It may seem like an oxymoron, but the tight period of a market cycle when space is scarce and developers are most optimistic is also the most dangerous, observed Sandy McNair, president of real estate research firm Altus InSite.
“Office historically has been the one that we blow up, it has the longest cycle,” he said. “It takes a long time to get a building organized and once you start you are kind of committed to finishing.”
That three to five-year development cycle has the danger signal flashing brightest in Toronto, which has witnessed the construction of six new towers since 2009 making up 4.4 million square feet. The good news is that new space is all but fully leased (96.7% according to figures compiled by Altus InSite). The bad news is that new space has created more than 1 million square feet of backfill (or vacant) floor space in established core buildings that include Commerce Court West, First Canadian Place and 77 King St. W.
“In Toronto the backfill is the concern, “ he said. The big surprise is some of best buildings in the city are suffering from the new construction. “ They are great buildings, really well located, owned by really strong pension funds who are investing significantly in the assets and yet there they sit with huge chunks of space at rents that are under pressure to decline rather than grow.”
The situation in Toronto is unusual because normally new top-flight buildings usually affect less-prestigious A and B class buildings rather than triple-A buildings such as the financial towers. “That hasn’t been what has been happening. Whether it is because they are blocked because there is a rival law firm or accounting firm or it is just a step too high to go for some of the potential tenants,” McNair said.
The Bow, in Calgary at 1,840,000 sf is nearly completed and is the largest office tower in Canada since 1976 when First Canadian place (2.3 million sf) was completed in Toronto. Using The Bow as a reference point, this map illustrates how much space is either underway or proposed in Calgary and Toronto. (image credit: Altus Insite)
The Toronto backfill issue could grow dramatically with new buildings underway or planned that if fully built will add another 4.7 million square feet of space. Those state-of-the-art towers typically boast superior quality of life features making them more sought after by employers looking for any edge to attract and retain workers and get more productivity out of them, Altus contends.
Having one million square feet of space sitting empty is not a total bad news story considering that four times that amount of new space has been added to Toronto’s downtown core, noted the Altus president. The banks, in particular, have been adding space (and people) even as they have been cramming more people into offices, dropping their average density from about 260 square feet per person to 150 square feet today and they now are aiming to drop that down to 120 square feet per person, McNair said.
By comparison, the booming commercial market in Calgary boasts a density in excess of 300 square feet per person. “Who is to say what is right and wrong. Certainly in Calgary there is a longstanding tradition of using space as an employment attribute. “
Altus finds that the situation in Calgary is less worrisome than in Toronto as the energy capital appears to have moved beyond the boom and bust cycles of the past. The deep pockets required for multi-billion-dollar mega projects to suck up oil out of the tar sands means that the oil companies and firms that serve them will be around for decades, regardless of short-term swings in oil prices. Those long time horizons have given the Calgary office market a stability it never had before.
Calgary has absorbed 3.8 million square feet of space over the past three years as seven new towers have sprouted up and are now 95% leased. That does not include the mammoth new Bow development (1.7 million square feet) which does not seem to be causing any vacant space issues either. “The backfill just hasn’t been an issue that it usually is when you have got that much new supply,” said McNair. “It is basically doing it on just one of its two industries, the gas industry is really quite quiet. It would be even more steamy if the gas industry was in good shape.”
Can Government Shrink? Ottawa Asks
Ottawa, traditionally the most stable office market in the country by virtual of the federal government occupying nearly two-thirds of the available space, appears to be in flux given signs the government will finally make good on repeated promises to shrink its footprint, said McNair. An unprecedented event, Ottawa’s top tenant suddenly requiring less space, is a much-discussed topic in the city and many are underestimating just how bad it could be, the Altus president added. ”I think there is a real risk of Ottawa becoming a lot more dangerous place than most people perceive it to be….particularly if you have got an A-minus or a B or B-minus building.”
While Toronto and Ottawa are flashing red and Calgary looks to have moved beyond decades of instability, the most unusual major office market remains Vancouver. The west coast city is characterized by a high number of small tenants and buildings have adapted to accommodate them.. “Where there are lots of tenants in Calgary who would be in the hundreds of thousands of feet, there are hundreds of tenants in Vancouver who would be 1,800 (square feet),” explained McNair.
Vancouver’s unique characteristics can be seen in the Oxford building now going up in Vancouver with a floorplate of just 8,000 square feet or built for four Vancouver-sized tenants per floor. “You just wouldn’t do that in any other market. The standard plate size would be 25,000 plus (square feet) in any other market.”