Overall Canadian investment activity in the first five months of 2020 decreased by 13% compared to a year ago, with the most considerable drop seen in residential land and office sales. Industrial and apartment properties continue to lead in activity with a total volume of $3.8 billion and $3.1 billion, respectively. Industrial activity was 15.4% higher compared to the same period a year ago. Still, combined April and May 2020 investment activity decreased by almost 39% compared to 2019. While initial investment activity in June 2020 has increased marginally compared to May, it is still anticipated that activity in the first half of 2020 will still be down significantly compared to the same period last year.Ā Overall cap rates have also shifted upwards amidst continued concerns over the pandemic. Both investors and lenders remain diligent and cautious in approaching market opportunities and will continue to face challenges in the second half of the year.
According to theĀ Altus Groupās Key Assumption Survey results from June, investorĀ intentions in terms of opportunistic buying and flight to quality have remained relatively stable between April andĀ June.Ā Higher-valued assets will continue to be in short supply with increasing pressure on rental growth rates and pricing, while also creating opportunities for development. A slightly higher number of investors intend to stick to their investment plans for office and retail, particularly for food-anchored retail with necessity-based grocery retailers that have performed very well. That proportion of fervent investors has also increased significantly for industrial (+9%) and even more so for multi-residential (+18%), especially with the easing of COVID-19 restrictions and the gradual reopening of businesses across Canada as markets transition into Phase 3.Ā Property owners in the multi-residential sector are, however, facing their own set of challenges which include increased costs for health and safety protocols, threats of rent arrears, weakening demand from immigration due to restrictions on border controls, and more recently, the financial implications ofĀ CMHCās suspensions on re-financingĀ for multi-unit mortgage insurance. Ā As a result of ongoing challenges and unanticipated strains in the property markets along with heightened uncertainties in the economy amid the pandemic, it is expected that overall transaction activity will be down in 2020 compared to last year.
When Choice Properties Real Estate Investment Trust reported its second-quarter financial results this week, one of the key takeaways was that more of its retailing tenants are paying their rent. Does the upbeat news apply to other REITs?
The REIT sector is languishing amid uncertainty over the financial health of its tenants. REITs that are exposed to the retailing sector ā which has been devastated during the pandemic by the triple whammy of store closings, the threat of bankruptcies and surging levels of unemployment ā have been hit particularly hard.
RioCan REIT, which owns 222 retail and mixed-use properties, has seen its unit price collapse 46 per cent since February, even as much of the Canadian economy has reopened and the S&P/TSX Composite Index has recovered to within 11 per cent of its record high.
SmartCentres REIT is down 37 per cent. First Capital REIT is down 39 per cent, CT REIT (which has Canadian Tire stores among its anchor tenants) is down 21 per cent and Crombie REIT is down 22 per cent.
The tumbling unit prices ā and stable monthly distributions ā have raised dividend yields to a range between 5.8 per cent (CT) and 9.4 per cent (RioCan), underscoring why the sector may appeal to investors wondering if there is potential for a turnaround here: You get paid handsomely while you wait.
The second-quarter results from Choice Properties suggest that there is a compelling bullish case for retail REITs at todayās beaten-up prices.
First, the rate of rent collection is improving as the economy reopens. Choice Properties (where Loblaw stores are the principal tenants, accounting for 56.6 per cent of gross leasable area) said that it has collected or expects to collect 93 per cent of monthly contractual rent from its retail tenants in July.
Thatās up from successful rent collection of 88 per cent in the second quarter ended June 30, and a low of 86 per cent in April.
Rent collection from industrial tenants improved to 99 per cent in July, up from 97 per cent in the second quarter. Although rent collection from office tenants held steady at 89 per cent, these tenants account for a small slice of the revenue pie.
The takeaway here: āThis is an encouraging sign as our rent collections are steadily improving each month, as more tenants are getting back to business,ā Rael Diamond, Choice Propertiesā chief executive, said on a conference call with analysts.
Second, expiring leases this year are nothing to worry about. Just 1.9 per cent of Choice Propertiesā gross leasable area is expiring by the end of 2020, and the average base rent for this space is $11.85 per square foot. Thatās well below the average base rent of $14.69 per square foot for the entire portfolio, which implies that renewals could be lucrative.
Third, Canadians are buying again. Statistics Canada estimated that retail sales increased 24.5 per cent in June, following an 18.7 per cent increase in May. This could be owing to pent-up demand after the lockdown, but itās an encouraging sign for struggling retailers and their landlords.
No doubt, thereās a lot of uncertainty ahead because of the continuing pandemic and its longer-term impact on the economy. Retail bankruptcies are among the biggest threats to REITs.
Dean Wilkinson, an analyst at CIBC World Markets, noted this week that retail bankruptcies are probably heavily weighted toward small businesses. Retail REIT exposure to these tenants, though, is less than 10 per cent, on average.
āWe found that retail-centric REIT valuations are reflecting a much worse outcome than that which is likely to prevail,ā Mr. Wilkinson said in a note.
Choice Properties is arguably one of the safer bets in the retail REIT sector, given the fact that Loblaw is a healthy, stable tenant. The REITās relatively low dividend yield of 5.9 per cent suggests some confidence among investors.
RioCan and SmartCentres, on the other hand, have yields above 9 per cent, reflecting greater risk because of a broader tenant base. But the opportunity in this sector, especially after Choice Propertiesā financial results, is hard to ignore.
Canadian commercial real estate owners and managers have plenty of potential pain points these days as the pandemic continues, but anĀ Altus GroupĀ survey indicates they are increasingly concerned about office leasing rates over the near and mid terms.
