Reimagining and Reworking Office Space in Canada
Downtown cores across the country continue to face the residual effects of the widespread lockdowns during the course of the pandemic, which prompted many companies to rapidly shift their workforce from downtown offices to working from home.
This has certainly caused a disruption to the traditional office workplace as we once knew it, and it’s safe to say that today’s workforce could never have imagined or predicted this current scenario. As many companies have successfully shifted to a hybrid work from home model – a model that most agree is likely here to stay – this has left many wondering, especially those in the commercial real estate sector:
What will become of the office class?
We have turned to our teams in Toronto, Ottawa, Winnipeg, Edmonton, and Calgary to break down just how this asset class has changed in their respective cities and share their predictions for what they believe is to come for the future of this class that has traditionally dominated much of the downtown market in Canada’s larger centres.
Trends across the country
While each city has its own unique set of circumstances and differences that affect its downtown office rental market, among the five cities there is a common theme of questioning and re-evaluating the purpose and use of traditional office space.
Right sizing and movement within the market are also trending across the country, and further reports suggest other types of movement both in and out of the major centres, including an insurgence of tech-based companies scooping up empty spaces in a few downtown cores.
There is a common theme of questioning and re-evaluating the purpose and use of traditional office space.
There have also been plenty of mainstream media reports surrounding the idea of using the empty buildings to solve other types of housing problems; from conversions to affordable housing complexes, to ending homelessness. It all sounds very promising and offers a potential silver lining in an unforeseen and unprecedented situation. However, as we dive into each city, we hear from our teams about how complex these conversions can be, and touch on some of the red tape from a construction and cost perspective.
Landlords are having to provide inducements and incentives like lowering rents or allowing for subletting to keep and attract tenants – due to the highly competitive nature that the surplus of available inventory has created.
With more vacancy, each city is seeing movement between the classes, seeing higher occupancy in the AA asset class, with the lower classes being the least desirable of what is currently available. Taking this into consideration, some operators are taking this time to improve older assets or working towards building certifications that make the space more attractive or more efficient to run.
Operators are taking this time to improve older assets or working towards building certifications that make the space more attractive or more efficient to run.
Market outlook and predictions
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According to the latest Q3 2021 CBRE report, the total office vacancy rates in Toronto are currently sitting at 9.9 per cent, as compared to a rate of 2.3 per cent in the Q3 2019 CBRE report. With vacancy rates varying across the country, although Toronto has seen one of the smaller increases of vacancies at 7.6 per cent, it represents over a 3.3x increase in overall vacancy over the 24-month period, which is a meaningful trend for the area.
“I believe that the trend of working remotely will move towards a hybrid model as the office remains a very valuable cornerstone of any successful business,” says Oliver.
There is an appreciable amount of value in face-to-face meetings, such as the ability to collaborate and attract top talent. The question that remains is, what amount of office space is needed to accomplish this?”
Office [space] remains a valuable cornerstone of any business. The question that remains is, what amount of office space is needed to accomplish this?Christian Oliver
Of course, it will vary from business to business and sector to sector, but Oliver’s advice to the many employers who will need to consider the purpose of their office, is: Is it necessary for the company to do business?
“Employers should analyze the effectiveness of their organization to work remotely,” says Oliver.
“A cost-benefit analysis would be a good start to contrast the loss in revenue due to inefficiencies in remote working with the reduction in the office expense. Of course, this and many other metrics will need to be monitored over time and should be continually scrutinized.”
Toronto holds the headquarters and head offices for a significant number of national and multi-national corporations. Look to these organizations to set a precedent and lead workplace trends for the rest of the country.
It is widely understood that in Ottawa, the federal government dominates the region’s economy as both employer and landlord. According to the Treasury Board of Canada (2019), Canada’s federal public service employs approximately 288,000 employees – and nearly half (42 per cent) of those employees are in the national capital region, which consists of Ottawa, Gatineau, and the surrounding urban and rural communities.
The latest figures published by CBRE in Q3, show that the occupancy levels in Ottawa are slowly beginning to rise for some industries, namely construction, professional services, and Fortune 100 big tech. And although this is positive movement in the right direction, perhaps the more significant news is that the federal government has announced they are going forward with the proposed GCworkplace – a new program aimed at embracing new ways of working for federal employees. Its goal is to reduce the federal government’s leased office space by 20 per cent in the next 20 to 35 years.
