Ashleay: Welcome to iA Financial Group's “In Your Interest!” podcast, where we aim to share with you the essentials of economic news and its impact on your finances. My name is Ashleay, and this week we're talking about real estate with Sébastien Mc Mahon, our Chief Strategist and Senior Economist, and Claude Sirois, Managing Director, Real Assets and Private Equity at iA Financial Group. Hi, Sébastien. Welcome, Claude.
Sébastien: Hello, Ashleay.
Claude: Thank you, Ashleay. Hello.
Sébastien: Just to start, Claude, your title is complicated, how do you think we could simplify it, Ashleay?
Ashleay: I think I would just go with Head of Real Estate for iA. What do you think, Claude?
Claude: Well, that's good. I like that.
Ashleay: Yeah, sounds good. It's got a ring to it. So, as we know, the real estate sector has been impacted by the changes brought about by COVID. Residential, commercial, office and industrial sectors have all shifted. How does the current situation compare to pre-COVID for all these sectors? And what about residential?
Claude: The short answer is it doesn't compare at all. When you go through what I'm going to call the “food chain”—shopping centers, industrial and logistics, residential and office—you see that the pandemic has changed how we do business and, for the consumer, for the individual, how they shop, how they work, how they entertain themselves. So everything has changed, everything. And obviously this is the case as it relates to real estate, because you cannot live without real estate: you need a roof. So obviously there has been a large impact throughout the four categories.
Sébastien: Yeah. And when we go to a shopping center, it seems pretty much the same as it was in 2018/19.
Claude: You know, it's ironic because at the beginning of the pandemic it was doom and gloom: everybody said that that was it, we're done in shopping centers, everybody's going to shop online, everybody's going to get their little box stolen from the balcony. And that's it, right? But that's not what happened; on the contrary. You know, the cover page of Time magazine in 1989, when the Internet arrived, said “kiss your mall goodbye.” Okay?
Sébastien: Yeah, 1989.
Claude: Yes. And shopping centres still exist today, and they will still exist tomorrow; they have this ability, like other asset classes, to adapt. This is what happens. So today what’s basically happened is the tenant mix has changed and evolved. But it's all about the experience. Next time you go into a shopping centre—because I do this sometimes, by default—just look around at the age group. And you'll be surprised to see 20-, 25-, 35-year-olds. And look to see if they have bags, because that's what retailers are looking for. Because, you know, there was this other myth that said “the young population—are you kidding me?—they're not going to go into shopping centres!”
Sébastien: No, but they’re crowding shopping centres
Claude: Yes, they live in this environment, this social environment. So it's a bit ironic.
Sébastien: Yeah, it is. So the client experience is still alive and well. Because businesses want to create an experience for their clients and, psychologically, that's how the human brain works: you want to be entertained, you want to have an experience. And shopping centers still provide that.
Claude: And I think with what happened, that’s even more so the case today. Today the experience is paramount in everything we do, including shopping. It’s about wow moments: you want to have more wow moments because you just don’t know what tomorrow may bring, and so you say to yourself, “okay, let's do it.” Which is why entertainment spending has increased dramatically, because people are going out again.
Sébastien: But people are still buying lots of stuff online. So this accounts for industrial and logistics. Meaning there's more than just factories; there's also distribution centers. So all of this should be alive and well, too.
Claude: Absolutely. You know, here's an asset class that was on steroids before COVID and it's just continued to accelerate through COVID. The impact of this has been huge. Just to give a sense of the rent per square foot of industrial space: if you would have asked anybody in Quebec—or elsewhere, but let's take Quebec as an example—their rent would have been $6.50/$7 a square foot. Well, today it's close to double that.
Claude: It has increased dramatically because there is such a demand from onshoring, from people that want to store their goods and to ensure that they have access to their goods and are not at the mercy of a pandemic. This means that there's a lot of industrial space being occupied and the vacancy across the province and the country is at an all time low, at around 1%.
Sébastien: Maybe the spot where it's more complicated would be in office spaces?
Ashleay: What do you think the office of the future looks like?