āLandlords are worried about near-term lease rollover,ā said Colin Johnston, president of research, valuation and advisory at Altus Group, in an interview with RENX. āSo if youāve got a great building and you donāt have any lease expiries coming up in the next few years, youāre feeling pretty good.
āBut if youāve got some near-term expiries, couple that with this work-from-home phenomenon (and) thereās some questions as to how strong the rental rate market is going to be going forward.ā
Layoffs and rising unemployment, small business bankruptcies, more stringent financing conditions and a decline in consumer confidence were all identified by respondents as factors which could significantly impact the commercial real estate market in Canada.
Work from home: āThis is workingā
However, the AltusĀ Key Assumptions SurveyĀ of 115 Canadian CRE executives from pension funds and life companies, publicly traded corporations (REITs), private companies and brokerages highlighted another, more concerning trend in the office sector ā the long-term adoption of remote working.
The June survey, following on an initial survey conducted in April, also found concerns over recession, government debt, oil prices (a particularly strong concern in Alberta) and bankruptcies have intensified.
The surveys asked the executives which risks might have the most lasting impacts on the commercial real estate market.
āLayoffs and rising unemployment and small business bankruptcies have consistently been there for office,ā said Johnston..
āBut what happened with this June survey, a bunch of people said āHey you forgot something else. Forget financing. Letās talk about this whole-work-from home phenomena and how that is going to lead to a significant changeā.ā
When the initial survey was taken, the focus was on getting people out of the office and setting them up to maintain productivity from home work environments. Two months later, that has shifted.
āNow office landlords are saying āPeople are being pretty productive. This is workingāĀ ,ā Johnston observed.Ā āThis work from home is really, really significant going forward.ā
Factors affecting office leasing
That is leading more executives to worry about rent sustainability and office leasing going forward.
āThese trends are here to stay,ā added Johnston. āThe longer it goes on, I think weāre going to fundamentally change and if you ask me if weāre going to have a hybrid working (environment), I think thatās whatās going to happen.
āYouāre going to have a bunch of people either on flex hours, because they canāt commute in on the GO Train or the subway, and weāre going to have flex days in the office as well.ā
In the survey, Johnston said several respondents suggested the suburban office market could become popular again. Perhaps in the major markets because of COVID, fewer employees will want to use the public transit systems to head downtown.
Johnston said managing cash flows and balance sheets is also a prime consideration.
āWhen we asked the question to landlords if they are going to defer their cap-ex or reduce the scope of their capital expenditures on their office buildings, thatās growing as well,ā he said.
āNaturally people are trying to protect their balance sheets, so theyāre going to defer a little bit there and not spend as much on their buildings because theyāre going to have to spend a bunch on cleaning their buildings.ā
Strong office market pre-COVID
Johnston said owners of downtown office space in major urban markets may not be experiencing major rent collection issues, but with fewer people in the buildings parking revenue is certainly impacted and the health of food court tenants and other services will be severely challenged.
āIn Canada, we had a very, very strong office market going into this. We had historically low vacancy rates, we had increasing rental rates,ā Johnston noted. āWe were in a good position.
āI donāt in any way want to say that the office market is going to crater, because itās not, but I do think this work from home is going to create some uncertainty and itās going to play out over the next six to 18 months.
āAfter layoffs and unemployment and small business bankruptcies, I think work from home is right up there.ā
Survey respondents said over the longer term, a rise in vacancy from bankruptcies and rationalization of space will also exert downward pressure on net effective rents and increase the risk of bad debts.
Cash flow may be affected by longer periods of absorption for some premises, in addition to loss of base rent, loss of recovery from operating costs and other revenues.
As the economic impact of the pandemic remains uncertain, investors take a more cautious approach amidst lingering risks.
The latest results fromĀ Altus Groupās Investment Trends Survey (ITS)Ā for the 4 Benchmark asset classes show that the Overall Capitalization Rate (OCR) pushed up this quarter from 5.02% in Q2 2019 to 5.15% in Q2 2020, and up from 4.94% from the previous quarter.
The COVID-19 pandemic caused several economic shocks across various sectors resulting in rising unemployment rates, limitations in workforce productivity, supply chain constraints and shifts in consumer spending. Challenges with rent collection have also impacted how investors are examining certain asset classes, notably for retail. But, for the first time in a number of years, the expectation for Tier I Regional Malls are up materially in terms of IRR. For the most part, the commercial real estate sector remained resilient, withstanding the current economic shock ā particularly the industrial sector which maintained its strong fundamentals. Overall investment activity based on preliminary activity indicates transaction volume is down across Canada, primarily because of the pause in the market.Ā The good news is that deals are continuing to close.
The Bank of Canada recently noted economic growth is expected to resume in Q3 of this year, but warns the road to economic recovery may be a long and bumpy ride. However, some growth is expected in the near term as restrictions ease up across the country, markets slowly edge towards normalcy, and development activity resumes. With the help of government assistance programs, many businesses may be able to stay afloat. The latestĀ economic forecast from the Conference Board of CanadaĀ expects growth to shrink to -8.2% this year and return to 6.7% in 2021 and 4.8% by 2022, granted the country avoids another national pandemic shutdown. The board also projected unemployment to peak at 13.7% at the end of the second quarter and forecasts 1.3 million jobs to be added from July to September pushing the unemployment rate down to 10.5%. Ā While interest rates may remain low for a more extended period, investors of various sizes still face risks in maintaining traditional income streams and are searching for alternative and more flexible ways to generate yields in the short and long term. Buyer momentum on the location barometer for all markets were down this quarter with the exception of Calgary, which moved up slightly from the previous quarter (Figure 2). However, Vancouver, Toronto, Ottawa and Montreal still showed positive momentum and retained their positions as the top contending markets. It is these larger major markets which remain resilient and are expected to lead the path to recovery upon reopening of the economy and as labour markets mend from the jolt of the pandemic.
