Simple mechanics of supply and demand may be driving condos down, but industrial, retail, and even office show signs of positivity
Canadian investors have watched the downturn in the condo market with a mixture of horror and schadenfreude, depending on whether or not they had a stake in that sector. Because condos dominated so much of Canadians’ real estate investments, however, a downturn in that market has cast a pall over how many retail investors view real estate as a whole. Even as we hear stories of unsold units and stalled projects across major cities like Toronto and Vancouver, one CEO drives home the fact that there are plenty of Canadian real estate subsectors insulated from the headwinds in the condo market.
Dean Orrico, President & CEO of the Middlefield Group, explained that the Condo market currently suffers from an oversupply issue after decades of low interest rates and high immigration resulted in a glut of development. As condo rents fell and demand dynamics shifted, that market had seen a precipitous drop. Commercial real estate, however, is not suffering from those same dynamics and instead offer a range of different opportunities and return profiles that Orrico believes advisors can make good use of.
“The Canadian commercial real estate market is very healthy. In many respects, depending on which segment of commercial real estate you're focused on, it is fundamentally as good as we've seen it in decades,” Orrico says. “Now, that's distinct from the condo market because that's not commercial real estate. But when people think about real estate, they often think just about residential, and they read the headlines about condos. That can be quite misleading because you paint it all with the same brush, when it's really, very distinct.”
Orrico outlined the current landscape for the four core sectors of Canadian commercial real estate: retail, industrial, office, and multifamily residential. He explained how different supply and demand dynamics have shaped those sectors and how the impact of Canada’s ongoing rate cutting cycle has driven new upside opportunities in this space.
The hottest ticket in commercial real estate, Orrico says, has been industrial. For the past decade the rise of ecommerce and last-mile delivery services has demanded a huge amount of warehouse space. Development has been relatively easy and cheap, but demand had largely kept pace and was accelerated by COVID-19 lockdowns. The Greater Toronto Area, Orrico says, was one of the hotbeds for this development. Rents in that market went from around $10 per square foot to as high as $23 per square foot over the past decade. While the pandemic-induced demand has abated somewhat, Orrico says that ecommerce demand continues to rise.
The ease of industrial development, as well as the euphoria around the space, has caused something of a supply glut over the past few years in markets like the GTA. Industrial rents fell as a result, down to around $17-$18 per square foot. Orrico notes, however, that leading Canadian industrial REITs are seeing a resurgence in demand and in rents. Because supply is relatively cheap and easy to build, it’s also relatively cheap and easy to stop. As rents fell, new construction halted, and demand has filled the gaps in industrial real estate.
Grocery-anchored retail has been another key source of positivity for real estate investors. These strip malls and big box districts have enjoyed some of the same tailwinds as the condo market did, with high immigration driving demand and low rates keeping costs down. However, there has not been the same glut of supply as in other real estate sectors, resulting in greater stability and strong overall demand. Major retailers, especially grocery businesses, are looking to expand on the back of strong business growth, but are finding few locations to expand into, driving rents higher.
While not necessarily a market of the same scale as retail, industrial, multifamily, or office, Orrico also highlights the positive tailwinds behind senior assisted living properties. The demographics of an aging baby boomer population support higher demand for this sector which he thinks shows real promise after getting past its COVID-era tailwinds.
Office has long been a laggard in Canadian commercial real estate, as COVID-era work from home policies have persisted well into the decade. Moreover, 2019 and 2020 saw a huge amount of new office space come online, right in time for a collapse in demand. Orrico notes that recovery had been slow, but that the new return to office mandates being instituted by the banks are causing a renewed push for office space.
Multifamily housing had been a major beneficiary of Canada’s high levels of immigration. Curbs to the influx of newcomers, however, have resulted in some weakening of demand for that segment of the market. Orrico notes, too, that multifamily apartments have seen the most sentiment contagion spread over from the condo space. He argues, however, that Canadian multifamily housing doesn’t compete with the condo market, and tends to exist in a lower rent bracket with more resilience. He notes that some multifamily REIT providers are trading lower, but that some of their fundamentals support resurgence.
For advisors’ clients, who may have been burned by a condo investment or watched their friends or family lose money, there is a real sense that real estate is something they may not want to touch. Orrico understands how easy it is to lump real estate into a single bucket, but argues that the unique headwinds and tailwinds inside each subsector of commercial real estate demonstrate just how much diversification this sector can offer.
“Sometimes we paint everything with the same brush. But owning a home or an investment property is very different from actually owning commercial real estate. That ownership structure typically has more leverage than commercial real estate does. You've got loan to value of three to one on a home typically, and it's typically kind of 0.4 to 1 in a REIT,” Orrico says. “When you own a REIT, or a fund of REITS like mine, you're not having to worry about paying the maintenance fees, paying the hydro fees and all that kind of stuff, which you do have to do when you own a home. And maybe the most important difference of all is liquidity. If, for whatever reason, um you're concerned about the direction of the market owning something that's publicly listed with exposure to commercial real estate you can get out anytime you want.”
