Memo #12: A Snapshot of Main Street Commercial Real Estate

By: Glenn Miller, Senior Associate with Canadian Urban Institute

The impact of COVID-19 on thousands of landlords, retailers and other Main Street entrepreneurs across Canada has been – and will continue to be – potentially devastating. As communities enter more advanced stages of re-opening, this memo discusses some of the challenges facing Main Street before COVID in order to distinguish between pandemic-related impacts and more systemic issues.

To take the economic pulse of Main Street B.C. (before COVID), we interviewed commercial real estate brokers as they are uniquely qualified to read fluctuations in market conditions affecting landlords and prospective tenants. The following insights represent a sampling of views from real estate professionals in cities in B.C, Manitoba and Ontario. Most believe the future of Main Street remains positive, but they caution that every main street is different, and all are dependent on the strength of the local economy.

Increases in property taxes are linked to redevelopment pressures on Main Street

Rising rent levels were already a concern before the pandemic, but brokers suggested that rents are rarely the sticking point for finalizing deals. “Rents are set by the market and it is always possible to negotiate,” a Greater Toronto Area (GTA) broker explained. In his experience stores don’t sit empty because of rent considerations alone. “You can’t renegotiate a weird store configuration or a low ceiling. The visibility of a store and its location on Main Street are critical factors that determine a store’s success. The physical constraints of a property are what you have to work with.”

The real villain is rising property taxes, brokers noted, because they represent a “non-negotiable” component of operating expenses. Several brokers expressed concerns over how provincial assessment corporations establish land value, a key factor that determines the size of the tax bill. The Ontario experience illustrates a problem common in many provinces.

“More than 20 years ago, Ontario adopted current value assessment,” an Ontario broker explained. “In neighbourhoods where redevelopment has taken place, MPAC (the Municipal Property Assessment Corporation) will periodically reassess area properties at higher values, based on the hypothetical potential to build, say, a 12-storey condo, even if there is no intention to redevelop,” the broker said. “Calculating land value based on ‘highest and best use’ instead of ‘current use’ undermines Main Street. A municipality and the BIA can work their socks off to promote a street’s vitality, then lose popular restaurants or successful independent stores because taxes passed on to the tenants don’t reflect their ability to pay.”

The consensus among brokers interviewed for this memo is that, as currently implemented, the property tax system is an unnecessarily blunt public policy instrument. Post-COVID, they suggest that BIAs and chambers of commerce should collaborate with provincial ministries to strike a reasonable balance between delivering sufficient tax revenue to municipalities and protecting the viability of independent stores on Main Street.

Developing condos with ground floor retail on Main Street has pros and cons

Responding to the desire of young professionals and empty-nesters to live close to downtown, municipalities are introducing mixed use policies into official plans to facilitate construction of condos on Main Street.

Several brokers cite the positive impact of such policies. “The addition of condos (on Main Street) has proven helpful to retailers,” a London Ontario broker reported. “Retailers appreciate the additional foot traffic generated by new residents. Overall, Main Street redevelopment is a positive trend that will continue to have benefits post-COVID.”

But in Winnipeg, another smaller regional market where the municipality has tried to entice developers to build housing downtown, a local broker cautioned that there is a significant time lag in achieving critical mass of downtown housing in a city where the focus is still on suburban living. “Promoting this kind of shift can take a generation,” he suggested. “It takes a brave consumer to be the first to buy in a neighbourhood that is still transforming, so the retailers are still waiting.”

A potential downside of encouraging condos on Main Street is a risk this will hasten the demise of independent retailers, which most observers believe have the skills and flair necessary to cultivate the kind of customer loyalty needed to support a street’s long-term success.

“When four or five independent stores close to make way for a new condo,” a Victoria. B.C. broker noted, “the default tenancies are franchise operations or ‘non-traditional’ tenants like dental clinics, exercise facilities or pharmacies, which do nothing for the ‘buzz’ you want on Main Street. Replacing independents is an uphill challenge as they lack the ‘Grade A covenants’ demanded by the bank.”

Another complaint from brokers is that the design of retail space at the base of new condos is often less than ideal. “Frankly, if the condo architect says a column is needed in a certain location on the ground floor to support the condos above, the developer will say ‘go ahead’ with little consideration given to the shape or practical requirements of a future retail tenant,” reported a GTA broker. “When that condition is replicated in several locations along a street, this diminishes the street’s potential.”

“The bottom line,” a Victoria, B.C. broker says bluntly, “is that even before the pandemic, more and more storefronts were being leased to tenants serving needs that can’t be met through purchases on Amazon. Tenants like fitness centres may not be exciting, but this is better than vacant storefronts,” she said.

“The surge in on-line retail sales triggered by COVID makes the local provision of goods and services requiring face-to-face contact even more important,” added a Winnipeg-based broker. “Remember, Main Street is competing against the malls as well as e-commerce.”

The economics of starting and sustaining an independent retail enterprise are daunting, brokers agreed. One possibility could be the creation of community trusts to act as financial backers and/or incubators to make it possible for condo developers to seed ‘independence’ into the new streetscapes created as a result of redevelopment. On the design front, a Toronto broker praises the City of Toronto’s recently released retail space guidelines for condo developers and architects as a positive step to ensure that new retail spaces have built-in flexibility and consumer appeal.

The question of ‘who owns Main Street?’ could be pivotal over the long run

Brokers have conflicting views of the future of ‘independent’ stores versus ‘chain’ or ‘franchise’ operations. Most believed that while independent retailers help establish and sustain the character of a Main Street, independent start-ups typically have less financial flexibility to withstand shocks to the system like COVID.

The role of locally-based landlords – whose knowledge of Main Street often stretches back generations – in supporting independent retailers or restaurateurs cannot be overstated. Brokers expressed a concern that family-owned properties are being bought out by REITs and private equity firms.

“Second and third generation families understand the history of a street,” a GTA broker commented. “The problem with REITs is that the focus is on ROI (return on investment) rather than doing deals that are good for the long-term economic health of the street. In my view, some professionals acting for REITs are not sensitive to the needs of retail.”

A negative impact of the rise in popularity of REITs and private equity investors noted by brokers in ‘hot markets’ like the GTA is the inclusion of demolition clauses in leases as owners seek to preserve the option to redevelop. “Attracting higher quality tenants becomes a challenge because leases with a termination clause deter tenants from investing capital in in-store improvements,” a broker suggested.

A surprising explanation for why stores can stay vacant for a year or more, heard from brokers in different jurisdictions, is that owners “may not be motivated to strike a deal.” Properties held for a generation or more are likely to be debt free. “Residential units above the store provide more than enough revenue to cover costs and even deliver a modest surplus,” one broker explained. “If the owner is semi-retired or perhaps has multiple properties across a city, the hassle of making sure a vacant store is in good order can deter landlords from making the effort to negotiate a lease.”

To make it less attractive to allow stores to sit vacant, BIAs in Toronto successfully lobbied the City to remove provisions allowing rebates on vacant property. Post-COVID, brokers suggest that there may be a role for ‘activist BIAs’ to work constructively with problem landlords, but the reality is that Main Street will need to adjust to changing ownership priorities as family-owned landlords are replaced by corporate interests. Campaigns to foster investor confidence in the future of Main Street retail might be the answer, brokers suggested.

This memo benefited from confidential interviews with brokers representing Avison & Young, CBRE, ReMax, Colliers and several independent brokers. Glenn Miller FCIP, RPP is a senior associate with the Canadian Urban Institute.