Marvin Ngambage, director of mortgage origination for Canada ICI in Ottawa says, “Understandably, as this transition is made it will have a definite impact in the Ottawa office space, where the majority of the nation’s federal employees work. However, due to Public Services and Procurement Canada (PSPC) leasing regulations, it is difficult to predict exactly when the market will experience the effects of these space reductions, as these regulations do not allow the federal government to terminate their leases mid-term, or to sublet their space.”
But as it stands today, Ngambage says the office market is relatively stable given the large footprint occupied by the federal government.
The [Ottawa] office market is relatively stable given the large footprint occupied by the federal government.Marvin Ngambage
Inducements have increased significantly as landlords try to preserve their pre-pandemic rental face rates and tenants are reluctant to commit to longer term deals. Ottawa is also seeing a disproportionate increase in subleasing activity as companies have been downsizing and subletting until they’re more certain about the new normal.
As per Cushman & Wakefield’s Office Q2 2021 report, Ottawa saw an increase in sublet space in Q1 2021 of 19.9 per cent (sublet vacancy as per cent of all available space), which has since stabilized back down to 12.5 per cent in the second quarter – mostly due to positive net absorption.
In other good news for the Ottawa market, Quebec’s Groupe MACH’s recently acquired 1870 Alta Vista, a 112,000 sq. ft. Class A, LEED certified office building. Representing the group’s first foray into Ottawa, and their fourth major transaction in Ontario for the year, companies like Groupe MACH prove that there remains positive movement and opportunity within the market space.
In efforts to solve other housing issues, Ngambage says there are some conversations being had about converting some of the obsolete office buildings in the area.
However, this can be a challenging initiative for developers to take on, says Ngambage, as there are many hurdles they need to overcome to make the project successful.
“For instance, building floor plates and engineering need to accommodate for the desired conversion, or construction costs can quickly inflate to the point where development yields no longer make sense,” explains Ngambage.
But that is not to say it isn’t possible. For example, the conversion of 331 Cooper Street, which was announced earlier this year by Serco Realty Group, plans to convert the seven-storey office building into an eight-storey multi-residential development. The building, which has 20 office suites and dates back to the 1960s, upon completion will comprise a total of 45 residential units with a rooftop amenity on the 8th floor. Its completion is slated for late 2022.
“As of right now, just exactly how these office spaces may be used or transitioned on a large scale is still largely uncertain,” says Ngambage, adding that, “right now the general consensus is that it’s simply is too early to tell when we will reach a more stable and predictable environment.”
In Winnipeg, Andrew Loewen, senior mortgage underwriter at Canada ICI, predicts suburban office space will become more in demand over the coming years and that small businesses will rent space closer to where people live; reducing commute time, traffic, and parking costs.
“Businesses are now realizing they don’t need to have office space for every person within the company,” says Loewen, “and leases will likely be cancelled or not renewed as a result.”
In Winnipeg, the city is starting to see this fallout already, as the downtown office vacancy rate went up in the third quarter of 2021 to 14.6 per cent as per the 2021 CBRE Q3 report.
This is, however, in part due to one of the country’s largest insurance providers, Canada Life Assurance Company, not renewing their nine-floor lease; leaving behind in their wake 120,000 sq. ft. of vacant office space in the downtown core. On the flip side however, Harvard Developments is renovating the concourse and lobby of 201 Portage, and the opening of True North Square also stands out as a major highlight for the market.
The office is set to four towers and over one million square feet of office, residential, retail, hotel and public space. The first tower, a 17-storey Class A office building, opened in June 2018 and is nearly fully occupied.
In the meantime, many office landlords are adapting in other ways; spending substantial amounts of money to improve their buildings, or trying to obtain new designations such as a WiredScore Wired Certification, which assesses the digital connectivity and smart technology within a building.
“The general speculation is that the office asset class will continue to hurt for a while longer as Winnipeg has substantial supply and a smaller demand for new space,” says Loewen.
Loewen adds that he believes the lower office class spaces in particular, will be hurt the most, as higher-class office spaces will continue to lower rents and incentivize tenants, drawing them away from older, dated office spaces and into newly renovated or developed spaces.
However, he remains optimistic, noting that the strong push for back to work from the government has seemed to have helped the Canadian office market.
And as Loewen simply puts it, “The more people that are downtown, the more people will need to be downtown and that will drive demand.”
