The global pandemic delivered an unprecedented shock to economies worldwide, and its reverberations in the commercial real estate (CRE) sector were immediate and profound. Traditionally, real estate markets exhibit a six-month or longer lag in response to broader economic shifts, providing a buffer for adaptation. However, as the world witnessed, the sudden, widespread shutdown of economic activity created instantaneous pressure across all segments of real estate. Residential markets saw houses withdrawn and condominium showings curtailed, while the retail sector faced widespread boarding up. While most residential sectors eventually rebounded with surprising vigor, the retail and, more recently, the office sectors have faced a more protracted and complex path to recovery. This leaves a critical question for investors, renters, and landlords alike: What comes next in this transformed landscape?
Ryan Henry
The Rise of Remote and Hybrid Work Models
One of the most significant and swift changes brought about by the pandemic was the widespread adoption of remote work. For decades, the concept of a white-collar workforce operating outside the traditional office environment was often viewed with skepticism, if not outright heresy, by many employers. A pervasive lack of trust in employee productivity without direct supervision held back this potential transformation. Yet, the exigencies of the pandemic forced an unplanned global experiment in telecommuting. What many analysts have now definitively concluded, supported by a wealth of data, is that employees are often just as productive, if not more so, when working from home compared to their office counterparts. This paradigm shift, having proven its efficacy and acceptance, is now firmly established as a permanent fixture in the modern professional landscape, whether in its pure form or through various hybrid models.
The implications for commercial real estate, particularly the office segment, are substantial. Many professionals in sectors like legal and finance have no immediate plans to return to their physical offices, with some timelines stretching into 2021 or even indefinitely. High-profile companies such as Apple, Shopify, and Twitter have openly declared their intentions to re-evaluate or abandon existing lease commitments, signaling a broader trend. This sentiment has materialized tangibly in markets like Toronto, where the volume of office subleases in the downtown core has experienced a dramatic surge, tripling in number. This increase in available sublease space reflects a fundamental reassessment of spatial needs by businesses adapting to the new work realities.
Scott Mulligan
Toronto’s Office Market: Resilience Amidst Uncertainty
Scott Mulligan, a seasoned real estate veteran and partner/broker of record at Ellington Partners, Corporate Real Estate Advisors, offers a sobering but ultimately resilient outlook for the Toronto office market. He projects that vacancy rates in the city’s core could climb to the mid-teens. This anticipated rise will occur even as companies largely unaffected by the pandemic step in to occupy space vacated by those less fortunate. However, Mulligan provides crucial historical context, reminding us that the current challenges, while significant, do not rival the depths of the 1990s real estate downturn. During that period, Toronto’s vacancy rates soared to nearly 20 percent, exacerbated by landlords who had speculatively constructed towers without securing tenants or guaranteed cash flow. Toronto’s commercial real estate market has a proven track record of weathering storms and staging rebounds, suggesting that recovery is inevitable. The pivotal questions, however, remain “when?” and “to what extent?”
Anthony Scilipoti, president and CEO of the acclaimed think tank Veritas Research, presents a more cautious timeline. He believes that a meaningful rebound in the commercial office sector is years away and likely to be marginal in its initial stages. Scilipoti anticipates a more dramatic downturn before any significant recovery, particularly impacting older, less technologically advanced buildings that struggle to compete with newer, amenity-rich, and tech-enabled spaces. This anticipated decline, he warns, will likely coincide with the cessation of government subsidies, which have effectively kept many businesses in a state of what he terms “suspended animation.” Without these critical lifelines, the true economic impact on businesses and, consequently, their real estate needs will become starkly apparent.
Anthony Scilipoti
Scilipoti further emphasizes that the trend of working from home was already gaining traction before the pandemic. Forward-thinking leaders had begun to recognize the strategic benefits of transferring the significant costs associated with office leases from the business’s balance sheet to the employee. COVID-19, in essence, acted as a powerful accelerant, pushing this nascent trend into overdrive and solidifying its permanence. This enduring shift is expected to have a lasting and potentially devastating ripple effect, extending beyond just the office sector. Ancillary services, particularly the restaurant industry that relies heavily on office worker traffic, have already felt this impact acutely. Scilipoti’s concerns are echoed by the closure of numerous restaurants, especially those located in high-traffic urban centers and the world’s largest underground PATH system, many of which may never reopen.