Market highlights for the quarter include:
Overall cap rates shift upwards, tempered by concerns over the pandemic aftermath. Investors and lenders remain diligent and cautious of market opportunities and upcoming challenges in the second half of the year.Ā Overall cap rates moved up to 5.15% this quarter with all markets shifting upwards compared to the previous quarter. This was the first overall increase since Q1 2016. Edmonton, Montreal and Ottawa showed the most increase from the previous quarter and year-over-year; Edmonton and Vancouver had the highest increase over other markets with Montreal remaining stable.
The swift transition to a remote work environment has some tenants offloading their excess space, pushing up the sublet market. In a few cases, landlords are also offering to reduce rents to retain existing tenants over a longer period.Ā Downtown Class āAAā Office cap rates rose to 5.53% this quarter, up from 5.30% in the previous quarter and 5.36% in the same quarter last year. Halifax was the only market that had no change from the previous quarter, while all other markets showed an increase. On a year-over-year comparison, all markets shifted upwards with Calgary having the highest increase.
Industrial real estate remains a top performing asset and has been almost immune from the virus and is expected to maintain its strong market fundamentals in the long term. The demand for industrial real estate continues to swell in lock-step with the sharp increase in e-commerce and omni-channel operations. Higher-valued quality assets will continue to be in short supply, increasing pressure on rental growth and pricing, while also creating some opportunities for ground-up development.Ā Single-Tenant Industrial cap rates moderately inched upwards to 5.36% from 5.28% in the previous quarter. Compared to the same quarter last year, overall cap rates compressed slightly moving down from 5.46%. Halifax was the sole market that had cap rate compression from the previous quarter, while all other markets moved up. Quebec City and Ottawa were the two markets that had the highest increase in cap rates compared to the same quarter last year.
The pandemic has hit the economically-sensitive retail sector in many ways, changing the way retail operates and accelerating consumer trends such as online shopping in an already weak sector. Operators are reassessing their strategies and structural decisions around leases in order to adapt to ongoing challenges and shifts in consumer and tenant expectations. However, the average IRR for Tier 1 Regional Malls moved upwards for the first time in several years. Moreover, food-anchored retail, particularly with necessity-based grocery retailers are expected to perform very well and gained a spot as one of the top 4 preferred asset classes (Figure 3). Overall, the sector will need to remain agile and resilient as it continues to face uncertainties in the near term and prepares for a potential resurgence of the virus.Ā Overall cap rates for the Tier I Regional Malls sector increased to 5.29% with all markets moving upwards from 4.94% in the previous quarter and from 4.84% in the same quarter last year. Montreal had the highest rate increase from the previous quarter and Halifax showed the most increase from the same quarter last year.
Demand for multi-res continues to be strong and investors retain a robust appetite for this asset class. However, the multi-residential sector is facing new challenges from increased costs for health & safety processes, threats of rent arrears, restrictions on border controls weakening demand from immigration, and more recently CMHCās suspensions on re-financing for repairs or reinvestment causing financial complications for many property owners.Ā Suburban apartment cap rates marginally moved up to 4.43% from the historically low 4.25% in the previous quarter and 4.40% in the same quarter last year. Quarter-over-quarter, Edmonton had the highest increase in cap rates, with Quebec City remaining stable, and all other markets moderately shifted upwards.
The top 15 products/markets, which showed the most positive momentum were:
OttawaĀ Multi-Tenant Industrial
VancouverĀ Single- and Multi-Tenant Industrial, Industrial Land and Food Anchored Retail Strip
TorontoĀ Suburban Multiple Unit Residential, Food Anchored Retail Strip and Industrial Land
HalifaxĀ Single-Tenant Industrial
Quebec CityĀ Multi-Tenant Industrial
MontrealĀ Suburban Multiple Unit Residential, Industrial Land, Food Anchored Retail Strip, Single- and Multi-Tenant Industrial
Looking northeast at the Union Centre proposal, image via submission to the City of Toronto
Plans put forth byĀ Westbank CorpĀ andĀ Allied Properties REITĀ for a 52-storeyĀ Bjarke Ingels Group-designed office tower have evolved in a recent resubmission to the City of Toronto.Ā Union Centre, slated for an unorthodox site at Lower Simcoe Street and Station Street just west of Union Station, made waves inĀ March, 2019Ā when visuals for the terraced and greenery-infused development were first revealed. Now, Official Plan and Zoning Bylaw Amendment applications have been resubmitted, outlining a more acute level of design detail and some key changes following feedback from City staff and theĀ Design Review Panel.
A City Council-approved scheme to build aĀ 48-storey office towerĀ on the property predates the current proposal, which would be built over the privately-owned Station Street. The property also includes the SkyWalk to the south and the seven-storey data centre at 171 Front Street West to the north. While the SkyWalk will be largely rebuilt and integrated into the base of Union Centre, the highly sensitive data centre is staying put (and unchanged), leaving a narrow but manageable space for the landmark tower to rise.
Looking northeast at Union Centre, image via submission to the City of Toronto
The proposal was presented to the Design Review Panel in September, 2019Ā where panelists drew attention to a number of elements of the design, including the width of the building and the viability of its abundant green roofs. Comments were also directed towards optimizing the pedestrian experience of Station Street, which currently functions as a nondescript access point for parking and loading.
