Occupancy at large grocery-anchored retail outlets is at historical highs. “We witness a very strong leasing environment since Covid,” observes Lee Goldman, Senior vice-president and portfolio manager at CI Global Asset Management. While the occupancy rate historically oscillates around 95%, it stands at 98.4% for RioCan Real Estate Investment Trust (REI.UN), at 98% for Choice Properties Real Estate Investment Trust (CHP.UN), at 96.2% for First Capital Real Estate Investment Trust (FCR.UN). “Rent growth is in the 10% to 15% range for 2023,” Goldman adds.
The same applies to the U.S. “REITs are all reporting earnings and saying that leasing momentum is very strong,” reports Josh Varghese, real estate and capital market advisor and board member, The situation is very different from the first year of Covid when landlords had such distressed tenants that many accepted deep rent discounts and even accepted a portion of monthly sales as rent.
“After being locked up, people realize that going out to shop is part of their lifestyle,” notes Chris Koutsikaloudis, analyst at CI Global Asset Management.
Online Shopping is Slowing – but Not Stopping
The juggernaut of online shopping, after reaching a share of 10.7% of retail sales in 2021 in Canada and 15.6% in the U.S. in 2023 according to Statista, seems to be slowing down. In Canada, Statista expects it to grow to 13.2% by 2028.
“Traffic in malls is growing,” states Brenda Lum, Managing director, credit ratings, North American real estate rating, at DBRS Morningstar, who also points to a crucial trend in the retail world: “Malls are becoming destinations, she adds, with restaurants and entertainment. Take Yorkdale, in Toronto, which has cinemas, restaurants, and experiential events. After lockdown, we realized that people want to come out to look at and feel things.”
Physical retail certainly not going away – and neither is e-commerce. “The pandemic has showed us that we need an integrated model: not only Web activity, not only physical presence, but both,” Lum adds.
The “demographics” of retail are also changing. “Historically, malls had a lot of parking, Lum recalls. As transit develops and density around malls increases, some of the parking is being developed for multi-family real estate, and that is increasing foot traffic into malls.” She points to developments like The Well in Toronto, linked to the notion of the 15-minute city, where the experience of citizens integrates work, shopping, eating and playing.
A Widening Polarization in Property Quality
Varghese warns against over-generalizing. “You can’t just make a blanket statement that ‘retail is back’. It’s back for certain properties.” Indeed, on the one hand, you have new or upgraded destinations with a lot of traffic, and older, neglected properties that are suffering. “There’s a greater polarization between high and low quality,” he adds, although that polarization is not as sharp in Canada as in the U.S. “There’s less saturation of retail in Canada than in the U.S.,” Lum points out, “Our dynamics are different; we don’t have the same number of dead malls. Most malls that do exist are well curated.”
However, retail linked to office real estate “is still challenged, mostly because of the hybrid work model,” Lum observes. “That has suffered a lot, more than mall retail,” Goldman adds, “It has rebounded, but people are not all back at the office.” Vacancy rates stand near 18% in major urban centres across Canada, but “there are reasons to think that we’re close to the bottom,” Goldman slips in. The polarization has been even sharper in office real estate: “There has been a flight to quality,” Goldman adds. And bad quality’s been suffering.
REITs Not Yet Realizing Rebound
A healthy retail space doesn’t translate into booming REITs. For example, if RioCan, at $18.66 has stepped up from its low of $14, it is still well below its post-pandemic high of $25.23. The same stories can be told concerning Choice Properties and First Capital: they are well above their pandemic troughs but below post-pandemic highs.
Goldman points to two underlying factors in Canada holding up the retail platform. On the one hand, there is the strong inflow of immigrants bringing a steady increase of foot traffic into stores; on the other, “nothing new is really getting built, he notes. Less than 1% of the current inventory is being built. We’re not building at the rate necessary to follow population growth.”
The Recession Exception to Retail Rebound
But at the same time, two other factors are pressing down on retail: a highly levered consumer and higher rates that are eating into earnings. “If we had a deep recession, it could hurt,” Goldman believes.
Varghese points to the ominous alert signal that Canadian Tire presented recently with very disappointing sales, especially in discretionary items. “In Canada, he says, consumers are still highly levered and a lot of their worth is linked to housing. Costs can only go up for them, leaving less disposable income for discretionary buying. I would be less confident in Canada than in the U.S. for retail.”
Still Relatively Undervalued
In early December, the U.S. real estate sector presented one of the more promising outlooks for Dave Sekera, chief US market strategist for Morningstar. It exhibited a price-to-fair-value ratio of 0.86 - the second lowest after the communications sector at 0.84.
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