Higher-class office spaces [in Winnipeg] will continue to lower rents and incentivize tenants, drawing them away from older, dated office spaces.Andrew Loewen
In the past, there has been stability in the Edmonton office market as the federal, provincial, and municipal governments historically have served as both a major employer and financial anchor occupying nearly 40 per cent of all office space in the downtown market, amounting to approximately 16 million sq. ft. However, as seen in Ottawa, this will be changing due to the GCWorkplace program being implemented by the federal government.
Benjamin Clark, a senior mortgage analyst from the Canada ICI head office in Edmonton, breaks down how the office market has shifted, and gives us his projections for what changes are to come for Alberta’s capital city.
In previous years, the majority of leasing activity within Edmonton’s core was concentrated within the Financial District, which features several new Class AA office buildings including Stantec Edmonton, and Enbridge Towers. Following the revitalization of the downtown core with the construction of the ICE District and Rogers Place Arena, Edmonton’s Class AA market benefited from a strong flight to quality by prospective tenants, as AA vacancy decreased to the lowest of any office class in the city.
Fast forward to 2021, the majority of sublease space available within Edmonton’s downtown market is in Class AA buildings which exhibit several large pockets of available space. With the continued prevalence of remote work and the extension of many return-to-work dates, leasing activity has remained limited within Edmonton’s downtown area, with the overall vacancy increasing 20 bps to 20.60% in Q3.
Positive absorption was evident within the sublet space, as tenants took advantage of a host of competitive market rates offered through high quality sublease options in Class AA and A, resulting in a 40-bps decrease in sublease vacancy to 3.50% in Q3 (CBRE).
“The increased availability of discounted high-quality office space relative to previous years, is likely to increase competition from landlords of lower-quality assets,” says Clark. “We can expect increased competition from landlords of lower quality assets, as they face a race to the bottom in Net Effective Rents. This will likely ensure that Edmonton will remain a tenant’s market for the foreseeable future.”
The increased availability of discounted high-quality office space relative to previous years, is likely to increase competition from landlords of lower-quality assets…Benjamin Clark
The increase in competition amongst lower Class assets has also spurred the sale of several older officer towers at deep discounts to historic market levels, drastically lower than the replacement cost of these buildings. Canadian Western Bank Place sold for $96.4 million in November, an amount nearly $30 million less than the Jasper Avenue property sold for in 2010. Another notable sale was Sun Life Place, a 26-storey office tower constructed in 1978, which has previously undergone significant renovations and was 80 per cent occupied at the date of sale. Despite elevated levels of uncertainty in the Edmonton market, this sale was an indication that some investors believe there is opportunity in the market to purchase relatively stabilized assets at an attractive yield with limited downside risk, given the already heavily discounted values.
As seen in other major cities across Canada, conversions of older buildings seem to be happening more frequently in the office asset class. In Edmonton, several older obsolete office buildings were converted into residential space. This process can be challenging, as repurposing buildings can result in unforeseen construction costs and restrictive floor plates, which lower the efficiency of the residential build-out, factors which compress development yields and increase re-development risk.
Despite these added challenges, Strategic Group, a Calgary based developer, has repurposed several office buildings within their Edmonton portfolio. This includes the conversion of the aging Harley Court building, into a collection of one- and two-bedroom units which has been renamed the ‘e11even.’ This project was the largest office-to-residential repurposing project ever completed in Alberta.
Despite the post-pandemic elevated levels of uncertainty in the Edmonton market, Clark says he believes that the conversions and sales of these office assets are an indication that there are still opportunities to be had in Alberta’s capital city and he is hopeful for the market to return to a more stabilized state in the new year, and that it is important to consider that although remote working and the hybrid office space model have become prevalent during the pandemic, these trends may play a significantly smaller role within Edmonton’s local market due to the size, density and cost of real estate. Employees can expect significantly shorter commute times, and prospective tenants have access to lower cost office space in comparison to larger suburban markets, such as Toronto.
Kyle Edwards, senior director of mortgage origination at Canada ICI, examines both the theory and the practicality of what’s possible for Calgary’s office market touching on the buzz surrounding new leases from tech companies, suburban office tenants moving to the downtown core, and the potential of office conversions to multi-family units through the City of Calgary conversion grants.
The grants, which are otherwise known as the Calgary Development Incentive Program, are aimed at increasing Calgary’s economic activity by removing some of the vacant office spaces downtown and converting them into residential units. There is a total of $45 million in funding that is available through the grants – with a maximum of $10 million being made available per property, with the potential for more if Calgary city council approves the request.
Since the launch of the program back in August, there have been a total of 13 applications to convert up to 600,000 sq. ft. of office space.
