Pandemic restrictions have mostly been lifted, but the rush to return to the office may not have been as robust as expected. Greg Bonnell speaks with Colin Lynch, Head of Global Real Estate Investments at TD Asset Management, about the implications for the office space.
Most pandemic restrictions may be in the rearview mirror, but globally the return to office has not been as robust as some may have expected. So, has the heyday for office real estate passed? Joining us now to discuss, Colin Lynch, head of global real estate investments at TD Asset Management. Colin, great to have you back on the program.
Well, thanks for having me here. All right, so anyone who has a job that's in a traditional office and has been going into that job, either five days a week or a couple of days a week, is probably noticing something-- that we haven't seen the big return to office that perhaps we were expecting. What's happening out there?
Well, it varies around the world, first off. So that's definitely the case here in Canada, in much of the US, in Europe. A place that's been a little bit of an outlier is Asia. So in Singapore, in Hong Kong-- COVID aside-- in Tokyo, and Seoul, there has been a much more robust use of office-- and in places like Sydney. So let's put Asia to the side and let's look at North America and Europe. And, yes, it has been a little bit slower than a lot of folks would have initially anticipated.
Is the heyday of office over? I would argue no and yes. No, if you are well located, great amenitized, transit-linked office that is relatively new, and by that meaning new build or was renovated, that's also great environmentally sensitive office. That, I think, has a wonderful future ahead of it, after we get through the dynamics of COVID, and the degree of return to the office, and we figure out and finalize the broad hybrid experiment that we are all living through.
Where the heyday of office might be over is in lower-quality office, older office, that is, older-generation office that is not decarbonized, that-- meaning it's not ESG-friendly-- and is not really close to transit or major transportation infrastructure. That's going to be challenged, and we think around the world, that's going to be a theme regardless of whether you're talking about Canada, or the United Kingdom, the USA, or even some of the stronger markets for office in Asia-Pacific. We think that's going to be a theme.
And so for those offices, yes, some of some of the heyday might be over. And the question will be, what do you do with those offices? Do you invest the capital to revitalize the interior spaces or the exterior look of the office, or do you convert to a different use? And that can be quite expensive.
Do we have any indication of which way we may be leaning on that? Because I can think of before the pandemic, some of the traditional office spaces right in the downtown core of Toronto were undergoing that revitalization, saying, don't worry, we're-- like we're freshening things up because, in the end, if you want to attract tenants-- and I guess in this situation, you want to attract workers-- give me that interesting environment, give me that lucrative reason to be there. Do you-- have we seen which way that's going to fall yet, or is that still up in the air?
Yeah, that's a good question. We have seen a significant number of offices pursue refresh and modernization programms, so whether that's the lobbies and producing a more welcoming environment, whether that is incentivizing new tenants and providing what we call tenant incentives to allow tenants to build up and freshen the space, whether that's doing a significant retrofit of offices. We've seen that certainly in Toronto, as mentioned, but in other cities across the country, whether it's Montreal or Vancouver.
So that's going to continue, and particularly, as we see more and more impetus towards better quality ESG offices, that's going to require a significant retrofit of offices. And so we're going to continue to see that, and I would argue, probably ramp up because there's a lot of older generation offices, whether it's in cores or outside of cores.
The conversion to multi-unit residential is an interesting theme. We've certainly seen this in a few places-- Australia being one, the United Kingdom being another. But we are seeing this in Canada and there's a program in Calgary, for instance, where the municipal government in Calgary is trying to incentivize. And they've had some success incentivizing office owners to convert those offices to other uses, usually apartment buildings. The only issue with that is it is very expensive, as you can imagine, and not all offices are designed in a way that works for an apartment building. So if you think-- if you're living in an apartment, you'd like to have a window--
Maybe some plumbing.
--some plumbing, yes. And not all offices are built with a floor plate that allows for you to have a lot of window space. And so you could see some offices you'd have to-- if you convert to a residential apartment, you would have very long and narrow apartments with a very limited amount of window space. And that tends to be an issue because we like to have a view and et cetera.
So some of those considerations really matter as it relates to the cost to retrofit-- and, yes, the plumbing, a number of other things, ceiling heights. So not all offices can be converted readily to residential. And so there's going to be some that we call stranded, that will struggle to attract tenants, and will struggle to have an alternative use, and will struggle to justify the amount of capital required to upgrade the office to be something that is ESG-leading. And those offices will have a tough time.
I want to talk about the economic backdrop. Of course, one of the unknowns of this year is if there is an economic pullback, will it be deep enough to call it a recession and what kind of effect that's going to have on a number of asset classes. Is there two ways to consider this when it comes to commercial real estate, what impact a recession might have?
Certainly. When you look at real estate and commercial real estate, ultimately, commercial real estate serves the economy. So if the economy is slowing, there is certainly an impact that will be felt in commercial real estate, no doubt about it. And whether it's a slowdown, a recession, a light recession, or deep recession, lots of folks can debate, but the key is that there is going to be a bit of a slowdown. So how does that impact the worlds of real estate?
So office is really on the front lines. Because if you have an economic recession, generally the number of jobs stagnate, might decline, tenants begin looking at their space and say do we really need that space? Now, that's been happening already because we are in-- we've moved from, call it, four days or five days a week to something that looks and feels more like two to three. And so a number of tenant occupiers are going through that right now. So recession might accelerate some of that thought. There is also a view that a recession might prompt more people to come into the office, so that's a little bit of a contrary notion--
Or is this like the FaceTime thing, the economy is tough, it's harder to come upon a job, maybe I want people to see me in the office.
Yes. And we don't know-- that's in the realm of psychology-- but there's certainly folks in the real estate industry that think that more economic tough times will prompt more people to-- yes, to be in the office in order to develop those relationships, whether it's with a superior or with teammates as well. And if you look historically, office tends to be the most exposed to recessionary environments, so tends to do really well when things are growing and it tends not to do so well when things aren't.
Conversely, if you look at residential, we all need a place to live. And at the end of the day, whether it's a recession or economic growth, the economics don't tend to be as much of a driver as the demographics. So if the city's growing, attracting new folks or if people are having kids later in life, if you have a lower number of married or common law individuals, that means that you have more and more households. And so that creates significant demographic growth, and that demographic growth tends to drive demand for housing. And so housing tends to be more driven by some of those demographic factors, particularly in the medium to long-term.
And then, industrial and retail are in the middle. They certainly are impacted. So industrial, these are warehouses, these are light manufacturing facilities. And so if we have an issue with the economy, we'll do less manufacturing, less shipping of goods. But we also have e-commerce, so we have to look at the two, but certainly a slowdown doesn't help. And then retail, well, folks are out and shopping. And we've seen that in December, lots of folks went out and shopping and we have COVID. But if we don't have as much money to spend and we're feeling the pinch, then that's going to impact certain retailers. So that's the broad view-- office the most exposed, multi-unit residential the least exposed, and then you have industrial and retail in between. [AUDIO LOGO]