Claude: Okay, so let's look at it before the pandemic. People would commute to work, they would take the kids to school. With the pandemic, the whole dynamic has changed, including how we work because the hybrid model is here to stay. This means certain questions are being asked, including “do I need that much space to welcome my employees?” I think at the beginning of the pandemic, a lot of tenants, occupiers, businesses, said, “well, you know what, I don't know; I don't know if I should give up my space because maybe it will come back.” So it was kind of a standstill for a while. I'm going to call this the “rightsizing” of tenants and occupiers, who decided they didn’t need 20% or 30% of their space. We see a lot of that happening and, as a result, the vacancy level increases. For example, downtown Montreal before the pandemic had an office space vacancy rate of maybe 9 to 10%. Today we sit at 17%.
Sébastien: Okay, that's big.
Claude: It's a huge increase. And unfortunately, I don't see that number decreasing in the short-term.
Sébastien: Yeah. And just as we were recording this, the federal employees strike just ended and they accepted a—
Claude: The irony, If I may?
Sébastien: Sure. Okay.
Claude: The irony is that even though we’ve all seen the demonstrations of some of those employees in front of their offices, it was probably the first time some of them have been there in three years, some have probably never been there.
Sébastien: But it was funny because there's lots of economic studies about that: how employees are willing to take smaller paychecks and raises if they get teleworking in exchange. So there is some value to that. As a business, you need to adapt. As an employer, you receive the work from the employees and in exchange you used to give a salary, you used to give insurance pension plans, now you need to give them telework. It just meant that you need to adjust your mix. That's where we are.
Ashleay: There's that and there's also the office conditions, right? So the ones that did keep an office space, now they're being asked, I suppose, by employees for different experiences: they want a gym, they want a cafeteria, they want different things that we didn't have before.
Sébastien: We mentioned the client experience, now it’s the employee experience.
Ashleay: And what about strategy? How can we monitor the real estate cycle for opportunities. And what are the differences between Quebec City, Montreal, Toronto, Vancouver and even the States.
Claude: There are clearly differences. Real estate is different across the board, from the different asset classes, which we just talked about, to different markets. The US is clearly another market: there are currently office towers to which some developers, owners, investors are throwing the keys back to the lenders because they see that they cannot recoup their equity, their investment.
Sébastien: And it's big firms like Blackstone.
Claude: Blackstone, Brookfield, lots of the high-profile players. Which is unusual because there was this reputational risk, you may harm your relationship with lenders. They’re reaching a point where they've got to do something. Well, Canada is a bit different. We're not at that stage yet at all. But that being said, we cannot take anything for granted. There will be some casualties, the B and C class office categories, specifically. But clearly the various markets—the Vancouver market, the Montreal market, Toronto, Calgary—are evolving differently. But there's one common denominator across all of them: all the CBDs, the downtowns, are suffering. All of them.
Sébastien: Yeah, they all changed. The face of downtown has changed. So maybe one last question, on one of my favorite topics: interest rates. So with the massive rise that we've seen recently, I'm sure you feel the impact, but do you feel the full impact? Is there still more to come?
Claude: I mean, it has obviously slowed the pace of investment and development significantly in the last in the last few months. I think it will continue for a while until there's more visibility about where the interest rates are going to land. But you add that to the construction costs that have increased, and you get a lot of developers that say, “shoot, my numbers don't work anymore. The returns that I expected, I'm not getting them.” So they say, “well, you know, okay, I'm going to hold on; I'm not going to develop, I'm not going to start construction.” Unfortunately, with residential, for example, where there's a ton of pressure on rent, where we welcome a million immigrants a year, if we don't create that supply in order to reduce the pressure on residential, well, it's going to be a bumpy ride.
Sébastien: Yeah, I agree.
Ashleay: Well, thank you, Claude. Thank you, Sébastien. And to all the listeners, thank you for being here. Once again, if you like the episode, we invite you to share it with your friends or give your opinion on the listening platforms Apple, Spotify or Google Podcasts. Thank you and we'll see you for a second episode about real estate next week! Love this podcast? Want to know more about economic news? Follow our “In Your Interest!” podcast available on all platforms. Visit the Economic News page on ia.ca or follow us on social media.