Bill Argeropoulos, Avison Young’s principal and practice leader for research. (Courtesy Avison Young)

The amount of available sublet space increased in the Greater Toronto Area (GTA) office market and the downtown vacancy rate rose slightly during the third quarter of 2019, according to Avison Young.

The increase in the amount of available sublet space is unusual, jumping 371,000 square feet between quarters to a two-year high of 2.7 million square feet, according to Avison Young’s Q3 office market report for the GTA. That represents 16 per cent of the total available space in the market.

The majority of the GTA’s sublet space is in the suburban Toronto East (31 per cent) and downtown (29 per cent) districts.

“It’s often a case of businesses taking extra space to accommodate future growth,” Bill Argeropoulos, Avison Young’s principal and practice leader for research in Canada, told RENX. “This is particularly evident among the growing number of tech companies in Toronto.

“In some cases, their growth is more rapid than expected and new premises are required, with the original space then marketed for sublet.

“The opposite can also be true, as business circumstances can mean that expectations are not met as growing companies burn through their funding, leaving surplus space to be put on the market . . . or sometimes workplace densification means that extra space is simply not required.

“One quarter doesn’t necessarily constitute a trend, but this is something we’ll be watching closely. Too much sublet space can be a bad omen in a down market but, in the current hot market, the spaces will still be leased and tenants are likely to be able to recover their costs fully, given rising rents.”

Decreased transaction volume

More than two million square feet of space was transacted across the GTA during the third quarter, about half the previous leasing volume during Q2.

Among the most notable lease transactions during the quarter were:

* Scotiabank’s 406,400-square-foot sale/leaseback at 2201 Eglinton Ave. E. and 888 Birchmount Rd.;

* Royal Bank of Canada’s 193,000-square-foot renewal at York Mills Centre;

* and the Centre for Health & Safety Innovation’s 101,000-square-foot renewal at 5110 Creekbank Rd.

Over the summer, as decision-makers on both the landlord and tenant sides take time away from the office, there’s typically a lull in the real estate decision-making process, according to Argeropoulos.

“The risk in a market as tight as downtown Toronto, however, is that any delays have the potential to cost tenants money as rental rates continue to rise — or they may miss out on some options altogether,” he said.

The most notable deal of the quarter was Cadillac Fairview‘s purchase of the East Harbour site from First Gulf and its partners for a reported $690 million. The largely vacant 38-acre site is located three kilometres east of the downtown core, with capacity for more than 10 million square feet of commercial space.

The GTA office vacancy rate was 5.8 per cent in the third quarter, versus 6.1 per cent a year earlier.

Downtown office performance

The downtown availability rate rose by 30 basis points to 4.3 per cent while the vacancy rate was up 10 basis points to 2.2 per cent.

“After posting a record low of 1.8 per cent late last year, it was inevitable that vacancy would rise at some point, and it has — modestly,” said Argeropoulos.

”The big questions are how will the market react as tenants — especially the big banks, CIBC, TD and Scotiabank — start moving into new towers in the next three years. How much backfill space will they leave behind and what will be the impact on rental rates?

“I think the answers will start to become clearer as we approach 2020.”

Seventy per cent of the 9.9 million square feet under construction downtown is pre-leased, which Argeropoulos said is about what’s expected. The figure could be as high as 80 per cent, he added, since some deals haven’t been officially announced.

“I’m confident that, by the time these buildings are completed, they will be almost fully leased — which some developers are already thinking about as they consider their next projects.”

Midtown office performance

The midtown vacancy rate was 2.7 per cent. While little new supply is on the way in midtown, some space could return to the market in the Bloor Street node as tenants relocate to new downtown towers in 2021.

CT REIT (CRT-UN-T) and Oxford Properties announced they’ll buy Northam Realty Advisors’ 33 per cent stake in the 846,000-square-foot Canada Square office complex at Yonge and Eglinton, to become 50-50 partners in the property.

