Office – Managing property taxes through a pandemic
Office – Managing property taxes through a pandemic
Pre-COVID, office supply was on a high, and then…
The start of 2020 was promising with strong employment gains in the Canadian job market in Quebec, Alberta and Nova Scotia. The amount of new office supply that hit the market in the early part of the year was almost double that of 2019. In the first quarter, nine buildings with a total of 838,601 square feet of office space were completed, with over 70% preleased.
In the second quarter of this year, new office supply remained stable with eight completed buildings totaling 842,005 square feet, of which almost 72% was preleased. Downtown Class AA office cap rates rose to 5.53%, up from 5.30% in the previous quarter and 5.36% in the same quarter last year.
Office vacancy Q2 2019 vs. Q1 2020 vs. Q2 2020
Source: Altus Group
As office tenants rapidly shifted into working from home, property owners worried about rent collection. Losses of 25-30% were anticipated. The good news – collections held at 95%+ nationally.
As the end of the year approaches, investors are cautiously optimistic. The latest results from Altus Group’s Investment Trends Survey show the Overall Capitalization Rate has changed little – 5.14% in Q3 – but grew from 5.01% in the same quarter last year.
So, in the short term, the office asset class has been insulated from the worst effects of the pandemic.
During the decline in office space utilization dueto the transition to remote work, landlords started re-thinking building operations, such as elevator wait times, operating hours and occupancy rates. During this bridge phase of the pandemic, investors and owners of A and B class buildings in major centres are redesigning, rather than redeveloping spaces. They are investing in measures to protect health: sanitizing dispensers, plexiglass shields, signage, automatic doors, HVAC assessments. In B and C class buildings, tenants are often driving changes.
As the Canadian labour market rapidly shifted into working from home, Statistics Canada reported that about 40% of Canadian employees have jobs that can be completed remotely. Ahead, this points to a potential mix of in-office and work-from-home concepts as employees slowly return to offices – but still creates additional operating costs.
Some tenants are now offloading excess space, pushing up the sublease market. As well, previously ever-rising office space rents are now levelling off as some landlords begin to offer tenants reduced rent. In Canada’s major office markets, vacancy rates and subletting activity increased in the second quarter of 2020 while office rents dropped slightly.
As the COVID-19 situation changes through the calendar year, from a tax perspective it’s important to be astutely aware of how the real estate market is currently being impacted compared with the time of valuation.
Downtown Class “AA” office cap rates rose to 5.58% in Q3, up slightly from 5.53% in the previous quarter and 5.36% in the same quarter last year. Edmonton was the only market to see a decrease compared to the previous quarter. On a year-over-year comparison, all markets shifted upward with Ottawa seeing the highest increase.
With many offices likely to remain empty until at least the end of this year due to pandemic restrictions, landlords continue to search for solutions as more tenants consider returning some space to the market, further driving the sublease trend in downtown Toronto and Vancouver.
Property owners need to be mindful of whether we are seeing a temporary or a fundamental change in office demand. If it is the latter, property values also face a fundamental shift.
Be mindful of a potential shift in property value – and a corresponding need to address property tax
While leases in the office sector are relatively long term, property values can change rapidly. To ensure that property taxes stay in line with value, consider the following strategies.
Continually scan the market
Will there be a permanent transition to working from home paired with a decline in the need for office space? Or will demand for office space continue to climb as employees gradually return to offices to facilitate socializing, innovation, productivity and more?
For answers, property owners should continually monitor the industry landscape and changing tenant preferences. Business associations in major markets are a helpful source of information, with many tracking the impacts of the pandemic on members and the local economy.
Review results of monthly financials for income shortfalls
Companies need to understand current property value and how COVID-19 impacts valuations. Nine months of financials are now available to review results month-over-month. If budget projections indicate a significant income shortfall, that impacts property value – and taxes.
Inform the assessor about affected rent collection and vacancy rates
Assessments for office buildings are based on market transactions. Since there have been few sales during the past nine months, assessors will be studying additional factors to determine value. COVID-impacted rent collection and vacancy rates are important data to share.
It’s also important to communicate any other pandemic influenced factors that may impact future rental income, such as building design or elevators that cannot accommodate physical distancing.
Looking forward: occupancy levels will determine values
An adjustment in office demand across the country will dictate where office vacancy rates go in the next couple of years. This will determine property value and related taxes.
For owners who are able to maintain occupancy levels, your property tax pain point will be significantly lower than less successful competitors.
Manage property taxes for all of your assets, through the pandemic
To help you closely align property tax mitigation strategies with the current marketplace, this white paper presents a current picture of the challenges facing nine distinct asset classes in the time of COVID-19, along with steps to mitigate the impact of this consequential expense.