The following update is based on our ongoing discussions with borrowers and industry peers, but we are ultimately taking direction from the government, financial regulators, and our stakeholders. Our observations continue to evolve, and we are focused on opportunities in every asset class as follows:
Residential
Last week, National Bank of Canada forecast a 14% decline in residential home prices as a result of widespread unemployment and a marked drop in immigration. Since February, average home prices in the GTA have indeed dropped nearly $90,000, but the conclusions National Bank has drawn are both preliminary and based on data that may not show the whole picture. New listings have been down 60% during the same reporting period, and the listings that did result in sales are likely homes in the lower price range, so conclusions have to-date been based on a sample that does not show a complete composition of the housing market.
While there has been a softening in prices as economic pressures prevent families from buying homes and new immigration remains on hold, the forecasted declines still need more time to be proven out as balance continues to prevail in the residential market.
Condo prices in the GTA were up 1.8 per cent in the first two weeks of May, compared to the same period in 2019, and detached houses were up 2.6 per cent, though only 198 properties in that category were sold. As we reported last month, the market remains relatively balanced, as both supply and demand are historically low, and when both sides decide to return to the table pricing may not be as depressed as these forecasts predict.
The multi-family sector has continued to show tremendous resilience. Landlords have been reporting that GTA rents have softened slightly since the beginning of the COVID-19 pandemic, but after a period of dramatic rent increases before the pandemic, the latest reported rents are in line with market expectations. On a related note, it will be interesting to see how the rental market responds to a recent spike in available units, with owners who rented out furnished units on a short-term (Airbnb basis) are now turning to long-term rentals for their furnished units. Tenants continue to pay their monthly rents at better than expected rates, despite the disproportionate effect of unemployment on lower-wage workers who are generally renters. The longer-term viability of rent collection is still uncertain as government relief programs taper off after the summer, but tenants are still motivated to maintain their rents over other discretionary purchases, so we think the values of these assets will remain intact.
Commercial
Office – The COVID-19 pandemic has already introduced a rethinking of office space usage. On May 29, Toronto Mayor John Tory announced that two dozen major employers had agreed to keep most of their downtown staff at home at least until September. Others have made well-publicized announcements that remote working will continue indefinitely.
Meanwhile, 8.7 million square feet of new downtown office space is currently pre-leased in new developments, of which 3.2 million square feet will be to tenants either expanding their footprints or relocating from suburban or midtown markets. With all of this new supply coming onto the market, the downtown office vacancy rate had been forecast to exceed 8% by the second half of 2023. COVID-19 has exacerbated the issue, and vacancy could climb to 12% or higher.
It is still impossible to say how drastically absorption will be affected and how much of a drop the office market can expect to see in rental rates.
Retail – The retail market continues to be severely challenged as a result of closures and a precipitous drop in discretionary spending. The sector has unprecedented levels of unemployment in most retail, food service, and hospitality services. According to a recent survey of hundreds of commercial tenants by a Toronto Business Improvement Association, nearly three-quarters of small businesses weren’t able to pay their full rent in June and an even greater proportion say that they won’t be able to come up with enough money to make July’s rent.
The bottom line is a correction seems likely when valuing properties that depend on retail tenancies.
Industrial – We continue to see stability in industrial assets, as warehousing and logistics benefit from the increasing move to ecommerce from traditional retail. Rental rates for tenanted industrial buildings have inched upward, and transactions for industrial properties are proceeding. As supply chains become more local, there could be additional demand for large bay industrial space. Industrial properties had increased dramatically in value before this downturn, but whether there is normalization of values to 2018 levels or a demand-driven push to keep values high, the asset values remain strong.
The effects of this economic downturn and eventual recovery on the real estate market are causing lenders to take a very measured approach to any new business. These circumstances are directing loan opportunities to Hillmount Capital, where traditional bank financing is proving unsuccessful.