Looking southwest at Union Centre, image via submission to the City of Toronto
The revised plan reduces the total gross floor area from 151,069 mĀ² to 149,044 mĀ². The change in GFA results from the removal of the proposed live performance venue, which has been partially replaced by retail uses in the upper levels of the podium. While the venue will continue to be considered as a potential component of the project, the “uncertainty around demand for large-scale live performance venues” informs the decision to exclude it from this iteration of the design.
With the live performance venue tentatively shelved, the retail program has increased its presence from 1,478 to 2,722 mĀ², and total office space has also expanded from 103,867 to 105,245 mĀ².
An expansion of the abutting data centre has been allocated additional space as well, with 8,337 mĀ² contemplated across five floors, slightly more than theĀ 8,199 mĀ²Ā initially contemplated.
Comparison of building massing along Lower Simcoe Street, 2019 submission and revised proposal, image via submission to the City of Toronto
The main lobby entrance has been moved to Lower Simcoe Street to replace the data centre entrance, which has been relocated to Station Street and reduced in size to allow for additional retail and pedestrian animation. The ground-level setback has increased and the height of the forecourt has doubled from six to 12 metres, creating a more prominent entrance fixture.
Station Street will be afforded a wider pedestrian realm compared to the previous submission, providing a 2.1 to 4.2-metre clearway on the south side of the corridor. A reduction in the width of vehicle lanes from 6.5 to 6 metres gives additional space to the pedestrian realm, coupled with the relocation of the vehicular ramp for underground access further west. Three levels of parking provide 98 new vehicular spaces and 443 bicycle stalls.
Pedestrian circulation through the building, image via submission to the City of Toronto
The revised scheme maintains the PATH connection through the site, with the relocated office entrance providing a more accessible entrance to the network from Lower Simcoe Street. A future bridge connection to the InterContinental Hotel and the Metro Toronto Convention Centre has shifted from level three to two, providing a more seamless connection to and from the UP Express and the link to Union Station.
East elevation, Union Centre, image via submission to the City of Toronto
The tower itself has also undergone some alterations, including the building height, which has increased from 266.7 to 274.2 metres. The number of storeys remains at 52, with the height jump mostly stemming from an increase in the heights of the mechanical floors. The height of the east podium has also increased to match the height of the office lobby, supporting a continuous retail stretch and also potentially accommodating the live performance venue.
South elevation, Union Centre, image via submission to the City of Toronto
Despite criticisms levied by City staff at the 91.5-metre east-west width of the buildingāwhich staff had requested be reduced to 72.5 metresāit remains unchanged. One of the building’s proposed signature elements, a linear core of elevators positioned along the northern facade to maximize efficiency of the floor plates, also remains untouched. The elevator cars are expected to be illuminated at night, visible through the translucent glazing of the envelope.
West elevation, Union Centre, image via submission to the City of Toronto
The resubmission will be accompanied by a Site Plan Approval application at a later date.
North elevation, Union Centre, image via submission to the City of Toronto
As COVID-19 reconfigures global markets, owners and operators of hotels in Canada are anxiously anticipating what the travel and tourism sector will look like in the months and years ahead.
With only a small minority of this countryās hotels currently open, this wait-and-see period is an optimal time to prepare to succeed in the emerging marketplace. If change is needed, this is the time to do it. Later, there may be fewer options.
Already, lenders are reviewing their hotel portfolios to determine where readjustments are required. Hotel owners and operators are experiencing massive revenue losses, while fixed costs remain relatively unchanged and future demand for hotel rooms is uncertain.
Lenders may have to make choices to support certain operators at the expense of others. For properties with no cash flow coming in and burgeoning carrying costs, they will likely require owners to provide a plan to transform or sell. In fact, these discussions have already commenced in some secondary and tertiary hotel markets, as well as Alberta, which is experiencing an additional economic blow to the oil and gas industry.
Recovery of Canadaās hotel sector is not expected to be immediate, even when travel and social distancing restrictions are lifted. Given this uncertain future, this may be the ideal time to pivot.
While the hospitality sector struggles, demand for multi-family housing ā including affordable, market rental, seniors and student housing ā remains relatively robust. Most major markets are under-supplied with affordable options despite the recent and anticipated decline in home prices and rents.
Converting hotels into multi-family housing can help to meet this demand by enabling owners and investors to quickly move supply into the market. As well, City councils look positively on these types of developments because they help to ease the housing and economic needs of residents. There is also a growing track record of conversions that demonstrate how to successfully deliver these projects.
This is an optimal time for hotel owner-operators to determine if your properties are positioned to be winners in the marketplace that will emerge ā or whether an alternative use for these assets, such as conversion to multi-family housing, might be a more financially rewarding option.
Here are the key factors to consider when assessing the feasibility of a conversion.
Demand in the new hospitality industry
The pandemic and its related restrictions on business and leisure travel have had an unprecedented impact on the hospitality industry. Fear of community spread of the novel coronavirus has led to cancellations of flights, events and room bookings that have decimated hotel occupancy rates ā and profit margins. This spring, Canadaās hotels experienced a 90% drop in revenue as occupancy plummeted to less than 5% [1].
While the duration and depth of this downturn continues to be unclear, it is clear that industry recovery will be a long process. Hotels are only gradually reopening on a selected basis, which varies significantly from market to market.
The Hotel Association of Canada and the American Hotel and Lodging Association recently released health and safety protocols for new pandemicĀ standards. With extensive requirements for cleaning and physical distancing, these represent heavyĀ additional costs for the industry.