Reimagining the Office: Design and Demand in a New Era
While a significant portion of the workforce continues to operate remotely, Scott Mulligan, drawing on various industry sources, maintains that this widespread remote model will not be universal or permanent for all businesses. He projects that roughly 10 percent of all businesses will ultimately transition to a fully remote operational model. Another 20 percent are likely to adopt a hybrid approach, combining part-time remote work with part-time in-office presence. The substantial remainder of the workforce, however, is expected to return to more traditional office-based work, albeit within modified environments. This return will be crucial for stimulating the resurgence of Toronto’s office and associated restaurant industries. Ryan Henry, Vice President of Investment Sales and Leasing at RDH Group, Royal LePage Commercial, shares this optimistic perspective. He points to the resilience of his clients in the services and tech sectors, who, even during the peak of COVID-19’s impact, continued to sign leases and collaborate with designers to create innovative, pandemic-friendly work environments.
The shared belief among industry leaders like Henry and Mulligan is that office space demand will experience a rebound in 2021. This anticipated resurgence is predicated on several key factors. Firstly, regardless of the prevalent work model, some level of in-person collaboration and meetings will always be necessary for fostering company culture, innovation, and team cohesion. Secondly, government-mandated health regulations concerning physical distancing and hygiene will likely necessitate an increase in the square footage allocated per person within office spaces. This requirement for greater individual space will, by definition, drive up the overall demand for office real estate, even if the total number of employees in the office at any given time fluctuates. The office, in this new paradigm, is transforming from a mere place of work to a hub for collaboration, culture, and strategic interaction.
Evolving Lease Agreements: A New Era of Negotiation
Regardless of the precise timing or extent of the office market’s rebound, a fundamental shift is underway in the nature of commercial lease agreements. Tenants, now more than ever, will demand significantly greater flexibility. This includes unencumbered permissions to license out portions of their leased space without requiring explicit landlord approval, a departure from traditional, more restrictive clauses. Furthermore, businesses will seek options to relinquish space or reduce their rent payments should their usage requirements decrease over the lease term. A particularly critical demand will be for a more expansive force majeure clause. This enhanced provision would allow tenants to defer or avoid rent payments if unforeseen events, such as future pandemics or government-mandated shutdowns, prevent them from operating their business effectively.
Landlords, in turn, will also seek to mitigate their own increased risks. They will likely push for clauses that release and indemnify them from liability should any health outbreaks occur within their buildings, regardless of the cause. Both parties, recognizing the heightened risks associated with unprecedented events, will be compelled to conduct a much deeper dive into their existing insurance policies. A clear determination of coverage for such hazards will become paramount, leading to more rigorous policy reviews and potentially new types of specialized insurance products designed to address pandemic-related risks.
Many industry observers anticipate that the additional cleaning costs and projected increases in insurance premiums, direct consequences of the pandemic, may serve as deterrents for some businesses considering a full return to traditional office spaces. As a result, tenants who demonstrated viability and adaptability throughout the pandemic may leverage their strong positions to demand caps on operating costs. These caps would specifically apply to expenses related to enhanced cleaning protocols, contributions to the landlord’s insurance, or any future premium increases directly attributable to an outbreak within the building. This signals a future where operating expense clauses in commercial leases will be subject to far greater scrutiny and negotiation.
The Future of Retail: From Transaction to Experience
The management of future pandemics and public health crises presents a particularly troubling outlook for enclosed shopping malls. Anthony Scilipoti anticipates that the traditional mall model, focused primarily on transactional shopping, is unsustainable. Instead, he believes malls must undergo a radical revitalization, reimagining their core purpose. The future of the mall, Scilipoti suggests, will be centered around creating an “experience-driven” event, rather than merely a destination to purchase new items. Consumers will no longer visit malls simply to decide what they want to buy; instead, they will be entertained, immersed, and engaged by brands through interactive experiences, with the actual purchase often occurring later, perhaps online.
