CRE execs expect office tenants to downsize.

The bad news is that in its latest Key Assumptions Survey Update, a majority of CRE executives canvassed by Altus Group are concerned an office space downsizing of 10 to 20 per cent could result from the COVID-19 pandemic.

The good news is that for owners and managers of high-quality office space, strong market fundamentals across most of Canada should allow this space to be taken up fairly quickly — if in fact the downsizing occurs.

The results show 57 per cent of respondents active in the office sector believe their tenants will downsize (21 per cent were not yet sure, 22 per cent did not believe there would be a downsizing).

“I think if it is 10 to 20 per cent (downsizing), we will be able to absorb that in most of the CBDs in Canada fairly well,” said Altus Group’s Colin Johnston, the firm’s president of research and valuation, Canada. “The important thing to remember is we had some of the healthiest office markets in North America prior to the pandemic. We had very, very low vacancy in Toronto,] and in Vancouver we had positive rental growth and had for several years.

“Montreal had new construction for the first time in a while so it was very, very strong. We had great fundamentals, we hadn’t overbuilt (and) even though we had new product coming on, it was predominantly pre-leased, so the market was very strong.”

Large office occupiers waiting to make decisions

The survey was conducted in November and drew responses from 115 executives with pensions funds and life companies, publicly traded corporations (REITs), private companies and brokerages. The survey focused on office and retail trends.

“By no means is surveying 100-plus people a massive sample size, but I think it was interesting people said 10 to 20 per cent,” Johnston noted. What is already evident is that larger occupiers are attempting to hedge their bets on the future of office space.

“It will definitely take a long time to play out but what I think is interesting, when it comes to renewals, we are seeing people doing two- and three-year renewals because they don’t want to make a call on their long-term space planning needs.”

With so many factors in play, there is almost a wait-and-see attitude across the industry, from both tenants and building owners and managers. Leasing rates are generally holding steady in the major urban centres, despite more sublease space coming onto the market and an expectation work-from-home trends will remain to some degree.

While there is also a shift back toward suburban office space, there is no firm commitment to a massive hub-and-spoke movement. At least not yet.

Questions remain about work-from-home

Johnston said there is more certainty among larger occupiers such as financial and accounting firms, law firms and other service-based sectors that, at some level, work-from-home will continue. The question remains how many workers?

“In our discussions with them, what they’ve found is it’s the back-office workers they are not really going to need (in the office full-time). The finance departments, the marketing departments, IT etcetera. There’s a lot that can just be done remotely,” Johnston explained.

“When we talk to law firms, the lawyers are saying, ‘Of course the partners will be back, we need to be back, to collaborate. But the paralegals, I don’t know if we are going to need all of them to come back.’

“I think there’s an idea that some people will have hybrids, will be working one or maybe two days at home, but there will be some people that there won’t be a requirement for them to come back. What we don’t know is if they don’t come back, you have less employees but are these less employees going to need a bit more space?”

While the overall office footprint is still a big question mark, Johnston said one trend is beginning to solidify. He expects a “flight to quality” to quickly absorb the best space, but to create challenges for lower-quality office owners.

“One thing that is more clear is that people are definitely more pessimistic for the lower-quality office assets. That seems to generally be more entrenched than it was before,” he said. “I think the B and C market is definitely going to be challenged and that became clear in this report.”

Retail key assumptions

The retail report highlights a sector which is facing challenges across almost all segments. Trends already in play due to e-commerce and last-mile distribution have been accelerated.

About 90 per cent of respondents believe rents will decline for virtually all classes of retail properties through 2021. The exceptions are power centres (68 per cent believe rents will decline), and grocery- and food-anchored strip retail where 53 per cent believe rents will remain stable and 14 per cent believe they will increase.

Lag vacancy is expected to grow, as well as financial allowances for vacancies and bad credit.

“The one thing that has become pretty clear to me is that these secondary malls, the ones that were already in trouble and perhaps lost a Sears and lost a Target, the timeline for redevelopment or repurposing has definitely been accelerated,” Johnston said.

Some of these properties could join a trend already taking hold in the U.S. Since 2016, Johnston said, 24 malls representing eight million square feet have been repurposed for distribution facilities.

“I think we’ll see that happening in Canada, maybe not to that extreme because the U.S. was over-retailed and had a lot more ghost malls.”

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