M&M Panel: Aggressive Government Response to COVID-19, Strong Fundamentals Will Limit Severity of Canada’s Downturn
TORONTO — Investment demand for commercial real estate assets in Canada will be adversely impacted by the outbreak of COVID-19, but the market’s strong real estate fundamentals heading into the crisis and extensive forms of government aid should work in tandem to offset the damage and fuel a strong recovery.
Such was the consensus of a panel of investment sales brokers and executives from Marcus & Millichap’s various Canadian offices, who convened on April 21 for a teleconference to discuss the state of the market. Marcus & Millichap, based in California, operates six offices with more than 60 combined real estate professionals in Canada.
Much like the United States, the public health crisis that is COVID-19 has caused innumerable closings of nonessential retailers, restaurants and hotels in Canada, as well as reduced office and industrial activity. As of April 29, there were 51,150 confirmed cases of COVID-19 in Canada and 2,983 deaths, according to Johns Hopkins University. Meanwhile, its citizens remain under stay-at-home orders.
Consequently, commercial investors across Canada are seeing their properties experience dips in occupancy rates, reduced cash flows from tenants whose businesses are suffering, and consequently less demand for assets that had been listed for sale prior to the outbreak.
Hessam Nadji, CEO of Marcus & Millichap, acknowledged these market conditions in his opening remarks for the panel. However, the firm’s top executive was also quick to point out that the depth of government aid flowing into businesses should work to alleviate the cash flow and occupancy issues that commercial owners are facing.
“Markets are really grappling with uncertainty as it affects pricing, net operating incomes, occupancies and rent collections,” he said. “The headline numbers are drastic and unprecedented, but the government responses have also been as unprecedented as the problem itself. The decisiveness and scale that governments have executed with will go a long way in mitigating the depth of the downsides and in fueling an exceptional recovery.”
Nadji noted that during the Great Recession of 2008, the government’s responses to aiding businesses and citizens were more reactionary than preconceived, helping to create a “playbook” by which to manage the current crisis. Nadji also cited strong pre-crisis fundamentals underlying Canadian commercial real estate — the country added roughly 400,000 new jobs in 2019, its highest annual total in 15 years — as the second half of a successful formula for recovery.
Specifically, he pointed out that on a national level most commercial real estate property types in the United States and Canada were neither overbuilt, nor were borrowers overleveraged prior to the COVID-19 outbreak — unlike during the last downturn. Had the market been choked with bad debt, the fallout from COVID-19 on commercial real estate would likely be much stronger, Nadji noted.
“The exogenous shock from COVID-19 is occurring at a time when the industry’s fundamentals had just previously been in great shape,” he said. “Does that even matter when we’re seeing these sensational unemployment and retail spending numbers? Yes it does.”
“It’s hard to imagine that anything could offset the depths of the pain we’re feeling right now, but it’s important to know that the combination of healthy fundamentals and extreme measures being taken will eventually make a difference,” concluded Nadji.
In addition to experiencing a 15-year high in annual job growth in 2019, Canada’s economy expanded last year in terms of gross domestic product (GDP), albeit by a smaller margin than in past years.
Nadji closed his statement by suggesting that the healthcare side of the crisis must be stabilized before economic resurgence can really begin. But if large portions of national and regional economies can restart by mid-summer, markets should see “some normalization of financing, price discovery and better assessments of occupancies and rents,” in the second half of the year. Pent-up demand for a variety of consumer goods and services will then set the stage for hefty amounts of capital to flow into commercial real estate.
Mark Paterson, vice president and regional manager of the firm’s Toronto/Ottawa office, took the baton from Nadji and pointed to the importance of information sharing to find smart solutions for clients during these uncertain times. Paterson then affirmed the strength of the market prior to the crisis and the efficacy of the government response as a one-two punch for softening the economic damage.