Some portion of business travel will never return, replaced by video calls and virtual conferencing. Many hotels generate significant revenue from renting space for meetingsĀ and events, which also affects guest room bookings.
It is a similar situation with international travellers. More than 22 million people visited Canada last year. But with a pandemic that experts predict may endure for two years, fear of travelling and enforcement of social distance protocols may linger even longer.
The good news is that while international and business travel will be limited in the short to medium term, local and regional travel is likely to increase as inter-provincial travel restrictions are eased and Canadians opt for drive-to destinations to reduce travel risks.
Realistically evaluate strengths, weaknesses, opportunities and threats
Will your property have a stake in this new hospitality market? Or will it be able to gain a stake?
To find answers and develop an appropriate plan, a SWOT (strengths-weaknesses-opportunities-threats) analysis is a good place to start. This enables you to identify the threats and opportunities for your hotel assets in the context of this newly forming marketplace, as well as to assess the strengths and weaknesses of your property that will propel and/or inhibit optimal performance or growth.
An analysis should reveal answers to questions such as the following. What are the characteristics of your market? What was your market share pre-COVID? Was it growing or shrinking? What was your propertyās pre-COVID market segmentation: corporate, leisure, international, national and/or regional? Where do you believe demand in your market will come from? What do your projections indicate for the next two, three and five years?
Can the hotelās physical infrastructure accommodate physical distancing requirements? Or can it be altered sufficiently with a reasonable capital investment? Can it meet the evolving needs of guests and brand standards? If you invest the funds, what returns can you expect? If you continue operating, will the hotel brand support you? Will your lender?
Being realistic is crucial. Smaller, older, owner-operated hotel properties, particularly those in secondary and tertiary markets, may not adapt well to a novel coronavirus world and could face a significant struggle to rebound. For these properties, weighing options is vital. Should deferred capital expenditures be at the point where there is unlikely to be a positive return over the long term, itās time to determine the best use of these assets.
Evaluate the options
Affordable, market rental, seniors and student housing ā these all represent potentially profitable conversions for hotels with complementary footprints and infrastructure. Conversions to multi-family buildings could also allow for a stable, long-term return, compared to condominium or commercial conversions.
The following is an overview for each type of housing, along with examples of successful conversions.
Affordable housing:Ā Most jurisdictions across Canada need more affordable housing, especially urban areas. In 2018, at least one member of 283,800 Canadian households was on a waiting list for social and affordable housing. [2]
After announcing Canadaās first-ever National Housing Strategy, the federal government allocated $55 billion in the 2019 budget to this 10-year plan to help reduce homelessness and improve the affordability, availability and quality of housing for Canadians in need. All levels of government are jointly delivering this strategy. Cities are supporting this initiative in numerous ways, including prioritizing the development of affordable housing, reducing or exempting fees and expediting permits for affordable housing developments.
Still, itās challenging for municipalities to cost-effectively build this type of housing. Conversions of hotels with a complementary floor plate can present an attractive solution. At the same time, location is key because affordable housing is generally needed in city cores.
The BC government, for example, purchased the 65-room Comfort Inn Hotel near downtown Victoria to provide temporary housing for the homeless amid the COVID-19 pandemic. BC Housing is one of the operators and is consulting with the community about a permanent conversion to an affordable housing site.
This spring, the City of Toronto signed contracts with numerous hotels for hundreds of rooms to ease crowding in homeless shelters. Mayor Tory said officials were also investigating whether some sites could be converted into permanent housing to help with the cityās affordable housing shortage.
Recently, Horizon Housing in Calgary purchased a local hotel, The Elan, with plans to convert the hotel to offer 62 studio, one- and two-bedroom affordable housing units.
Itās helpful to keep in mind that affordable housing is independent of economic cycles so itās a particularly appealing alternative use for hotel properties. Crucially, due to intense demand for this type of housing, financial and other support is available from various levels of government to induce supply.
Can the hotelās physical infrastructure accommodate physical distancing requirements? Or can it be altered sufficiently with a reasonable capital investment? Can it meet the evolving needs of guests and brand standards? If you invest the funds, what returns can you expect? If you continue operating, will the hotel brand support you? Will your lender?
Being realistic is crucial. Smaller, older, owner-operated hotel properties, particularly those in secondary and tertiary markets, may not adapt well to a novel coronavirus world and could face a significant struggle to rebound. For these properties, weighing options is vital. Should deferred capital expenditures be at the point where there is unlikely to be a positive return over the long term, itās time to determine the best use of these assets.
Market rental:Ā There is unprecedented tenant demand and rental growth in apartment buildings across the country. Rental rates are at or near 10-year highs in almost every market. The national average vacancy rate at the end of 2019 was 2.3% and average rents for purpose-built rental units grew nationally by 4.1%.[3]
Last year, North Americaās first all-suite hotel, the 35-storey International Hotel in downtown Calgary, which had opened in 1970, was renovated into 252 premium long- and short-term rental apartments.
The 45-storey Edmonton House apartment hotel was the second tallest building in the city when it opened in 1971. It was converted to a suite hotel in 2006 and then nine years later, into a 328-unit apartment building. Ā The landmark building is currently for sale again, with notable interest.
The key challenge for conversion to market rental is whether a property may require extensive and expensive renovation to meet the demands of todayās renters for a variety of high-quality amenities with features and services similar to those offered by upscale hotels.
Seniors housing:Ā Reflecting the rapid growth of Canadaās senior population, the number of hotels being transformed into retirement homes and assisted living facilities has been growing over the past five years or so.