This experiential retail model is already being successfully implemented by pioneering brands. Canada Goose, for instance, offers customers the unique opportunity to test their cold-resistant jackets in a simulated freezer environment, transforming a simple try-on into a memorable adventure. Lululemon hosts a diverse array of health-related events, such as yoga classes, while subtly showcasing their latest athletic wear. In these environments, shoppers can engage deeply with a brand’s offerings, order custom clothing that is shipped to them at a later date, or, more commonly, return home and complete their purchase online after a compelling in-store experience. The emphasis shifts from immediate transaction to brand engagement and immersion.
The Complexities of “Percent Rent”
This fundamental shift towards experience-driven retail, where consumers may visit a physical store to engage with products and brands but make their final purchase online, necessitates a corresponding change in how landlords collect rent. The traditional model of “percent rent,” typically calculated as a portion of a tenant’s in-store sales, becomes increasingly problematic. As sales migrate online, landlords are likely to demand that percent rent clauses encompass a portion of the tenant’s online sales as well, rather than solely in-store transactions. However, this proposition raises significant fairness issues. Online sales may often have little to no direct correlation with the physical in-store experience, making it difficult to justify a portion of that revenue as rent for the physical space. Furthermore, calculating percent rents on online sales could severely erode retailers’ already thin margins, potentially forcing them to either cease operations or abandon mall locations altogether. Retail tenants, therefore, must pay meticulous attention to their percent rent clauses, ensuring they are not unduly expansive or detrimental to their profitability in this evolving retail landscape.
Opportunities and Toronto’s Enduring Appeal
Despite the pervasive chaos and uncertainty ushered in by COVID-19, industry leaders like Ryan Henry, Scott Mulligan, and Anthony Scilipoti have all identified significant opportunities emerging from the disruption. Sectors involved in office planning and redesign have experienced a boom in work requests, as companies scramble to reconfigure spaces for new health and safety protocols and hybrid work models. Similarly, the construction industry is seeing high demand, particularly for the repurposing of now-defunct office and retail spaces into alternative uses, such as much-needed storage facilities. While traditional anchors of the Canadian office market, like major banks, are reducing their downtown footprints, a new wave of previously lesser-known companies is stepping in to fill the void.
For example, wealth management firms, government agencies, and rapidly expanding tech companies are all actively growing their physical footprints, absorbing a substantial portion of the demand shortfall left by departing banks. While Scilipoti anticipates an economic crunch on the horizon, Henry remains optimistic about Toronto’s ability to rebound at a significantly faster pace than other major global economic hubs. His confidence stems from Canada’s comparatively effective handling of the pandemic, which has instilled a sense of security among both domestic residents and overseas investors. Henry, a recent father and caregiver to his own father, emphasizes his personal comfort with his family residing in Canada. This sentiment resonates with many international investors who laud Canada’s robust healthcare system, stable government, and diverse population and economy. These intrinsic strengths, collectively, provide a compelling foundation for Toronto’s longstanding growth trajectory to continue and even accelerate in the post-pandemic era, cementing its status as a resilient and attractive investment destination.
Conclusion: Adapting to Permanent Change
While industry experts like Scilipoti, Mulligan, and Henry may offer slightly divergent perspectives on the pace and nature of recovery, there is universal agreement on one fundamental point: COVID-19 has catalyzed permanent changes in how we live, work, and interact with our built environment. Beyond the immediate shifts in daily routines, this period has fundamentally altered what stakeholders deem important and non-negotiable within the framework of commercial real estate leases. The emphasis has irrevocably shifted towards flexibility, risk mitigation, and adaptability. Success in this new landscape will hinge on the ability of landlords, tenants, and investors to understand, anticipate, and proactively respond to these enduring transformations, ensuring that commercial real estate continues to serve as a dynamic and supportive foundation for a re-imagined economy.