There is a future for retail real estate in Canada

Values and vacancies are expected to head in opposite directions, but retail space will remain attractive for certain sectors and purposes

There is a future for retail real estate in Canada

According to data recently released by Altus Group, professionals working in Canada’s retail real estate sector see lower market rents and increasing lag vacancy periods on the immediate horizon.

That may not be news to anyone who has been keeping an eye on Canadian retail since COVID-19 arrived in March; since the survey was conducted in April, when panic over the coronavirus was at its peak, its results should be grim. But Colin Johnston, president of research for Altus Group’s valuation and advisory division, says the challenges facing Canadian retailers will not necessarily lead to the death of retail real estate.

One of the strengths of the retail space has been its diversity: While some properties struggle, others succeed, providing balance and resiliency. That realization pops up repeatedly in the Altus data, where those surveyed see a marked difference between the fortunes of top-quality assets in core urban markets and lower quality assets in the suburbs.

Regarding market rents, 77 percent of respondents foresee the rent value of quality assets falling in 12 months if COVID-19 is under control by June 30. That figure was 87 percent for lower-quality assets. The difference between the two numbers isn’t remarkable, but the details are telling. For top-quality assets, only 21 percent of respondents expect market rents to fall by more than 10 percent. For lower-quality properties, that number was 48 percent.

The same bifurcation could be seen when Altus asked about lag vacancy. For top assets, just over 30 percent of respondents expect vacancies to last for nine to 12 months, with about 18 percent expecting 12 to 18 months. For lower quality assets, the number of respondents expecting nine to 12 months of vacancy was lower – about 27 percent – but the numbers expecting 12 to 18 months or more than 18 months of lag vacancy were both considerably higher.

According to Johnston, those lesser quality assets in suburban markets include old, enclosed community malls, the kind that used to have a Zellers at one end and an Eaton’s on the other. These malls, home as they are to mom-and-pop retailers and second-tier name brands, were struggling even before COVID-19. Now, as vacancy rises and rents come down in more desirable malls, those retailers may find an opportunity to relocate to properties with better foot traffic.

“That’s just going to accelerate the obsolescence for some of those older, enclosed community centres,” Johnston says.

That is going to result in a lot of vacant suburban retail. But Johnston sees in that space an opportunity. It can be repurposed. Getting the best modern use out of it won’t necessarily mean a costly, time-consuming demolition/rebuild process.

Johnston says a growing trend in the U.S. is the conversion of these dying suburban malls into distribution centres for online retailers. Since 2016, more than 25 malls in the States have undergone similar transformations.

“You’d probably have to have it rezoned, and that might not be as easy as you would think, but it’s very good for a company like Amazon. It’s close to highways and it’s close to a population, which is great for last-mile fulfillment,” says Johnston.

For mall owners that choose to maintain their properties’ current footprints, Johnston sees their tenants shifting from retail operators to community-focused entities like medical clinics, government offices or public services that are likely to see an increase in demand.

“You may see learning centres or day cares go in there because we’ll definitely need more of those,” he says.

Ironically, the prospects for prime retail, which doesn’t enjoy the same flexibility and access to highways as small suburban spaces do, are a little cloudier. With so much retail activity in major population centres being driven by experiences that can no longer take place – pop-up events, food markets, bowling alleys, trampoline parks – that incentive to get in the car and drive to a place crawling with people has disappeared.

“All that experiential retail was supposed to provide new anchors,” Johnston explains. “It was a reason for people to go to malls, as opposed to the boring old department stores that weren’t speaking to customers anymore, or to the youth. So now, what happens to experiential retail? That’s the big question, because experiential retailing and physical distancing do not go together.”