In 2016, there were 5,935,635 seniors 65 years of age and older, representing about 17% of the countryās population; this percentage is expected to increase to 24% by 2036. [4]Ā Within six years Canada will require 131,000 more spaces for seniors. [5]
Ā Hotels can often be good candidates for such conversions because senior residences do not necessarily require full in-suite kitchens and hotel dining and meetings spaces can readily be converted to dining rooms and amenities for seniors.
One example is the 23-year-old Peninsula Inn Hotel in Niagara Falls. It is currently undergoing a $5 million conversion into a wellness, supportive living and enhanced care residence. Amenities will include an indoor pool, tuck shop, fitness centre, activity room, chapel, and an outdoor patio and bistro.
Like hotels, many retirement and assisted-living homes operate on an owner-manager model. Using a third-party operator to manage a seniors facility can help to mitigate the risks associated with conversion.
Student housing:Ā Developing off-campus rental housing for Canadaās growing student population is close to 15 years behind the US and the UK according to the Real Estate Investment Network. Only three per cent of Canadian university students live in purpose-built off-campus student housing compared to 10-12% in these countries.[6]
While demand has been accelerated by international students, which the COVID-19 crisis has dampened in the short term, it is expected to pick up again.
Over the past few years, there have been numerous successful hotel-to-student housing conversions across the country. Colleges and universities are increasingly partnering with private developers to build residences that the secondary institution subsequently owns, operates and occupies. Partnering with an institution reduces risk and opens access to government incentives.
One of the earliest examples was the 11-storey Hotel Ibis in downtown Toronto. Purchased by Ryerson Polytechnical Institute in August 1993, it was repurposed into housing for 270 students and a home for the Hospitality and Tourism Management Program.
Hotels with a high suite count present good conversion options. Most important though, is location. Housing for students needs to be within a short walk of campus or readily accessible by transit.
Determine whether conversion is feasible for your property
To determine whether any of these options might be viable for a hotel property, a highest and best use analysis and feasibility study are essential.
Highest and best use analysis
This analysis can quantify the level of demand and supply for optional uses of a building within specific markets and project which option will likely add value and generate long-term returns. It answers key questions such as the following.
What is the macroeconomic environment of the area: employment, income growth, population growth, demographic characteristics?
Current and future market demand?
Sector profitability?
Competitive landscape?
Industry cost structure?
Regulatory controls?
The communityās position on potential redevelopment?
The results of this analysis can help to determine the best use of the asset ā and inform design, financing and ultimately, the marketing of a project.
Feasibility study
This next step is aĀ feasibility study. This can explore a range of options for a property to determine which one, if any, are the best approach. Or it can focus on a specific option to determine its viability ā legally, technically and financially. A comprehensive, well-designed study encompasses the following components.
Market feasibility:Ā Building on a highest and best use analysis, this study takes an in-depth look at the demand and supply factors for the proposed use and its sub-market. The study can identify market opportunities and provide recommendations related to market characteristics, such as product design, pricing and potential absorption.
Site suitability:Ā The study can determine whether the location is suitable for the vision, use and business model. This includes identifying government ordinances and examining the possibility and timing of securing any required zoning exceptions, variances or rezoning approvals.
Physical feasibility:Ā All multi-family housing ā no matter what type ā now requires a certain set of market-standard amenities. The feasibility study will determine whether a hotel conversion can accommodate this. A wood frame building, for example, is more easily renovated than a concrete building. Hotels built in the 1960s-1980s had larger rooms and tend to be good candidates for conversions, especially those with a predominance of suites and abundant amenity space.
Ā The feasibility study examines the physical characteristics of the property to assess potential financial ramifications.
Building ā condition of building envelope; HVAC; electrical, lighting and fire systems; technology infrastructure; finishes
Tenant space ā floor plate size and shape; usable square footage; common area factors
Legal/regulatory ā building codes; insurance requirements; government regulations
Financial modelling:Ā Since the operating model for each type of multi-family housing is different, financial modelling of the options is fundamental. This would integrate the renovation costs that will have to be incurred, revenues that are likely to be achieved, operating pro formas and net financial returns. This will also take into consideration the current market value of the hotel that is being contemplated for purchase.
Retirement homes, for example, must meet extensive building code standards as well as other standards for resident care and safety including fire prevention and protection. When it comes to operations, lease-up may take a year or two, impacting cash flow for a significant period. This is a particularly important consideration during the pandemic when the regulatory environment is evolving.
Financial modelling also takes into account financing costs, including the availability of government incentive programs. For instance, there is a wide variety of federal, provincial and municipal incentives available for the development of affordable housing. When it comes to student housing, secondary institutions have access to capital at rates that are significantly more attractive than those available to private sector borrowers. And Canada Mortgage and Housing Corporation offers programs for affordable and/or market rental, seniors and student housing. These supports can have a significant impact on project financing and returns for each type of conversion.
Property taxesĀ are another significant factor in financial modelling. While hotels, for example, are taxed at a commercial rate, rental housing is taxed at a residential rate. In Toronto, the commercial rate is about 3.5 times higher than the residential rate. In many other jurisdictions the commercial rate is at least double that of residential.
Use this transition time to position your property for long-term prosperity
Ultimately, equipped with a highest and best use analysis and feasibility study, along with a current valuation of a hotel property, determining the most profitable option for the asset can quickly become clear.
