In 2010, the federal government purchased Nortel Networks’ vast Carling Avenue campus in Ottawa with plans to consolidate the thousands of Department of Defence staff scattered among 40 different locations in the National Capital Region.
Three years later, those consolidation plans remain stalled by red tape, fiscal belt-tightening and the need for renovations. It’s that last one that’s interesting. Despite the fact that this was, up until a few years ago, a state-of-the-art facility, the required renovations amount to a large share of the expected $630-milion price tag attached to the project. The most recent update reports that the place already needs a roof repair that could cost as much as $5 million.
Meanwhile, across town at Dow’s Lake, the 46-year-old Sir John Carling Building, which has sat vacant for four years, is coming down. The 11-storey structure, which once housed 1,200 public servants, was deemed in such poor condition by Public Works that it was emptied and slated for “deconstruction” in 2009. The demolition has proceeded three years behind schedule as the stakeholders worked out how to preserve some heritage elements, safely dispose of the construction materials and divert as much waste as possible from landfill.
No matter how you cut it, commercial real estate that is outdated, in poor repair, or simply in need of a career change like the Nortel Networks’ campus is a big pain in the wallet.
Every building has a lifecycle
But every building goes through a lifecycle. It’s inevitable. What is state-of-the-art today will be superseded tomorrow.
Building standards, materials and processes are in constant flux. Any building, even ones built to environmental and sustainability standards such as BOMA BESt or LEED, represent only the best of what current construction standards can achieve, while at the same time remaining competitive in the leasing market. Despite the unwarranted hype and mystique that often surrounds a BOMA BESt or LEED certification, these buildings too will become dated and less desirable for tenants as the years pass.
The question is what to do about it when the time comes.
I will first state the obvious – buildings that are less desirable have trouble holding on to tenants and commanding a rental rate that makes the space viable as an investment or source of revenue.
This is much more of an issue in the office and professional markets than it is, say, in the multi-residential market. Commercial tenants put a lot more onus on the visual appeal and prestige of their digs than the average apartment dweller. Well-heeled tenants seldom are willing to accept better lease terms as an incentive to stay in a building that’s past its prime. They want to pay the full market price for an address that supports the visual identities and personas they wish to project for their businesses.
This leaves the owner/landlord in a tight spot. They can’t afford to stick with the status quo and suffer a downward spiral of diminishing returns.
The two sides of the market
This issue separates the market into two camps. The first is made up of investment funds and the like that want cash flow and reliable tenants in place. The second includes the redevelopers that are in the business of retrofitting old buildings or redeveloping entire properties. Redevelopers will purchase tired properties, perhaps from one investment fund, bring them back up to snuff, get them leased out, and then sell them to other investment funds.
But demolishing and rebuilding is costly and time-consuming. As the Sir John Carling building illustrates, there are concerns with waste diversion and disposal. And a full demo and new build entails a far greater tangle of red tape than a retrofit, even if the retrofit requires that the building be gutted right down to its concrete shell. All of this can delay a redevelopment project by years.
But if a building has what I call good bones, you may not need to demolish. Gutting it may be enough. It really depends on what the market wants. There are instances where, no matter how good its bones, a building just doesn’t cut it anymore. Maybe it’s not tall enough, maybe its ceilings are too low — there can be any number of factors depending on market expectations.
ROI is all that matters
The underlying motivation of a developer or an owner is still profit. They must balance the cost of a retrofit or rebuild versus the expected return. And when it comes to incorporating the latest in processes and materials that contribute to earning a BOMA BESt or LEED certification, they must again weigh any additional up-front costs this may entail against the potential cost savings that will result during the operational phase.
They also must consider factors that occupants may have come to view as necessities, such as natural lighting, secure bicycle lockups or environmental controls individualized to each work station.
But no matter what they do today, it will be surpassed by something else tomorrow. It’s the nature of the beast. Every new build or retrofit must be approached from the perspective that its revenue potential has a limited window before a new investment/reinvestment will have to be made.
Cities across Canada are crowded with buildings that were churned out by the dozens in the ’50s and ’60s and have little heritage value. Some have decent bones and can be gutted and retrofitted. But there are also hordes of other properties of an even older vintage that have reached the end of their useful lives and appeal only to a wrecking ball.
An aging and outdated inventory of building stock is becoming an acute problem. Real estate owners and developers as a whole have a lot of decisions to make over the next decade or two on how best to reinvest to unlock fresh value, or just pull the lever on some creative destruction.
To discuss this or any other valuation topic in the context of your property, please contact me at firstname.lastname@example.org. I am also interested in your feedback and suggestions for future articles.