The COVID-19 pandemic that hit centre-stage in mid-March, has brought about an unprecedented change. Around the globe, people are still quarantined in their homes, even as others practice physical-distancing, and still, others slowly expand their personal bubbles, all while world economy tries to adjust to the drastic and sudden transformation brought about by the pandemic.
Even now, just over four months after the official declaration by the World Health Organization of a pandemic, there is still concern about the strength and resilience of the nation’s real estate market even though prices have not dropped all that significantly. Every country, economic sector, business and family group continue to look for ways to survive the slowdown — and the key stakeholders in Canada’s real estate marketplace are in this mix, trying to figure it all out. Yet, the ‘real estate market’ is not one monolithic segment of the economy. There are different segments and divisions, each impacted and recovering in different ways. While headlines may be trumpeting the death of the suburban mall, anecdotal stories from real estate agents are highlighting the bidding wars for specific property types in certain neighbourhoods. Clearly, it’s not possible to predict the survival of Canada’s housing market based solely on one or two economic factors.
The resilience and differentiation between the various property market segments were clearly illustrated in a recent report released by RCLCO, a U.S.-based quantitative real estate analysis firm. Twice a year, RCLCO polls and discusses market conditions with industry experts across North America.
The initial takeaway from this, their most recent bi-annual report which was released on June 30, 2020, was how pessimistic property professionals were, today, in the wake of COVID-19 economic troubles. This is significant, given that more than two-thirds (68%) of the respondents have worked in the real estate industry for more than 20 years, and 85% of these respondents are either C-suite or senior executives in their organizations.
According to RCLCO respondents, a third of the respondents believed the overall real estate marketplace was in significantly worse shape than a year ago.
Despite the gloomy outlook and tough economic conditions, these industry experts did find a silver-linings. For instance, these experts pointed out that in virtually every real estate sector, the economic cycle was either at or would soon reach the bottom of this current market cycle; better still, a few sectors, such as multi-family residential, age-restricted complexes and vacant land were poised to enter early recovery in the next quarter, while the industrial sector was already in early recovery.
Phased openings and what it means for real estate
Even as the world continues to open up from a prolonged period of self-isolation and social distancing, each property segment and geographical area are impacted and responding to this pandemic in different ways.
To help, here’s a synopsis on how each geographical region and real estate sector is handling the current situation.
Impact of the pandemic on residential real estate
Around the world, the residential real estate market saw a temporary plunge in business due to mandatory social-distancing measures implemented in most countries globally. Headlines announced plummeting sales figures and buyers began to expect sudden and precipitous drops in housing prices.
According to a Reuter’s poll of more than 100 economists across the globe, housing prices in Australia, India, Dubai, Britain, Canada and the United States are expected to fall this year and next, based on the “worst-case scenario.”
As the New York Times reported, “prices across most major markets will fall, probably around 5%…and in some, it could be more significant,” according to Liam Baily, head of research at Knight Frank, global real estate consultants.
Turns out prices for residential housing did start to slip in April and May and even June. Agents, buyers and sellers began to see price drops in some areas and for some property types but the bottom didn’t fall out of the market, as many people expected.
For example, in Australia’s biggest cities, such as Sydney, housing prices dropped by approximately 0.5%, on average. Housing prices in suburban Australian communities faced slightly steeper declines with an average price drop of 0.6%. (In the UK, analysts at Capital Economics, a leading global independent economic research firm, predict an average price drop of 4%, by the end of 2020.)
Lack of first-time buyers is a major problem
In Canada, the biggest threat to housing prices is not the lack of supply, as sellers choose to wait out this current market, but a lack of first-time buyers and the impact of high household debt.
As Marc Pinsonneault, senior economist at National Bank of Canada in Montreal, pointed out, constraints on the budget will only worsen as soon as federal emergency payments stop and the period for mortgage deferral ends. The largest, but still unknown, impact will come if and when there are outright job losses, rather than temporary lay-offs.
Supply-chain problems hinder housing recovery
Other countries around the world have not faired as well. For example, India’s Covid-19 lockdown put the country’s struggling real estate industry in a tough spot. Developers are struggling to finish ongoing projects amidst supply chain disruptions and the loss of workers, who are fleeing to their hometowns. The result is a build-up of inventory of unsold properties, which is putting severe downward pressure on overall housing prices.
