Commercial Real Estate Outlook: The Industry’s Remarkable Resilience
BMO recently published its Commercial Real Estate Outlook, which highlights the industry’s remarkable resilience after the initial shock of the COVID-19 pandemic, especially compared to previous corrections.
The fact that commercial property default rates were modest compared to pre-pandemic levels came as a surprise.
In previous, deeper recessions (1990-94, 2008, etc.), all industries suffered more or less equally. During the pandemic, however, the service sector—including tourism, hospitality, restaurants/bars, retail and entertainment—took the biggest hit. This segment accounts for roughly 4% of GDP. On the flip side, 96% of the economy rebounded last summer, largely because the fundamentals for those sectors were strong leading up to the pandemic. Government relief programs helped mitigate the impacts to employees in those sectors.
Below are the key factors that are driving the four asset classes covered in the report:
Industrial
There's a direct correlation between the strength in the industrial sector and the surge in e-commerce fulfillment that only accelerated during the pandemic. The shift of retail sales from physical distribution to online increased the demand for industrial space. At less than 2%, availability rates are the lowest on record. This reflects the already tight pre-pandemic supply of industrial zoned land coupled with strong demand, and that's not expected to change. And as physical stores begin to reopen, we don’t expect a significant rollback in e-commerce demand.
Multifamily Residential
The employment impacts of the pandemic have largely fallen on the service sector, and those businesses can’t fully recover until we’ve reached a point in the vaccine rollout where people are allowed to gather inside without social distancing restrictions. Service sector employees, who were hit particularly hard by the pandemic, tend to rent apartments. However, the impact to this sector was fairly muted, with the national apartment vacancy rates raising barely a point to a still-low to 3.2%.
Why wasn’t the spike more dramatic? Mostly because of the Canada Emergency Response Benefit, or CERB, which along with UI has provided income support to impacted employees. But it’s also worth mentioning that multifamily residential is the most affordable housing option and less vulnerable to demand shifts than housing. As an undersupplied segment with strong demand, the demand elasticity for rental units has been relatively low even in the worst of times, and that's provided some protection for this segment as well.
Retail
Out of these four asset classes, retail is the one that has yet to fully recover, with bars, restaurants, gyms and entertainment decimated, in contrast to necessities and food-based retail that thrived during the pandemic as “essential services.” We expect a solid return to in-person retail shopping, particularly linked to a food and/or entertainment experience. But the pandemic only accelerated the trend toward e-commerce. So while retail overall is growing in a positive, stable way, the pandemic was the last thing bricks-and-mortar retail needed.
Office
We believe remote work will leave some kind of mark, but it’s difficult to say with any certainty just how much of an impact it will have. As noted in the report, the impact on occupancy could be limited to less than 20% of pre-pandemic levels, and some say half of that. At this point, it’s anything but clear: in a hybrid environment where people are in the office three or four days a week, how much office space can you really reduce? You’ll need a capacity that anticipates full capacity at least a day or two a week.
The headline here is that we started off with relatively low office vacancy rates nationally, except for Alberta, and the sector has managed to avoid a deep correction. Instead, the office sector will probably experience weakness for a couple of years before resetting to a new position based on a new hybrid work from home net impact yet to be determined. That reset will be the baseline for growth, then onward in tandem with the economy, tied as before with population, economic and employment growth.
Overall, the industrial and multifamily sectors weren’t hit as hard as retail and office. But as highlighted in the report, for those more impacted asset classes, repricing of rent and reuse of space will help markets find their new balance and allow retail and office owners to eventually recover and see more stable, positive returns.
Read more
Mike Beg
Head, Real Estate Finance
Mike Beg as Head, Real Estate Finance, Canada is responsible for management of BMO’s Commercial Real Estate Finance group and its client relationships across …(..)
View Full Profile >BMO recently published its Commercial Real Estate Outlook, which highlights the industry’s remarkable resilience after the initial shock of the COVID-19 pandemic, especially compared to previous corrections.
The fact that commercial property default rates were modest compared to pre-pandemic levels came as a surprise.
In previous, deeper recessions (1990-94, 2008, etc.), all industries suffered more or less equally. During the pandemic, however, the service sector—including tourism, hospitality, restaurants/bars, retail and entertainment—took the biggest hit. This segment accounts for roughly 4% of GDP. On the flip side, 96% of the economy rebounded last summer, largely because the fundamentals for those sectors were strong leading up to the pandemic. Government relief programs helped mitigate the impacts to employees in those sectors.
Below are the key factors that are driving the four asset classes covered in the report:
Industrial
There's a direct correlation between the strength in the industrial sector and the surge in e-commerce fulfillment that only accelerated during the pandemic. The shift of retail sales from physical distribution to online increased the demand for industrial space. At less than 2%, availability rates are the lowest on record. This reflects the already tight pre-pandemic supply of industrial zoned land coupled with strong demand, and that's not expected to change. And as physical stores begin to reopen, we don’t expect a significant rollback in e-commerce demand.
Multifamily Residential
The employment impacts of the pandemic have largely fallen on the service sector, and those businesses can’t fully recover until we’ve reached a point in the vaccine rollout where people are allowed to gather inside without social distancing restrictions. Service sector employees, who were hit particularly hard by the pandemic, tend to rent apartments. However, the impact to this sector was fairly muted, with the national apartment vacancy rates raising barely a point to a still-low to 3.2%.
Why wasn’t the spike more dramatic? Mostly because of the Canada Emergency Response Benefit, or CERB, which along with UI has provided income support to impacted employees. But it’s also worth mentioning that multifamily residential is the most affordable housing option and less vulnerable to demand shifts than housing. As an undersupplied segment with strong demand, the demand elasticity for rental units has been relatively low even in the worst of times, and that's provided some protection for this segment as well.
Retail
Out of these four asset classes, retail is the one that has yet to fully recover, with bars, restaurants, gyms and entertainment decimated, in contrast to necessities and food-based retail that thrived during the pandemic as “essential services.” We expect a solid return to in-person retail shopping, particularly linked to a food and/or entertainment experience. But the pandemic only accelerated the trend toward e-commerce. So while retail overall is growing in a positive, stable way, the pandemic was the last thing bricks-and-mortar retail needed.
Office
We believe remote work will leave some kind of mark, but it’s difficult to say with any certainty just how much of an impact it will have. As noted in the report, the impact on occupancy could be limited to less than 20% of pre-pandemic levels, and some say half of that. At this point, it’s anything but clear: in a hybrid environment where people are in the office three or four days a week, how much office space can you really reduce? You’ll need a capacity that anticipates full capacity at least a day or two a week.
The headline here is that we started off with relatively low office vacancy rates nationally, except for Alberta, and the sector has managed to avoid a deep correction. Instead, the office sector will probably experience weakness for a couple of years before resetting to a new position based on a new hybrid work from home net impact yet to be determined. That reset will be the baseline for growth, then onward in tandem with the economy, tied as before with population, economic and employment growth.
Overall, the industrial and multifamily sectors weren’t hit as hard as retail and office. But as highlighted in the report, for those more impacted asset classes, repricing of rent and reuse of space will help markets find their new balance and allow retail and office owners to eventually recover and see more stable, positive returns.
What to Read Next.
BMO Real Estate Forum: Atlantic Outlook
Mike Beg | May 11, 2021 Commercial Real Estate
This past year has been one for the books, and to say the commercial real estate industry has done better than expected since last summer would be an…
Continue Reading>
Tell us three simple things to
customize your experience
