Morningstar report projects improvements for beaten-down segments, with earnings to recover by 2022
After getting heavily battered during the pandemic, Canada’s commercial real estate market is slowly regaining its financial footing, though its recovery will remain patchy and somewhat protracted.
“The [financial risk] outlook for the Canadian real estate industry, as a whole, looks brighter over the next two years from the darkest days of the pandemic, albeit remaining weaker than pre-pandemic levels,” analysts from DBRS Morningstar said in a new report.
Financial risk assessments for Morningstar’s monitored issuers, the firm said, are benefiting from the current low-interest rate environment. Aside from incurring lower interest expenses, issuers have the opportunity to extend their weighted average term to maturity of debt at favourable rates.
“[I]ssuers may accelerate their capital recycling efforts, whereby they use proceeds from selling some properties to purchase new ones, fund developments, or repay debt, as transaction markets regain their footing,” the report said, adding that they “may also issue more equity as unit prices recover toward prior highs or proximate net asset value.”
Earnings for real estate companies, the report added, are expected to recover by 2022 given current progress in vaccinations leading to relaxed in-person gathering orders in certain provincial governments, as well as allow for more nonessential facilities to open. The biggest gains in earnings were expected from the discretionary retail sub-segment, which was most heavily impacted by the pandemic.
“DBRS Morningstar believes demand for enclosed shopping centres will take time to recover,” the report said, citing factors such as volatile cash flows throughout the pandemic, the discretionary nature of their tenants with elevated counterparty risk, and rising vacancies, among others. “As landlords who have lost tenants begin to experience a pickup in leasing traction and those who offered rent abatement once again collect regular rents the retail segment will begin to recover.”
Among the different subsectors, industrial real estate issuers involved in distribution and logistics have fared better as the pandemic supercharged pre-existing trends of rising e-commerce penetration, which it expects to persist. The office segment, meanwhile, is expected to broadly face continued struggles from higher-than-historic vacancies, including those in urban central business districts, because of shifting norms around remote work.
“As the ‘crisis mode’ of the coronavirus pandemic enters the rear view in the latter half of 2021 and further into 2022, we expect easing public health measures and tempered capital expenditures to drive [financial risk assessment] improvements for most publicly rated Canadian real estate entities,” the report said.