction, working in teams and innovating, as well as creating new business relationships instead of just maintaining existing ones. All of this can best be done in office environments.
- “If anything, they may well need more space because they’re concerned about the higher densities in their office space,” said Kennedy.
- Increased workplace flexibility through hoteling systems and having more people work from home, at least part-time, could reduce demand for office space. However, Johnston believes it will be balanced by the desire for increased buffering and distancing.
- While the office markets in most major Canadian cities have performed well of late, Calgary was a glaring exception. The most recent collapse of oil and gas prices has exacerbated the problems there.
- Johnston said Altus was seeing light at the end of the tunnel with absorption and had forecast rental growth for the next few years, but that will now be amended.
- Long-term leases signed years ago now have rents well above market value, and rents have decreased dramatically upon lease rollovers, according to Johnston. With Calgary’s downtown office vacancy rate hitting 24.6 per cent in Q1 2020, and expected to rise, rents should continue to decline.
- One note of optimism was expressed by Kennedy. KingSett has four per cent of its income fund invested in Calgary and owns a couple of office buildings there that have “already been written down substantially over the last four years.”
- She said rent collection for April was more than 90 per cent.
- Johnston said Altus was doing a lot of feasibility work for companies interested in building more seniors housing, which had been acknowledged as a growth sector because of Canada’s aging population.
- The large COVID-19 death tolls in seniors homes has likely put a pause on that. Down the road, however, there will continue to be a need for such facilities — albeit with increased staffing, cleaning, security and other improvements.
- “It’s not all seniors housing that’s being hit hard,” said Chin. “It’s long-term care which is the most vulnerable.”
- Johnston said the children of seniors often decide if their parents will go into these facilities. Their personal wealth has potentially been decreased in this pandemic-caused recession and they may no longer be able to afford to pay for it.
- Johnston believes the industrial sector should remain relatively unscathed and companies will want to build more if they can find the land. Industrial space close to cities will continue to be especially important for last-mile delivery of goods.
- Small-bay properties may be challenged, depending on where they fit in the supply chain, according to Johnston.
- Chin said supply chain issues might prompt some companies to stockpile certain goods to ensure availability, and places will be needed to store them.
- “We’ve lost some of our confidence in relying on global supply chains,” said Kennedy. “I think we may bite the bullet and pay more for certain strategic goods that we may want to manufacture at home.”
- Hotels will get “kicked in the teeth the hardest,” according to Sender, who believes the asset class is “in for a tough go for a period of time.”
- Johnston said tourist-oriented hotels will suffer because people may be wary of going to them, travel may continue to be restricted to some extent, and disposable income could be impacted over the next few years.
- Downtown hotels in major cities catering to diverse clientele – business clients as well as vacationers – may recover more quickly.
- Some new development has been temporarily put on hold due to COVID-19-mandated construction stoppages or slowdowns, which is likely to impact project budgets. Chin said the primary issue with development is delayed registrations because of municipal offices being closed.
- Johnston said Altus is still performing development appraisals, however, and it’s too early to say if land values have been negatively impacted.
- Although Otera is being conservative with its loan structures, Chin said the company is “looking at new development on a very selective basis. It depends on who the sponsors are.”
- Otera has been repaid on three large condominium loans through the COVID-19 crisis and Chin expects to be repaid on two more in the next month, which are positive signs.