“When we look at where we were with national consumer sales and household income coming into this crisis, we couldn’t have been in a better position to mitigate the blowback,” he said, noting that retail spending and household income had risen by 43 and 48 percent, respectively, over the past decade-plus. “Corporate profits were up and cash on hand was at an all-time high for many firms, and that type of entry for a pandemic provides cushion and shouldn’t go unnoticed.”
Paterson conceded that a major shift in spending is now underway in response to COVID-19, producing both winners and losers. Specifically, he said that Canadians had cut their restaurant and apparel spending by 80 and 90 percent, respectively, but that spending on reading, music, streaming and software services was on the rise.
In terms of the country’s labor market, after peaking at 7.2 percent in 2016, Canada’s unemployment rate had been steadily compressing for the past several years. But between February and March 2020, the national unemployment rate rose by 220 basis points from 5.6 to 7.8 percent.
Paterson estimated that at least one in 10 Canadian workers has filed for unemployment benefits since the national stay-at-home order went into effect. But he was quick to praise the Canadian government’s economic response to the pandemic as a damage control mechanism.
“The government has stepped up in ways it never had to before,” said Paterson. “We’re providing wage subsidies of up to 75 percent to help with layoffs of companies seeing significant decreases in revenue. Canadian banks are offering mortgage deferrals up to six months. We’re seeing new benefit programs for the unemployed and seniors, as well as increased time frames for taxes.”
More specifically, initiatives introduced by the Canadian government in response to COVID-19 include:
- the provision of up to $500 per week for up to 16 weeks for workers who lost jobs;
- the increase of child benefit payments by $300 per child;
- the offering of interest-free loans of up to $40,000 for businesses, with $10,000 to be forgiven if repaid before 2023.
In addition to echoing their belief in the combined power of the market’s pre-crisis strength and government aid to see the country through the crisis, the other panelists spoke about how volatile the current investment sales market is, and identified specific concerns that brokers are fielding from clients.
Panelist Aik Aliferis, senior managing director at Marcus & Millichap’s Toronto/Ottawa office, addressed the wait-and-see mindset that has enveloped the investment sales market as COVID-19 has hit the economy.
“Clients have hit the pause button and are trying to identify what’s going on in the market and being very careful,” he said. “With deals that are firm, they’re making sure they get closed. For deals with more conditions, those tend to be pushed. Deals that are in beginning stages are being re-examined and having their timelines re-evaluated. But overall, pencils are down and markets are on pause.”
Aliferis added that the old commercial real estate mantra of “every deal is different” holds even more truth now, as cap rates on comparable assets are currently showing major discrepancies due to differences in cash flows. In addition, he said that for some transactions, lenders are requiring borrowers to secure their financing further ahead of closing dates than they normally would. This change in policy further attests to the shaky ground on which many deals are being executed.
“Buyers are finding themselves in situations with tight time frames to close and no funding in place,” he said. “During non-COVID times, that wouldn’t be a problem, since the buyer presumably had cash reserves and other lenders would have been willing to facilitate the deal. But that’s not the case now.”
Brad Gingerich, senior managing director at the firm’s Edmonton office, said that clients and brokers are shying away from deals involving existing properties, which may have cash-flow concerns, and toward those that center on land acquisition, entitlement and building design. Gingerich’s team mainly plays in the multifamily space.
“There are just too many unknowns related to due diligence on buildings in today’s climate,” said Gingerich. “Until those are worked out, efforts are better spent on land deals.”
David Morris, senior managing director in the firm’s Vancouver office, chimed in with some insight on the Canadian retail market. Morris said that landlords in general are being very flexible and cooperative with mom-and-pop retailers — though less so with national retailers. Retail owners are also ramping up their efforts to vet legitimate requests for rent deferrals or abatements.
“Landlords are taking a much deeper dive into assessing the true impact of the shutdown on each tenant,” said Morris. “They’re looking at how large of an online presence a retailer has and if that retailer has had a significant shift in its brick-and-mortar sales to its online sales. It’s a potentially risky game to play, but we’re in uncharted territory here.”
— Taylor Williams