Resiliency of housing market put to the test
What really baffled some, however, was that when the economy finally started to open up a bit in June and July, housing prices in the largest (and typically hottest) residential real estate marketplaces, actually began to climb — at least for some price bands and for certain property types.
According to the RCLCO report, only 7% of respondents expected dramatic price declines in residential resale properties. (A dramatic decline is defined as a 20% or more drop in property prices.) Another 23% expected a severe drop in prices (between 10% to 20%); 34% expected a moderate decline in sale prices (between 5% and 9%), while 25% anticipated a minimal (up to 5%) drop in prices. Quite surprisingly, 11% of respondents anticipated absolutely no impact from the pandemic outbreak on resale housing prices.
Benefit of virtual solutions
One way the global residential real estate marketplace responded to the social-distancing clamp-down was to find and implement virtual options.
Rather than meeting in offices and coffee shops, buyers and sellers now meet their agents and brokers through Zoom or FaceTime. Shoppers started to rely on 3D house-tours and professionally prepared floor plans, while agents and sellers began to introduce cleaning and viewing protocols that reduced the risk of possible viral transmission for buyers serious enough to book viewings of properties. Finally, agents and brokers began to pre-screen buyers, asking them to obtain mortgage pre-approval prior to setting up viewings in order to demonstrate their commitment to purchasing during these unusual times.
As a result, demand for residential property continues to be high across most developed global residential markets, despite the pandemic. Developing countries, on the other hand, will face a much harder and more prolonged recovery as the impact of the virus continues to affect the poorest and least prepared segments of the population.
Work-from-home options may help real estate sales
According to the Reuter’s poll, published in the New York Times, more than half of the 72 polled analysts predicted that buyers would start to expand their house-hunt, moving away from major cities into more spacious and more affordable properties located in the suburbs and in smaller communities.
This migration will be spurred by people now accustomed to working from home. No longer facing long commutes, these first-time buyers and move-on-uppers, and those who seek a bit more space but without having to pay a large premium for that space, are no longer focusing their house-hunting efforts on urban communities. According to those save 72 analysts polled by Reuters, more than half predict an exodus away from big city homes as buyers move out to the suburbs and smaller communities in the medium to long-term.
“It will be fine-tuning rather than mass-exodus,” explained Miles Shipside, director at UK property website Rightmove in a New York Times article. “Cities are convenient as the commute is shorter, but access to outside space and space internally are bigger factors. That might mean finding that in cities, or moving further out.”
Impact of the pandemic on commercial residential real estate
Seniors housing, student housing, apartment and rental properties remain a bright spot during this pandemic-influenced economy.
According to the RCLCO report, more than half of all the C-suite respondents expected little to no impact on senior housing (57%), student housing (52%), residential rentals (78%), and rental apartments (79%).
As report authors noted, while the transaction volume in the multifamily rental sector, had dropped to nearly zero in the early stages of the pandemic, this segment is starting to make a strong comeback. “Many of the deals that had been pulled from the market in Q1 and Q2 2020 are likely to come back to the market in the second half of 2020, with very little, and for some of the best assets no, repricing.”
New home builders were hesitant, but see resilience in the near future
In the homebuilding space, many builders sharply curtailed the number of spec homes scheduled for the weeks and months after the World Health Organization formally announced the novel coronavirus pandemic (on March 11, 2020). This didn’t mean that builders stopped all activity. New build activity continued to move forward with a focus on projects and land development that was already in process before the pandemic hit. Instead, developers and builders opted to delay next phase projects, until a future point in time when there was better clarity on the impact of this pandemic on employment numbers and consumer optimism. Four months into the social-distancing requirements to flatten the pandemic curve, and many builders are starting to slow press forward with the next phases in their developments. This slow ramp-up is prompted, primarily, with strong sales activity, due to continued buy-side demand and extremely limited supply-side inventory.
Impact of the pandemic on commercial real estate
The pandemic-induced physical distancing may have changed the picture of the commercial real estate marketplace, forever.
In the last few months, many employees (and employers) have grown more comfortable with the work-from-home arrangements. Now considered a safe alternative to closing up shop completely, the work-from-home movement has now been given a large-scale working test that proves it’s not only possible but comes with a variety of benefits.
