TORONTO - It鈥檚 poised to be another challenging year for office real estate investment trusts, but some money managers say there could be decent entry points in the sector for long-term investors.
鈥淲e are in a 'darkest before dawn' scenario heading into 2024 for office REITs 鈥 there is no denying they are cheap 鈥 but there are numerous headwinds that office landlords face,鈥 said Michael McNabb, portfolio manager at Purpose Investments Inc., via email.
鈥淚 think a lot of investors forget that this was the hottest REIT asset class heading into 2020,鈥 he said, when office vacancy rates were extremely tight and investors flocked to the sector for its monthly payouts.
But post-pandemic, McNabb said he鈥檚 noticed pedestrian traffic in Toronto鈥檚 PATH system 鈥 an underground walkway network in the downtown core 鈥 is still very low on Mondays and Fridays in particular.
鈥淭he office isn鈥檛 dead, but I do believe it has changed.鈥
The COVID-induced work-from-home shift has ravaged the office market as many employers re-evaluated their office footprint. Firms have also looked at reducing their real estate holdings as a way to rein in expenses to help cope with the current weaker economy.
鈥淚t is likely that 10 to 15 per cent of demand has been permanently destroyed with (work-from-home) trends,鈥 said Maria Benavente, vice-president and real estate-focused portfolio manager at Dynamic Funds.
鈥淲e expect it to continue to be a market of haves and have-nots."
A September report from Colliers Canada showed the national office vacancy rate rose to 14.1 per cent in the third quarter last year, up from 13 per cent in the third quarter of 2022.
Office vacancy rates have been rising for three and a half years and will likely continue to climb in the short term with remote working still prevalent, according to the report.
Meanwhile, average asking rents for offices neared a record high of $21.08 per square foot, driven mainly by the removal of older office buildings and landlords negotiating concessions beyond lower rent, the report said.
John Duda, Colliers鈥 president of real estate management services, Canada, said he expects a 鈥渟low uptick鈥 in office space absorption by the end of 2024, but he鈥檚 not 鈥渁nticipating a radical turnaround.鈥
Part of the issue is the disparity between what employers and workers want.
鈥淲hat's been preventing a more dramatic shift in back-to-the-office, it鈥檚 been the imbalance in the employment market,鈥 Duda said in an interview.
鈥淭he employees have had a lot of power and that means they're just not coming in and saying, 'I won't come in.' But that is starting to shift and we're noticing it particularly in the (downtown) cores; the busy level has picked up very significantly.鈥
Units in Slate Office REIT, Allied Properties REIT, True North Commercial REIT and Dream Office REIT are all down between 62 and 85 per cent since March 1, 2020.
Sentiment remains fairly negative on the sector and timing the recovery is difficult, said Benavente, pointing out how Calgary鈥檚 office market was still struggling to recover from the 2014 oil price collapse even before the pandemic.
鈥淥ffice is a value investment 鈥 value requires patience and tolerance for volatility,鈥 she said.
鈥淲e think there is some value; however, investors need to be selective and be laser-focused on balance sheet, liquidity and dividend coverage. We saw many office REITs being forced to cut their dividends, sometimes even twice.鈥
Slate Office REIT, for example, suspended its monthly distribution in mid-November to conserve cash. True North Commercial REIT slashed its monthly payout early last year.
Office REITs will do well when the economy begins to recover and businesses return to hiring mode, Benavente said. Banks also need to be willing to lend more freely to office landlords for activity to pick up in the sector.
McNabb said he鈥檚 still very cautious on the sector and wants to see vacancy rates improve. But he believes longer-term investors could start 鈥減icking away鈥 at higher-quality companies, which could prove to be a good investment in time.
鈥淐ommercial real estate follows the simple economic rule of supply and demand 鈥 and currently supply is outstripping demand by a very wide margin,鈥 McNabb said.
This report by 春色直播was first published Jan. 3, 2024.
Companies in this story: (TSX:SOT-U, TSX:D-U, TSX:AP-U, TSX:TNT-U)
