How has Canadian retail recovered so quickly?

Retail real estate is back with a vengeance. The pre-pandemic rise of e-commerce, followed by the onset of pandemic lockdowns, had many analysts and experts predicting that retail real estate was doomed in Canada. Retail landlords worst nightmares were realized during the lockdowns, with fears they would have to shut down shopping centres. Even large-scale landlords had to shift their focus from long-term plans to ensuring that rent would still be collected each month. The picture was bleak.

As the pandemic ended, however, retail resurged. John Ballantyne, COO of RioCan Real Estate Investment Trust, explains that as social distancing restrictions eased and the post-pandemic economic realities took hold, retail has become one of the best performing commercial real estate assets on capital markets. Ballantyne explains exactly why retail has bucked expectations and resurged and outlined which retail subsectors offer the greatest opportunity and the greatest risk.

“All of a sudden, retail isn’t number four or five in investor preference anymore, it’s number two, or even number one given some of the challenges in multifamily and industrial right now,” Ballantyne says. “That’s because you have an environment where supply is constrained and demand is increasing, making a perfect storm for retail landlords.”

That perfect storm is driven by three major factors, according to Ballantyne. The first is population growth. Over the past two years roughly two million new Canadians have entered the country. The average Canadian spends about $12,000 per year on retail. That amounts to roughly $24 billion in additional retail sales. At the same time, development of new retail assets has slowed due to the rising cost of labour, materials, and capital which constrains supply. Finally, Ballantyne says that the pandemic actually validated physical retail. Lockdowns served to pen up demand for experiences, which has been let loose in recent years. Experiential retail — like restaurants — has been extremely popular, with restaurant sales rising around seven per cent last year. All of this has driven revenue growth for retail landlords.

That doesn’t mean every retail asset has been exposed to the same positive tailwinds. Ballantyne explains that the major winners in this drive have been plaza and strip-mall assets, typically anchored by a grocery store, offering essentials. Grocery stores, drug stores, liquor stores, and other ‘value’ retailers offering essential goods are the retailers which continue to offer the strongest set of returns. Grocery is perhaps the keystone to this current trend. While many analysts had predicted the pandemic would usher in an age of widespread grocery delivery, Ballantyne explains that consumers have shown a desire to shop in person.

“Ultimately, it’s an experiential thing. The cost of groceries has only gone up and consumers do want to control the quality of what they’re buying. Everyone wants to squeeze the tomatoes.” Ballantyne says. He adds that the logistics of grocery delivery proved very challenging and costly for grocers, which has further disincentivized much of a push towards delivery.

While grocers and essentials big box stores have been the winners, certain retail assets are under more pressure. Because offices have not returned to full capacity, especially in downtown Toronto and Ottawa, Ballantyne says that retailers who traditionally served office workers have lagged significantly.

Many malls have lagged as well, though Ballantyne jokes that “mall” is a four-letter word in retail, so the assets are usually called “enclosed centres.” Of those enclosed centres, the lagging assets tend to be mid-market fashion retail. Outperformance has come from the enclosed centres that have gone luxury. Ballantyne highlights the example of Yorkdale Mall in Toronto which has become the best performing retail asset in the country, with sales per square foot around $1,000 higher than the next competing retail space.

While he sees plenty of broad reasons to be constructive on Canadian retail assets, Ballantyne notes that he is somewhat wary of Canada’s lack of competition. Canadian retail tends to have a small number of dominant players in each sector — whether that’s electronics, department stores, pet retail, or almost any other category. Ballantyne believes competition could improve the landscape for Canadian retail and help drive further demand for retail real estate assets.

Nevertheless, Ballantyne remains bullish on Canadian retail real estate. His outlook, he says, is built on the back of basic economics.

“We have got supply constraints, nobody is increasing the supply of retail, and demand is being fed by immigration. Having more bodies in the country leads to increased revenues for retail landlords,” Ballantyne says, “Our ability to push rents with our existing tenants is substantial. We did about 500,000 square feet of new leasing in Q1 of 2024 and got 20 per cent rent spreads over what was being paid previously. There’s an ability to supersize growth.”