CT REIT also has a conditional deal to extend its ground lease with the Toronto Transit Commission, while adding an adjacent parcel.

This could mean a redevelopment of the asset, which could include a new Canadian Tire head office after the Eglinton Crosstown light rapid transit line’s scheduled 2021 completion.

Rogers Communications is selling its six-storey, 118,000-square-foot office building at 350 Bloor St. E. as it moves staff into adjacent owned facilities at 333 Bloor St. E. and 1 Mount Pleasant Rd., where a multi-year modernization plan has increased capacity.

Suburban office performance

The vacancy rate was 9.4 per cent and availability 13.4 per cent in the suburbs. Modest gains in occupied office space in the Toronto East and North markets were offset by notable losses in Toronto West, which had produced solid results of late.

Argeropoulos said the relatively poor quarter in the suburbs is the result of tenants relocating to new premises and sometimes taking less space in those locations, as well as new developments coming on stream which aren’t yet fully leased.

“I wouldn’t read too much into it, as the suburbs have fluctuated in terms of performance from one quarter to the next, but have generally had a good year thus far — better than last year.

“Despite the potential threat of tenants being attracted to downtown, there has been decent deal velocity within the suburbs,” Argeropoulos explained.

“There’s no reason why that shouldn’t continue, especially given the widening price differential between the landlord-friendly downtown and tenant-friendly suburban markets.”

There’s 1.5 million square feet of office space under construction in the suburbs, 62 per cent of which is pre-leased. There was 1.1 million square feet under construction a year earlier, with 49 per cent of it pre-leased.

“Going forward, a growing emphasis on urbanizing the suburbs and transit-oriented projects may very well attract more office development,” said Argeropoulos.

GTA office rents and co-working space

Rents are increasing across all asset classes.

“Our analysis of a large sample of downtown class-A lease deals reveals that average starting face rates have jumped by 56 per cent since 2016,” said Argeropoulos. “Across all markets, we are seeing a spread in rates asset-by-asset and deal-by-deal.”

The report says technology firms and flexible office solution providers are driving the downtown market.

While it hasn’t announced where it will reside or how much space it will take, New York-based proptech firm VTS is opening a new engineering hub as it aims to add 50 staff by the end of next year.

Knotel is the latest major addition to the downtown Toronto co-working market, advertising three locations totaling 42,000 square feet. More deals could be in the works.

“The co-working phenomenon is real and does provide a valid alternative for tenants of all sizes, from startups to enterprise,” said Argeropoulos.

“WeWork’s financial woes are well-documented, but are not necessarily indicative of a problem with the co-working model and there seems to be room for another player.

“Co-working tenants have been a major source of office demand recently, but they still represent a small share of the overall leasing market. With so many providers and limited scope for differentiation, there may be consolidations in the offing.”

New office construction

The suburbs accounted for all 300,000 square feet of new space added, across five buildings, during the third quarter. The year-to-date GTA completion total is 803,000 square feet, up slightly from the 749,000 square feet delivered to this point last year.

There are 40 buildings totalling 11.4 million square feet under construction in the GTA.

There are also five high-rise residential projects underway downtown with almost 296,000 square feet of office space on their lower levels.

“Given the scarcity of prime office development sites, mixed-use developments are increasingly incorporating notable blocks of office space along with the traditional residential and retail model,” said Argeropoulos.

“Mixed-use development is definitely the way of the future and flexibility will also be key.

“The logical extension of this is the concept known as hackable buildings, where several uses can co-exist in the same building envelope, including office, industrial, retail, residential and other amenity spaces.”

Future forecast

Looking forward, Argeropoulos expects velocity to continue and likely increase in the fourth quarter.

“Downtown, many tenants will be eager to put space under contract before rental rates rise further, although those with the luxury of time may wait to see what the impact of backfill space will be, as the relocation of tenants to new towers takes place over the next few years,” he said.

“These decisions will be scrutinized closely, perhaps more so than ever before. Though big lease deals were scarce during the third quarter, we may see some before the year is out.”