It also comes with some significant drawbacks, particularly for the harder hit commercial retail space.
Impact on retail commercial space
In the first few weeks various retail commercial sectors, ranging from bars and restaurants to malls temporarily shuttered their doors. Over that first month, there was speculation as to how these suddenly shuttered retail stores would survive. Clothing sales, alone, were down roughly 50% in the first few weeks of the crisis.
For some, like Waterloo, ON-based Plasticity Labs as well as globally present Microsoft, eventually there was an announcement that their bricks and mortar locations would not reopen — in fact, those bricks and mortar stores would never again re-open. A decision had been made to transfer all commercial business to online stores and e-commerce sales.
This won’t be the last of the closures for retail stores. According to Green Street Advisors, more than half of department stores in malls across the U.S. will close by the end of 2021. Another advisory firm, Coresight Research, predicts the closure of as many as 25,000 stores in the U.S. will close their doors for good by the end of this year — 60% of these closures will be stores located inside malls.
According to RCLCO respondents, regional malls will bear the brunt of the economic fall-out from this pandemic, with 46% predicting dramatic valuation declines (of 20% or more) in retail mall rents and sale prices; however, larger malls, big box stores and power centres were expected to fare a bit better with only 17% of respondents anticipating dramatic price declines over the next 12 months.
To combat the loss of foot traffic, mall owners and stores had to get creative. The Cadillac Fairview Group, a Canadian retail owner, developer and manager responsible for Toronto’s iconic Eaton Centre and the Shops at Don Mills, as well as Vancouver’s preeminent luxury mall, Pacific Centre, launched Ravel, an online program that hopes to become a virtual mall in a pocket. As Jose Ribau, Cadillac Fairview’s head of innovation explained during an interview on RBC’s Disruptors podcast, the Ravel is an attempt to entice shoppers back to buying by providing styles and colours that may not be currently in stock at retail stores; the program also helps these online shoppers compare items and selections across stores, allowing them to window-shop without fear.
In fact, in order to survive the current situation, the retail sector had to adopt digital and shift resources to online shopping. That meant shifting focus and resources away from retail schedules and setting up distribution infrastructure that relies on seamless online shopping experiences and door-to-door delivery service.
While some segments of the retail property space appear to be absorbing current economic downturns, others are struggling — not surprising given that many of these struggling segments were already experiencing challenges pre-pandemic with the rise of online shopping. With the exception of grocery stores and pharmacies, retail properties have been the hardest hit real property segment and, more than likely will be the last to recover.
Impact on educational institutions
The COVID-19 is also likely to create a broader market for online education. Depending on how long the lockdown lasts, schools and universities will be forced to find long-term solutions to take their classes online. Already, professors at colleges and universities across Canada have been instructed to prepare all their fall classes as online courses.
Impact on food establishments
One of the fastest transitions from in-person to online was seen in the retail foodservice sector. To stay in business, restaurants and bakeries had to quickly adopt a delivery system that allowed for efficient and effective door-to-door delivery of their eatables. For some, such as my family’s whole-food bakery located in Benicia, CA, this shift was a major departure from their original business model but vital if they wanted to stay open, profitable and keep people employed. The key was a swift acceptance of the limitations imposed by the pandemic and a willingness to offer a solution to self-isolating consumers. (Totally biased on this, but I’m proud to say that my family’s establishment, One House Bakery, quickly navigated the restrictions and quickly shifted from an eat-in community establishment to completely online and over-the-phone delivery and take-out business. This swift transition meant they were able to keep their doors open, figuratively speaking, and keep people employed — an admirable feat for a business that just celebrated its one-year anniversary in October 2019.)
As the economy begins to open up, some food establishments are preparing to open using government-approved six-feet-apart business models for those who want to dine-in, but many food retailers will forego dine-in options, continuing, instead, to rely on take-out and delivery models to fulfil customer orders.
As a result, the need for customer-space may drop significantly in the food retail space. This will hurt the pricing models used for store-front commercial real estate space. If in-person customer space is no longer in demand it will be much harder to demand the premiums typically expected for this type of commercial space. Instead, retail owners across all sectors will start to demand self-storage and closed-door space, where back-end operations can ramp-up to meet growing digital demand.