This information will also be invaluable in lender discussions. With the market experiencing a contraction in demand, and a concurrent contraction of capital available for acquisitions while lenders more cautiously weigh risks and rewards, a property sale at this time would likely yield lower values. Should you decide instead to move forward with a conversion option, your lender can be an invaluable ally in helping you realize the potential of your property.
As with any successful development project, having the right partners is key ā capital partner, consulting partner, development partner, and operating partner. Gather the expertise needed to realistically assess your property and to determine how it fits into the current market and how it might fit into a new market. Then use this transition time productively to position your hotel asset for long-term prosperity.
There have been many distractions in recent months asĀ Dream Office REITĀ (D-UN-T) deals with pandemic-related issues, but one of its core downtown Toronto projects continues to move ahead at almost full speed.
The Dream Collection is comprised of 11 boutique luxury office buildings on Bay, Richmond and Temperance Streets totaling about 500,000 square feet. Theyāre getting a variety of upgrades, including new facades, lobbies, bathrooms, elevators, and heating, ventilation and air-conditioning systems.
āThereās not a class of buildings like that in Toronto,ā said Dream Office REIT COO Gord Wadley in an interview with RENX. āWeāre on track to get everything complete by around Q2 of next year.ā
Some of the Dream Collection buildings back on to a āhā-shaped alley which Wadley said the REITĀ will animate into a ākind of European outdoor settingā that will feature stores, licensed restaurants and seating.
Wadley believes the Dream Collection will play an integral part in the REITās post-COVID-19 recovery and provide a strong return on capital investments.
The appeal of Torontoās Bay Street
āWeāve had really good demand in terms of the vacancies we have had. Our rates have been really strong. Weāve been doing some really good deals that rival some of the AAA towers in the market,ā he explained. āWeāre seeing a lot of people who find the appeal of having a Bay Street address, but (they prefer to have) a full floor at 3,000 to 5,000 square feet, which a lot of these floor plates are.
āTheyāre not typically sharing a massive floor plate. Theyāve got their own autonomy on one floor.ā
One of the Dream Collection buildings Wadley is most excited about is the completely leased, 62,932-square-footĀ 357 Bay Street, where tenants should be in place in the second half of 2021.
āWeāre actively working withĀ WeWorkĀ right now on their fit-up of the building,ā said Wadley. āIt was a total re-gut. We took all of the floors out, repoured the slabs and put in all-new base building systems.
āItās a beautiful historic building, but on the inside itās been fully modernized.ā
Dream Office dealing with COVID-19
While the Dream Collection project progresses, the REIT has been active on many fronts dealing with COVID-19 fallout, but so far it has not had to worry about rent collections.
Dream Office REIT collected 95 per cent of its April rents and 92 per cent in May while working with tenants to help them through the crisis.
The REIT owns 29 properties encompassing 5.3 million square feet of gross leaseable area. The average building height is 14 storeys and the portfolio is 89.9 per cent occupied.
āWhen we started working from home, we started reallocating people that traditionally did other jobs to be part of a client services team so that they could take concerns, listen, be an empathetic voice on the other end of the line and help facilitate,ā Wadley told RENX.
As part of that process, it agreed to defer gross rents for certain tenants for one to three months based on their individual needs.
CECRA and other government programs
The REIT has been educating tenants on government-led relief initiatives and assisting with back-to-work planning for their employees.
Itās working with smaller tenants who qualify for theĀ Canada Emergency Commercial Rent AssistanceĀ program (those paying less than $50,000 in gross rent per month, generating less than $20 million in revenues at a corporate level and experiencing a revenue decline of at least 70 per cent during April, May and June).
The REIT is reviewing approximately 50 CECRA applications from tenants and is lending a hand with other government relief programs.
āA number of our tenants are using the wage subsidy and small business loans,ā said Wadley. āThe student jobs rebate program is popular as well, and our client services team sends out a weekly update with links to all programs, new and existing, to help provide important information as it becomes available.ā
Back-to-office initiatives
Dream Office REIT developed a comprehensive back-to-work plan for tenants and is making a number of health- and safety-related changes to its buildings as employees start to return to their offices.
To promote physical distancing, building lobbies will have separate entry and exit points and unidirectional traffic flows.
Hand sanitizers have been placed at entrances, signage helps direct movement, and designated courier drop-off points have been introduced to minimize outside visitor traffic. Enhanced cleaning is taking place in high-touchpoint areas.
āWe want to over-communicate what weāre doing so thereās no ambiguity when people go in regarding way-finding, cleaning stations, UV technology in the elevators, some cleaning technologies for all of our escalators and common areas, hospital-grade cleaning, new filters in all of our HVAC systems, and some UV filtration in some specific systems,ā said Wadley.
āWeāre really trying to go over and above in terms of hopefully making people feel safe. I think itās incumbent on all landlords to do that.ā
The goal is to have all of these new technologies, systems and upgrades in place by August.
Dream Office REIT leasing activity
Despite COVID-19ās disruption to the leasing market, Dream Office REIT is managing an active pipeline of renewals and new leases with existing and prospective tenants. Itās working on approximately 370,000 square feet of leasing deals across the portfolio.
āWeāre getting more creative with deals in terms of maybe offering some additional landlordās work to the space to try and welcome tenants in,ā said Wadley.
While government restrictions have precluded in-person property showings to prospective tenants, Dream Office REIT has developed models for virtual tours of vacant units and to provide examples of finished spaces.
Portfolioās strengths should help stock price
The stock prices of most REITs fell sharply in late March and have made gradual upward climbs since then.
Dream Office REIT has been no different. Its price was $20.22 as of morning trading on July 7, down significantly from its 52-week high of $36.80 but up from its 52-week low of $15.21.
