Canada retail outlook

Construction slowdown leads to shortage of new retail space

May 04, 2023
  • Heli Brecailo
  • William Schneider
  • James Cook
Canadian retail real estate market tightens amid limited supply

Demand for retail space in Canada continues to outpace supply, resulting in a tight real estate market. Despite the reduced space available, leasing activity remains steady and comparable to pre-pandemic levels. Even with the uncertain economic conditions, many retailers are optimistic about their prospects in Canada and are seeking to maintain a competitive edge by securing prime locations.

In this context, the recent departure of Nordstrom and Bed Bath & Beyond from the Canadian market presents new opportunities to secure prime locations and introduce innovative concepts. While their exit is unfortunate and is a reminder how competitive and merciless this market can be, it isn’t expected to significantly impact the overall vacancy rate (up to 0.30 percent) because these stores occupy only a fraction of the retail space vacated by more impactful exits such as Target in 2015 and Sears in 2017.

The Canadian construction industry is currently grappling with several challenges as it strives to meet the continued demand for commercial space. High construction costs, labour and material shortages, and inflated borrowing costs have put a brake on the industry's ability to start new construction. The rate of project completion has slowed significantly, resulting in a backlog of projects and longer completion times.

In addition, the retail construction segment is closely tied to the residential construction sector, which has recently experienced a downturn in sales. This slowdown in home sales adds a layer of uncertainty to an already challenging situation, making it increasingly difficult for the construction sector to overcome these hurdles in the short term. As a result, it might take the industry considerable time to address the challenges and get back on track.

In a tight retail-space market, it comes as no surprise that asking retail rents have kept pace with inflation, with rent rates experiencing some of the most significant appreciations in the past five years. In most markets, the second and third quarters of 2022 experienced the fastest growth in rental rates.

However, despite this strong growth in asking rents, effective retail rents have not yet made substantial progress in catching up with inflation. Average rental rates have seen only a gradual increase. Calgary is finally approaching pre-pandemic levels, while Vancouver continues to lead the pack in terms of rental rate appreciation, followed closely by Toronto.

The retail real estate markets in Edmonton and Calgary are presently experiencing strong net absorption as higher oil prices and population growth create demand for new residential and commercial development. The retail sector in these cities is particularly noteworthy as they currently lead in project completion, making them more balanced.

The retail industry continues to show a strong preference for general retail spaces, with malls experiencing a remarkable rebound. Because remote and hybrid work arrangements remain popular, neighbourhood centres and power centres continue to perform well. However, the demand for strip centres has slowed.

Despite these challenges, the Canadian retail market maintains momentum as first-to-market brands enter and expand in the country. There has been a surge of new entrants in fashion, luxury, optical, and electric vehicles. Additionally, shoppers have shown a preference for brick-and-mortar stores and enclosed malls, leading retailers to compete for spaces. Canadians have also recently shown a strong interest in dining and travel experiences.

However, economic headwinds such as high inflation and interest rate hikes by the Bank of Canada mean that the retail market is unlikely to repeat its 2022 performance. Shoppers have become more cautious with their spending as more of their budgets are allocated to basic expenses. Businesses are similarly hesitant to expand due to the prospect of an economic slowdown. Nevertheless, some growth in the retail market is expected in 2023.

Fashion bounces back: Apparel and footwear industries see a surge in demand

The pandemic significantly impacted the clothing and footwear industries, leading many fashion brands to downsize in 2020 and 2021. With businesses now fully open, however, these categories are experiencing a surge in pent-up demand. In fact, clothing, shoes, and other fashion accessories have emerged as the top-performing categories in 2022, and this trend is expected to continue in 2023 as people resume their normal activities such as returning to offices, shopping centres, and public transit, and attending parties, weddings, and other events.

Demand for health and personal care products, as well as sporting goods, is also expected to continue to grow. The impact of the pandemic has raised awareness among Canadians about the importance of maintaining good physical and mental health and protecting themselves and their loved ones from illness. Additionally, as the Canadian population ages, the need for health and personal care products is also expected to rise because older individuals tend to require more specialized products to maintain their well-being.

As for general merchandise retailers like Walmart, Costco, Giant Tiger, and Dollarama, their growth in sales can be attributed to their broad product offerings, competitive pricing, and convenient one-stop shopping.

On the other hand, categories related to housing are expected to decline due to a drop in housing starts and home sales. 

Finally, there has been a noticeable shift in consumer behaviour from traditional grocery stores to food services. This has negatively impacted liquor and grocery stores, making them some of the slowest performers. With pent-up demand for experiences, and grocery and alcohol items undergoing steep price increases, it is unlikely that grocery and liquor stores will outperform in 2023.

Overall, most categories have recovered from the pandemic with higher volumes sold in 2022 than in 2019. The exception is jewelry, which saw a slowdown in the second half of 2022 after a strong first half.

Canadians continue to spend: Strong demand for travel, dining, and entertainment

Despite plans by all income groups to be more frugal this year, Canadians are continuing to spend, particularly on services such as travel, restaurants, cinemas, and theaters, which remain strong. This indicates a delayed adjustment to the current economic conditions and suggests resilience in spending. As a result, any decline in consumer spending in 2023 is likely to be gradual rather than sudden. Despite the uncertain economic environment, Canadians remain cautiously optimistic and willing to spend in certain categories.

This January, sales for both restaurants and QSRs increased by 6 percent over the previous month. The restaurant industry and food delivery services have shown significant upward momentum, with even real sales for food services now surpassing 2019 levels. 

The Canadian labour market is still robust, with the unemployment rate holding steady at 5 percent, indicating that shoppers still have purchasing power. Furthermore, increased government transfers to households in the form of tax benefits and pensions have helped support household disposable income, contributing to an increase of the household saving rate from 5 percent in the third quarter of 2022 to 6 percent in the fourth quarter.

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