Commercial real estate is booming in the greater Toronto area — all across Ontario, really. With light finally, at the end of the long COVID-19 tunnel, it’s time to look at the shape of the market and identify some trends, so we as investors, buyers, and lessors of commercial real estate can plan our next move.
Interest Rates in Commercial Real Estates
The era of rock-bottom interest rates may be coming to an end. In an attempt to beat back inflation, the Bank of Canada increased the overnight rate by 25 basis points in March and another 50 basis points in April.
The US Federal Reserve followed suit by raising its own Federal funds rate 25 basis points in March and another 50 points at the beginning of May, with more increases expected.
Increases in bank-to-bank interest rates make it more expensive for banks to loan money, which tightens up the supply of money they are willing to dump on the open market. With less money to lend, they also tend to charge more money to borrow it, in the form of higher interest rates on consumer debt products, including commercial real estate loans.
If it becomes more expensive to borrow money, demand for commercial real estate may wane, putting downward pressure on valuations.
A price downtrend due to rising interest rates may take several years to manifest, if it happens at all. Demand could remain high, keeping valuations on an upward trajectory.
Nevertheless, if you have thought about selling properties from your commercial real estate portfolio, now is an interesting time to consider doing so. Buyers are rushing to take advantage of the last low interest rates they may see for awhile, and you may get some of the most attractive offers you have seen in awhile.
Industrial Real Estate
Industrial real estate continues to be red-hot. In the greater Toronto metroplex, industrial vacancy rates sit at -2%. That was not a typo. Vacancy rates are actually negative, meaning there isn’t enough industrial space to meet the demand for industrial space. Waiting lists are forming, and bidding wars are breaking out over industrial leases, with companies setting their sites on remote locations in search of adequate space. It’s a good time to own industrial property … and a difficult time to be looking for a lease or up against renewal.
Industrial landlords looking to cash out may find themselves looking at all-time-high sale prices … but they may also want to take advantage of the red-hot demand for their product to negotiate best-ever lease terms.
Industrial tenants may feel the pinch of rent increases, but be wary of jumping ship. If you have a lease on a space that works for you, do what you can to work with your current landlord. Pickings are scarce in terms of new space to relocate operations.
Office Real Estate
Reports of the death of the office are premature. In fact, the office is making a comeback. With the pandemic on the wane, confidence is returning and companies and startups are returning to the office.
Yes, remote work is still prevalent, but the ubiquity of remote work is starting to look like a temporary phenomenon. Those who continue to work remotely are probably employees who have longevity and trust with the company. They can drive a hard bargain with their remote-work agreements because employers don’t want to absorb the turnover costs. But when it comes to new hires, employers still prefer to begin the relationship in-office.
On the other side of the “Great Resignation” some employees with longevity prefer to return to the office, and companies with no office space risk losing top producers.
Bottom line — companies and startups returning to the office have a rich selection to pick from. For office landlords, the long pinch might be coming to an end. Investors predicting a rebound for the office sector should be sharpening their knives and getting ready to buy.
Retail Real Estate
The COVID-19 pandemic was proclaimed as a death blow for retail, but it really only speeded up a restructuring of the retail market that was already in progress. The eCommerce bell could not be unrung, global shutdown or not.
Restaurants and gyms remain a bright spot in the retail market. Consumers leaving lockdown are eager to dine out and work out, so demand for restaurants and fitness centers remains high.
For the majority of retail tenants, the name of the game is to do more with less. It used to be that the bigger retail space you occupied, the greater the profit potential. Not the case anymore. Ecommerce has effectively capped the revenue potential of a brick-and-mortar store. Best-case scenario, your sales will be the same whether you occupy 3,000 square feet or 1,000, so it behooves retailers to find a way to make that more-affordable 1,000 square foot lease work for them.
This trend is best exemplified by a shopping experience I had at clothing retailer Bonobos recently. The store was remarkably small, with example garments of various shapes and sizes but very little inventory on site. I was able to pick my desired color and try on sample garments for fit, but once I had my ideal garment in line I completed the sale online — a hybrid brick-and-mortar/e-com business model.
I asked if ordering online would hurt the on-site sales people financially, but they said no — they didn’t earn a commission for closing me on a sale right then and there. I didn’t get the satisfaction of walking out of the store with my new clothes … but at least I knew that the garments would fit me when they arrived. I only have to send them back if I change my mind about the color.
Retail has the longest curve to beat, but even it will come back as shopaholics rediscover the joys of in-person browsing.
The Toronto Commercial Real Estate market remains hot, but big changes lurk on the horizon. If you like what you’re seeing, it might be time to make some big moves. Don’t hesitate to reach out to me — I have brokered hundreds of successful commercial real estate transactions and I’m always down to talk strategy.