āI think the fundamentals of our buildings are strong,ā said Wadley. āWeāre predominantly a downtown Toronto core REIT, which is the best market in the country in terms of commercial real estate.ā
Retail represents just six per cent of Dream Office REITās income, according to Wadley, which is another strength at a time when that asset class is struggling.
Rather than ditching their skyscraper offices after the pandemic, companies are keen to return to the workplace.
Brookfield Asset Management Inc., one of the worldās biggest real estate investors, is seeing higher demand for office space as workers return to socially-distanced buildings.
Rather than ditching their skyscraper offices after the pandemic, companies are keen to return to the workplace after spending as long as three months in lockdown, Bruce Flatt, chief executive officer of Brookfield, said at the Bloomberg Invest Global virtual conference on Wednesday.
āToday weāre leasing greater amounts of space to people than they had before,ā Flatt said. āThey want to accommodate their people and get them back quickly. Theyāre increasing their footprints versus taking less.ā
Most companies that Brookfield leases offices to are bringing workers back, said Flatt. The only reason some werenāt was a lack of social distancing space. Brookfield has reopened nearly all of its global offices, he said, with about 70 per cent of London workers returning and around 30 per cent of New York employees.
INFRASTRUCTURE BOOM
Brookfield is well-positioned to weather the pandemic. Flatt last month said the company had US$46 billion in client commitments for new investments and US$15 billion in cash, other financial assets and long-dated credit facilities across its various businesses that remain largely undrawn.
The company was one of six investors that bought a US$10.1-billion stake in Abu Dhabiās natural-gas pipelines, according to a statement Tuesday. Flatt said the deal was a taste of things to come for global investors.
The transaction shows āthat corporates and governments are going to have and will continue to outsource major amounts of infrastructure spend around the world,ā he said. The trend is starting now and will continue āfor the next 25 years,ā he said.
In the first quarter, Brookfield altered its strategy to investing in public companies that were trading at a fraction of what it cost to acquire assets directly from the firms. It pumped roughly US$2 billion into public equity markets, including repurchasing its own shares and those of its publicly traded subsidiaries.
The asset manager also recently acquired just over 7 per cent of British Land Co., one of the U.K.ās largest real estate investment trusts.
A survey by Colliers International finds projected decline in overall office space needs across Canada only expected to be 8.5% over four years
The current era of remote work has compelled a significant number of companies to reevaluate their need for office space, but the projected decline in overall office space needs across Canada is only expected to be 8.5 per cent, with most of the changes happening over the next four years, according to a new report from real estate company Colliers International.
The company surveyed 445 of its own tenants between May 26 and June 2 ā more than two months after remote working began for many white-collar workers ā and found that 47 per cent of respondents said their office space needs had decreased.
But of the 47 per cent, only 11 per cent said they would reduce their office space by 80-100 per cent, the survey said.
āAssuming the economy recovers to pre-COVID-19 levels, our analysis indicates that the factor of an ongoing work from home approach could result in a potential reduction of tenant office space needs by an average of 8.5 per cent.ā
A third of respondents said their office space needs would not change in the future, and a further 20 per cent said they were uncertain of what their needs would be over the next few years.
āThereās been a lot of talk of the death of the office. I would say the survey proves that it will not happen,ā said John Duda, president of real estate management services at Colliers. āNobody is really saying that we are not going to have office space. There will probably be more flexibility, but thereās no point trying to predict the long-term right now.ā
The Colliersā survey also showed that four per cent of its office tenants will likely shutter their businesses entirely because of the pandemic. āIf all these tenants followed through with these closures, it would lead to a three per cent decrease in rent collections, and a two per cent decrease in the vacancy rate,ā the report said.
Part of the reason why some businesses have indicated they would move towards a reduction in office space is because of the decline in the overall number of employees ā in fact, 56 per cent of Colliersā tenants fit this criteria. Just 44 per cent of those surveyed have maintained the same number of employees since mid-March.
But as life in some major cities begins to return to some normalcy, Brookfield Asset Management Inc., one of the largest owners of office real estate in North America, said Wednesday that itās seeing higher demand for office space as 30 per cent of its own New York employees and 70 per cent of its London employees return to work this week.
āToday weāre leasing greater amounts of space to people than they had before. They want to accommodate their people and get them back quickly,ā the companyās CEO Bruce Flatt told an audience at the Bloomberg Invest Global virtual conference.
Remote working had a substantial impact on productivity according to Colliersā tenants ā they estimated employee productivity to have declined by 22 per cent throughout the course of the pandemic.
āYou canāt create a productive work culture when everyone is sitting at home,ā said Duda, adding that companies such as Shopify Inc. for example, that have allowed employees to work from home indefinitely will eventually have a ārude awakeningā when productivity levels diminish.
Polling on this subject, however, is divided. A two-year long Stanford University study conducted back in 2018, for example, showed that work-from-home employees worked a true full-shift or more, compared to when they were present in the office simply because of fewer distractions in their midst.
An ongoing research project on remote working by University of Montrealās School of Industrial Relations showed that while workloads have increased because of telework, staff productivity has risen in tandem.
Michael Cooper, CEO of Dream Office Real Estate Investment Trust, believes that remote working could push certain office buildings that are older and in less central locations to remain vacant in the long run, although he disagrees with the notion that most offices will eventually become obsolete.
āItās just too early to tell. But I can tell you that our tenants are doing okay, and in fact over the last few years we have diversified and sold 140 buildings, keeping just 32 that we thinkĀ we wonāt have problems going forward,ā told the Financial Post in an interview.
