Commercial Real Estate Sector
June 3, 2020 | Canada
As this unprecedented situation continues to rapidly evolve, Avison Young’s briefing notes are intended to provide an up-to-date assessment of the impact on the commercial real estate market.
Period covered: May 16th to 29th, 2020
Who's paying rent and who's not?
Industrial sector resilient on rent collection (so far)
One of the healthiest CRE sectors heading into the COVID-19 pandemic was industrial. Apart from some regional disparities and small-bay assets, the industrial sector remains resilient through the opening months of COVID-19, and a key metric for all property types has been rent collection. A REALPAC survey conducted at the end of April representing nine industrial owners/managers and comprising some 170 million square feet (msf) of industrial space across Canada revealed some interesting results around delinquency rates and rent relief between small/single-bay and large tenants. Notable survey highlights include:
- April’s national average rent delinquency rate was 16% for small/single-bay tenants vs. 4% for larger tenants
- Specific areas of concern included small-bay tenants (44%), Alberta industrial tenants (33%), and tenants in the retail/entertainment sector (22%)
- Rent relief requests have been received from both non-essential and essential businesses
- Over half or 56% of all tenants were classified as essential businesses with only 9% of such tenants requesting relief for April
- 44% of all tenants were classified as non-essential with 37% of those tenants requesting relief
- Rent relief requests was highest among retail/entertainment tenants (37%) with two or more months of deferred rent
- Survey respondents were evenly split between those offering gross rent relief or net rent relief
- Some survey respondents stated that they have offered 100% gross free rent in exchange for a lease extension
Rent Relief Requests by Industrial Tenant Type
Source: REALPAC. Note: The vast majority of rent relief being offered to tenants is in the form of rent deferrals.
Based on tenant interactions and contrasting April rent data with May expectations, REALPAC’s members expect average collections to remain the same. The organization intends to benchmark April’s results against future monthly surveys.
Retail sales and delinquency rates, no surprise
Though not entirely a surprise, the dire situation for Canadian retailers became apparent when Statistics Canada released its Q1 2020 retail sales figures, showing record-breaking declines. More importantly, the results only captured the beginning of the pandemic as only about 40% of retailers had closed their doors during March. In short, retail sales dropped 10% to roughly $47 billion in March from $51 billion in February — the largest-ever monthly drop on record. Sales fell in six of 11 subsectors, accounting for 39.2% of retail trade. The outlook is not any better as the government agency estimates a further 15.6% decline in April sales with the caveat that the figure could change. This has trickled down to the CRE sector and retailers’ ability or inability to meet rent obligations as revealed by an April rent collections survey conducted by REALPAC. Results were compiled from 13 retail owners/managers representing 131 msf of retail space across Canada. Notable survey highlights include:
- April’s national average rent delinquency rate was 44% for enclosed shopping centres vs. 30% for open shopping centres and strip commercial retail units
- Specific areas of concern for rent delinquencies included uses such as restaurants (42%), fitness (33%), fashion (33%), and theatres (25%)
- Roughly 59% of all retail tenants are classified as non-essential businesses vs. 41% essential
- 59% of all non-essential tenants requested rent relief vs. 17% of essential tenants, who are still able to operate
- Over three-quarters or 77% of respondents offered gross rent relief, while 38% also offered net rent relief
- Dependent on negotiations with individual tenants – no survey respondents are offering rent abatement packages
- No respondents are currently offering rent relief for more than two months
- Contrasting April rent data to May expectations, survey respondents are expecting average collections to drop by another 10%
Rent Relief Requests by Retail Tenant Type
Source: REALPAC. 99% of rent relief being offered is in the form of rent deferral. No respondents are currently offering rent relief for more than 2 months.
The survey results also showed that, based on tenant interactions, owners/managers are expecting to collect only 55% of rents owed in May with 46% of all respondents citing that any “blanket moratorium” on commercial evictions would be “somewhat problematic”.
Investment market on pause, while returns are down
Commercial real estate investment sales activity across Canada’s six major markets registered almost $8 billion in Q1 2020, slightly higher than in the same quarter in 2019, but down nearly 50% since Q4 2019. However, the consensus is that a lot of transaction activity is merely “on hold”, and that plenty of eager buyers with capital to deploy are waiting to move forward with acquisitions when possible.
Data Source: Altus RealNet
The MSCI/REALPAC Canadian Quarterly Property Index (valued at CAD $164.7 billion across 2,400 properties) measures unlevered total returns of directly held, standing property investments from one valuation to the next. Though only half (or $82 billion) of the assets were valued during Q1 2020, the results show a widespread fall in values across markets and asset classes. Some key takeaways include:
- Total return came in at 4.6% vs. 7.5% annual rate in 2019 – pulled down by a sharp decline in Calgary (-4.3%) and in retail (-1.8%) generally
- The divergence in total return is almost 18% between the best (industrial / 15.8%) and worst (retail / -1.8%) asset classes – the highest spread ever reported
- With respect to city performance, divergence in total returns is roughly 15% with eastern markets faring better than western markets (except for Vancouver) – Halifax had the highest return at 10.8% and Calgary the lowest return at -4.3%
- By comparison, economic downturns in the early 1990s and the 2008-2009 Financial Crisis produced total returns of -6.4% (1993) and 0.7% (2010), respectively
- Since inception (1985), total average return has been 8.9% and 9.1% over the past 10 years Structural changes in retail have led to significant writedowns in the sector as well as in office. Meanwhile, the industrial sector’s performance to date is expected to come off its pace and deemed not sustainable by some market observers. More importantly, given that real estate’s performance lags at the best of times, and that asset valuations were conducted within two weeks of the shutdown, the Q2 2020 results may very well reflect the severity of the downturn more clearly.
Data Source: MSCI
Data Source: MSCI
The spread of COVID-19 and the containment policies being introduced are changing rapidly. While information in the briefing notes is current as of the date written, the views expressed herein are subject to change and may not reflect the latest opinion of Avison Young. Like all of you, Avison Young relies on government and related sources for information on the COVID-19 outbreak. We have provided links to some of these sources, which provide regularly updated information on the COVID-19 outbreak. The content provided herein is not intended as investment, tax, financial or legal advice and should not be relied on as such.