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The Northwood Perspective

Real Estate is Not Real Estate

Viraj Samani

From Cubicles to Condos: Why commercial real estate is more than just office towers

If you google "Commercial Real Estate", you'll see lots of headlines that read like the synopsis of a Netflix thriller:

It's easy to get caught up in the headlines. After all, many of the writers and consumers of the above publications work in office towers and can see the apparent demise firsthand.

But therein lies the problem. Many investors are painting all commercial real estate with a single brush, and assuming that the structural changes to certain segments of the office sector resulting from the pandemic and remote work apply to all segments.

Commercial real estate is a $20+ trillion dollar market in North America, but office real estate is a small segment of the overall market (approximately 15%). Commercial real estate is a broad term that encompasses all real estate used for business or to generate profit. It includes multifamily residential (e.g., apartments), office, retail, industrial, healthcare, hospitality – along with niche sectors like self-storage, data centers and cell towers.

Source: NAREIT US Data via Morningstar

As you can tell from the above headlines, office properties have become the poster child for all commercial real estate - but the other sectors have their own fundamental drivers and are experiencing their own unique economic shifts.

Take Greater Toronto Area (GTA) multi-family residential, for example. Real estate brokerage Colliers recently noted, "Record-breaking levels of immigration continue to drive population growth, exacerbating the already existing supply shortage in Ontario. Consequently, market rents are anticipated to continue their upward trajectory, with GTA rents experiencing a substantial year-over-year growth rate of 17.5%. These factors collectively contribute to a highly optimistic long-term outlook for the multifamily market". While rents in the office sector may be stagnant (or falling), there continues to be significant growth in multifamily rents across the GTA.

Even within the multifamily residential segment, there are substantial divergences between regional markets. For example, Toronto's year-over-year rent growth is nearly double that of Ottawa’s. And within Toronto, certain pockets are outperforming others. And within those pockets, some assets are financed heavily with debt, while others rely more heavily on equity financing. Those that relied heavily on debt may be struggling to keep pace with higher interest costs in a rising rate environment, while those with low or fixed rate debt are enjoying record profits.

Beyond multifamily, other sectors of the commercial real estate market have experienced their own shifts. Property and lease values continue to climb in industrial real estate, and end users in BC and Ontario are extending their search perimeter to neighboring provinces with more affordable pricing. Meanwhile in retail real estate, “of the top 30 performing regional shopping malls in Canada, over half have either announced plans or are currently undergoing massive redevelopment efforts that will add thousands of residential units to the immediate site”.

Despite these reasons for optimism in some segments of the commercial real estate market, we expect the headlines will continue to be one-sided, and dominated by the woes of commercial real estate - including office vacancy statistics, rising delinquencies, and stories of borrowers giving the keys back. It is important to look beyond these “click-bait” stories, and dive deeper to understand the nuance that drives each local market and each segment of commercial real estate.

With all that said, there are some macroeconomic trends that do have an outsized impact across all segments and regional markets of commercial real estate. For example, one tailwind that has helped all segments of commercial real estate over the last 20 years is the impact of falling interest rates. Warren Buffett might’ve put it best when he said “Interest rates are to the value of assets what gravity is to matter. And if I could reduce gravity’s pull by about 80%, I’d be jumping in the Tokyo Olympics”. 1

After experiencing the tailwind of falling interest rates for the past 40 years, all segments of the real estate market are now contending with the headwind of rising interest rates. And just like the apocryphal story of young Isaac Newton, some real estate investors are sure to be hit on the head as they discover the impact of gravity (interest rates).

What Does It All Mean

In the year before the pandemic, CBRE published the following:

“Once In a Generation": Demand for commercial property has never been higher, which makes finding space and negotiating for it all the more complicated. To be clear, this is not simply a traditional “Landlord’s Market”. Conditions are so tight that landlords are becoming increasingly particular and are able to control their portfolios like never before. In the tightest office markets, 10-year lease terms with top pricing are now standard.”

No one could have predicted the pandemic, or the structural changes it would create in our society (i.e., breaking the accepted norm of the five days in office work week). Now three years after the onset of the pandemic, we are still asking ourselves how permanent these changes will be. However, as we move forward, one lesson remains clear – no matter how well researched an idea is, the biggest risks are often the ones you cannot foresee. The only remedy is to acknowledge the limits of what you can know and diversify appropriately – amongst asset classes, and amongst sectors.

Data Sources:

[1] Buffett has been quotable on investments for so long, that this quote could have just as easily referred to the 1964 Tokyo Olympics as the 2020 Tokyo Olympics. Based on his age and stage of life, he probably would have had more success in the ’64 Olympics.


Viraj Samani

Viraj is a member of the client service team at Northwood and works with families in the areas of financial planning, taxation and investment management. Prior to Northwood, Viraj worked at BDO Canada where he gained experience in audit, as well as corporate and personal tax. He also spent 4 months volunteering at a business accelerator in Tanzania, where he helped social enterprises scale their operations and gain access to capital.

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