The conditions are still not ripe for major pension funds to be in the office acquisition market this year, according to participants in a wide-ranging discussion on the Canadian office market at RealCapital in Toronto.

“They're looking for a discount and I don't think there’s anything for sale,” said Adgar Canada chief executive officer Chris Tambakis during the event at the Metro Toronto Convention Centre on Feb. 25.

He was responding to a question from the panel moderator, Colliers president of Canadian brokerage services Daniel Holmes.

“A lot of pension funds are likely overweighted in office but, that being said, if there was a right opportunity that came along at an attractive price, I still think it could happen,” said Denise Wong, executive vice-president of Brookfield Properties’ eastern region and Canadian office division.

Hines senior managing director and country head for Canada Avi Tesciuba said he doesn’t expect a pension fund to buy an office building in Canada right now, but added it could happen somewhere else in the world.

Suburban and downtown office vacancy rates

Tambakis said downtown office vacancy rates have recently exceeded those in the suburbs because most new supply has been built in the downtowns. He expects that vacancy trend to reverse over a longer term and for rates to come down in both areas.

“I think the suburbs will always be a little ahead in vacancy, because you can build a 200,000-square-foot building in the suburbs in 18 months,” Tambakis explained. “There's not a lot of people building 100,000- or 200,000-square-foot buildings in downtown Toronto.”

Employment trends have a bigger impact on vacancy rates than such factors as building amenities, parking availability and traffic congestion, according to Tambakis.

The flight to quality

“The flight to quality is always there in the market,” Wong observed. “I think what happens, though, in periods of disruption and uncertainty, that delta becomes that much more pronounced, and we've definitely seen tenants take advantage of that.”

“Employers are finding that, to draw and retain talent, they need real estate,” Tesciuba said.  “Real estate, I think more and more, is not thought of as an overhead cost centre. It's thought of as a tool to attract tenants.” 

Tesciuba believes well-located and amenitized buildings can increase employee productivity, which can justify higher rents.

“We've got some premium buildings in the GTA that are in the suburbs that don't fit their local marketplace, and those will suffer and landlords will have to throw money at them,” Tambakis said.

Rents stable in Toronto and Vancouver

Real estate generally accounts for between three and seven per cent of a company’s operating expenses, according to Tambakis, who noted “people move to where the business can afford.”

Tambakis said there hasn’t been a meaningful disruption in office rents in Toronto or Vancouver during this cycle, but noted that Calgary has gone through a major "storm."

“It's about managing through the periods of disruption but, partly because of the limited supply that we've seen a lot of the time, there might not be availability, and therefore you're able to keep your asset rents where they are,” Wong said.

Impact of tariffs and low Canadian dollar

Tambakis doesn’t want to see Canada impose retaliatory tariffs on the United States because he doesn’t think it will be productive, will cause inflation, and put pressure on interest rates. He believes not buying American products, where possible, is a better strategy.

Tambakis doesn’t expect U.S. tariffs to have a major impact if they’re removed after a few months, but said it will be a different story if they’re in place for years.

Wong said more clarity has to be provided and it’s still too early to know what will happen.

“When it comes to construction costs, there could be implications in office and for anyone who would potentially be looking at office redevelopment,” Wong said.

Holmes said the threat of tariffs impacted transactions that Colliers was involved with in January and that some deals were postponed.

On the upside, Canadian real estate market fundamentals are still sound and the country has shown resiliency. Wong thinks the low Canadian dollar could create opportunities for foreign investors who appreciate the country’s stability.

Running out of AAA office space

Hines and Ivanhoé Cambridge are partners in developing CIBC Square, which will be the last major high-rise office project to be completed in downtown Toronto’s current construction cycle. Its second tower topped out last month and is 80 per cent pre-leased to a variety of institutional-grade firms.

Tesciuba said there’s demand for class-AAA space in Toronto and he expects another class-AAA tower to be launched in the next five years. It would require being at least 50 per cent pre-leased and would have to charge rents of $70 to $80 per square foot, he added.

Tesciuba expects owners of class-B buildings will invest in upgrades to draw tenants who can’t afford such high rents.

Tambakis said he doesn’t expect another class-AAA office tower to launch in the next five years, but does foresee smaller developments in the suburbs.

Canada and foreign office market comparisons

A flight to quality is also evident in the U.S., according to Tesciuba. He noted that, unlike in Canada, American lenders are forcing foreclosures and lower-quality office product is actively trading.

Tesciuba said the New York City market is recovering and he believes a new spec-build office development will be launched in the next 12 months.

Brookfield is investing in large trophy assets in international markets with limited acquisition opportunities. Wong cited a recently completed transaction involving a 1.5-million-square-foot office tower in Tokyo, Japan that was 90 per cent leased, has Amazon as an anchor tenant and was acquired for well below replacement cost.

Tambakis said the European market has recovered much faster than in Canada in all respects, including employees returning to the office, rents and vacancy rates.