Impact on office commercial space
Perhaps the biggest casualty of the pandemic will be office space.
Up until 2020, the office sector was moving more towards open-concept and shared workspaces that helped to increase the use of space in terms of flexibility and increased densification.
This trend came to an abrupt stop as soon as self-isolation and social-distancing requirements went into effect across the globe. Now, there is a greater demand for
the de-densification of employees in a workspace. Part of this demand will be satisfied by reliance upon remote working and work-from-home policies, but part of this shift will need to be a result of a new design in the workplace model. This new design will focus on health safety, a deeper reliance on digital technology and more flexible working solutions.
Even firms committed to reopening their doors are rethinking their business models. For instance, Shopify, a Canadian tech giant that employs hundreds of locally-based employees and takes up a large footprint in two Waterloo, ON office spaces, said it will continue to prioritize a work-from-home model even as governments give the green light to return to workspaces. This continued commitment certainly calls into question the firms originally stated long-term need for substantial square footage, as it continues to grow its market share in the global e-commerce marketplace.
This trend seems to be reflected in industry sentiment. Just under half of RCLCO respondents expect a severe (10% to 20%) or dramatic (20% or more) valuation decline in office space over the next 12 months.
However, the type of office space will play a large role in how this market segment will weather the economic storm of the next six to 12 months.
Two segments of the commercial office space that may get busier during this outbreak are third-party real estate services, such as a transaction brokerage, as well as corporate outsourcing firms, such as Basecamp, Google, TransferWise, Skype and Slack.
Also, experts anticipate that healthcare and medical office space will remain relatively untouched during this recovery period, with almost a quarter (24%) of respondents in the RCLCO report anticipating “no impact” to pricing and vacancy rates over the next year and more than two-thirds (65%) expect only minimal to moderate impact (less than 9% price declines, should they occur).
Overall, there will probably be a shift away from A-rated office locations that are often marketed as a way to gain exceptional profile for a business, but at a premium square foot cost.
Instead, there may be increased demand for the type of space that allows businesses better opportunities to offer healthier workspaces, including options to self-isolate or to monitor and assess contact risks. Another option will be a hybrid office that allows for more remote or work-from-home flexibility, while still offering office space and support.
“Both WFH and dedicated office spaces have their pros and cons and decisions by tenants over the next many months will be highly dependent upon the companies’ culture, financial health and future growth prospects,” explained Mitchell Blaine, of commercial real estate services and investment firm CBRE, in a recent The Record article by Brent Davis.
Commercial industrial offers the silver-lining
Industrial/warehouse remains a bright spot. According to a JLL report, the pandemic simply accelerated trends already in evidence across this sector. For instance, firms in the industrial space, as well as logistics and supply firms, were already posting record penetration into traditional retail sales prior to the pandemic. This growth was led by online grocery, omnichannel retailing and the integration of technology into warehousing. “Occupier demand had been exceptionally robust and vacancy rates were at near-record lows. The pandemic is highlighting the critical importance of supply chains and logistics real estate, and the sector is well placed to respond to the post-COVID-19 recovery,” wrote Carol Hodgson, senior director of global research for JLL.
While residential resale and rental housing appears to be pulling out of the dramatic bottom created by the pandemic, other property sectors may take a bit longer to recover. In the interim, leasing appears to be filling in the gaps, as longer-term moves and purchases seem to be put on hold.
The good news is that most industry analysts predict a full recovery within 12 to 24 months for most real estate market segments. Still, if herd immunity or a vaccine are not developed relatively quickly, the temporary workarounds put into place may not allow for a full recovery and this would prompt not only the postponement of major real estate decisions but the termination of these plans, which could lead to a dramatic reduction or a massive shift in the use of many commercial property types. This shift in how commercial space is used would result in a shift in pricing strategies and may dramatically decimate one sector only to have another sector take its place, in terms of demand and square-footage pricing strategies.
For now, however, most small and large companies with property decisions in their near future are taking a wait-and-see approach. The focus, right now, is “operational resilience” — the ability to shift resources to areas of the business that allow for cost-cutting while increasing revenue-generating business segments. As JLL report authors point out, “businesses will not go back to the way we knew before the pandemic, but will reinvent themselves to be more resilient, adapting their operational models to the ‘new normal’.”