Will Workers Return to the Office?

REITs are suffering – but there may be new tenants and opportunities soon.

Yan Barcelo 12 May, 2021 | 1:12AM
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Amidst the backdrop of a continuing bull market in residential properties, commercial real estate is still recovering. But there are new signs of hope and opportunities in an evolving demand mix.

At the end of the first quarter of 2021, the aggregate price of a home in Canada increased by 14.1%, “as strong demand continues to outpace supply”, according to Royal LePage’s most recent market study, which forecasts that 2021 will finish with a 13.5% increase. The situation with office and retail real estate is a stark contrast to what’s happening in the suburbs.

Downtown Doldrums Linger

Office and retail real estate sectors are still struggling in the wake of the pandemic debacle of March 2020, most REITs having not yet come back to their pre-pandemic levels, notes Howard Leung, investment analyst at Veritas Investment Research. iShares S&P/TSX Capped REIT ETF index (XRE), for example, still lingers below its pre-COVID peak.

There are signs of hope for commercial landlords. Rental collections in the office area have bounced back “in the 80-90% range, after falling to their worst level in March-April in the low 60%,” points out Corrado Russo, head of global security at Hazelview Investments. However, in retail, rent collection still stands around 60% after diving to the 30-40% range.

The existential question for office and retail rent demand is: will employees come back to their downtown offices, thus bringing back life to shops and restaurants? All interviewees offer strong glimmers of hope. The most telling is that, “in the U.S., with aggressive vaccine deployments, we’ve seen people coming back to the city,” indicates Russo, “Offices will lag, but employees know that employers want them back and they don’t want to be stuck scrambling to find lodgings at the last instant. The U.S. shows us that the trend of urbanization we’ve witnessed in the last 20 years is not going away.”

Leung points to surveys “showing that employees want a hybrid approach, sharing work between the home and office. For their part, employers prefer employees to be in the office in order to foster culture and ideas, something that is hard to do virtually.”  Leung also discerns strong lease commitments among technology companies. “To me, that’s a bullish sign for offices,” he adds.

Industrial Tenants May Move In

There are new developments emerging in real estate, mostly in the industrial sector, but it also extends to retail and housing. A strong trend is to build “in versus out”, as reports James McKellar, professor of real estate and infrastructure at the Schulich School of Business of York University, who also remains very bullish on city centres. That trend sees “future industrial developments happening closer to downtowns, because what is missing in logistics chains related to ecommerce are distribution centres close to consumers. These tend to happen around transit stations.”

Riocan Real Estate Investment Trust (REI.UN) is riding that trend with new “mixed-use” developments, one on the corners of Eglinton and Bayview, in Toronto, that combines, offices, retail and housing rental. Crombie Real Estate Investment Trust (CRR.UN) is also moving in that direction through its major shareholder and tenant Empire, owner of Sobeys and Safeway. Crombieis partnering with Ocado, a British firm specializing in delivery automation, notably grocery, to serve the fast-growing field of ecommerce. However, these developments remain relatively modest and don’t yet show up in the stock prices of Riocan and Crombie, notes Leung.

Lots of Uses for Land

Another emerging area is agriculture: “A lot of attention is being paid to land,” notes Russo, whose firm invests in such assets whereby farmers sell their farms to institutional investors who lease them back to them. Many new technologies in fertilization, soil measuring, equipment automation for planting and harvesting require increased capital that farmers need, and receive from investors. This trend is still minuscule, “institutional ownership of land amounting to less than 2%,” notes Russo, and no investment vehicles such as REITs allow retail investors to have access to it. But Russo believes that day is not so far away, adding that land value has appreciated yearly by 8.8% from 2002 to 2019, with the price of an hectare up from $1,445 to $6,092.

The most immediate opportunity, according to Russo, resides in office, retail and hotel REITs that stand to profit from a potential recovery. He also reminds long-term investors to keep an eye out for other REIT sectors such as warehousing, logistics, cell towers and data centres. “Presently, he says, they’re trading at fair value and, long term, show a big value upside.”



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About Author

Yan Barcelo  is a veteran financial and economic journalist with more than 30 years of experience, Yan writes for many publications in Toronto and in Montreal, including CPA MagazineLes Affaires and Commerce.

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