“Ultimately, the Calgary downtown office sector was built on the strength of the energy industry, which still drives this market. The resurgence in the energy industry has resulted in record profits for energy companies but has not resulted in capital investment that is needed to absorb office space,” says Edwards.
With some of the highest vacancy rates in the country, there certainly is a lot of space to be filled, as Calgary’s total office vacancy rate currently sits at nearly 30 per cent – which equates to a total of 13.5 million sq. ft. of empty office space.
In Avison Young’s Q2 2021 Calgary Market Report, it shows that the prime AA office market is performing much better than the A, B, and C class spaces with vacancy sitting at 19 per cent – whereas the class A, B, and C markets sit at 38 percent, 45 per cent, and 42 per cent respectively. And as with other markets Calgary is seeing a significant flight-to-quality, as prime AA class space has become quite competitive and available.
There is some movement into the city though, as several large tech companies have secured leases in the downtown core recently, scooping up approximately 320,000 sq. ft of the vacant office space, according to a recent article by RENX. However, in practicality these new leases equate to just two per cent of the vacant downtown office space, or less than one per cent of the total space available in the core. Although Edwards says this is positive news, he also adds that it will absorb very little of the approximately 6.5 million sq. ft. of downtown vacancies.
Edwards predicts that in Calgary as companies continue to adapt, we will likely continue to see mergers and acquisitions, as well as consolidations that will offset these gains. And as energy companies continue to invest in new technology and renewable energy sources, there is hope this will create new jobs and increase office absorption in the downtown, but Edwards says this process is likely to take several years to play out.
In respect to companies making moves from the suburbs to the core, Edwards says, “Unfortunately, there are not enough current suburban office tenants that would potentially move to the downtown to make any significant difference. With suburban availability currently sitting at approximately 26 million sq. ft, there is space to be filled, all around.”
As for conversions, the useful lifespan of a building is approximately 50 years without investment in improvements or maintenance. Major Canadian cities outside of Alberta tend to average approximately 15 per cent of their buildings in the 40–49 year age range; Calgary averages approximately 35 per cent which equates to approximately 15 million sq. ft. of aging downtown office space.
Edwards believes that while there is opportunity to redevelop some of these aging buildings with conversion grants, he also adds it isn’t a feasible option for all of them.
“There is opportunity to redevelop these aging buildings to lower the vacancy and revitalize parts of the downtown,” says Edwards. “The conversion grants are a viable option for a few of the downtown buildings, but the majority of the vacant buildings are not designed to be converted or are simply too big, and the cap the city has put on a single building will not provide enough incentive to make a conversion viable,” he added.
While Edwards believes the above noted actions will absorb just a small percentage of the current available space, he says there are still plenty of opportunities that remain for the world class city, despite the numbers.
“Calgary is a city that has emerged on the global stage in recent years and is still considered one of the most livable and best cities in North America,” says Edwards.
Calgary has the capacity and probably more options to attract any company to our downtown core – Canadian, or otherwise.Kyle Edwards
A best-in-class office product, with more elaborate common areas, modern construction and building efficiencies, that commands the highest rents and tends to attract stronger covenant tenants, such as banks, government, insurance companies, etc. These buildings tend to be situated close to the core within their respective markets and have excellent access to major public transit hubs. Buildings are typically larger than 750,000 sq. ft., with 5 to 10-year tenancies and some 15-year leases for inbound tenants. Occupancy levels assumed to stabilize at close to 95 per cent of comparable market net rates.
A strong-performing asset, typically between 400,000 and 700,000 sq. ft., which is well located, and may have smaller floor plate sizes, solid amenities and less elaborate common areas. The majority of the tenants have 5 to 10-year lease commitments. Occupancy levels assumed to stabilize at close to 95 per cent of comparable market net rates.
Older office product, typically in the range of 100,000 to 250,000 sq. ft. These buildings tend to be occupied with a diversified tenant mix but lack a large anchor tenant. Shorter lease commitments occur in this asset class with the average term ranging between 5 and 10 years. Average floor plate size can be significantly smaller.
Any statements made by Canada ICI that are forward-looking may include assumptions regarding projections and expectations regarding: market trends in the office asset class nationally, and more specifically, in the local markets where we operate. While we consider these expectations and assumptions to be reasonable, they are inherently subject to significant business, economic, competitive, regulatory and other risks, contingencies and uncertainties which are beyond our control and could cause actual results to differ materially from any future results, performance or achievements expressed or implied by these forward-looking statements. The information presented has been obtained from sources we believe to be reliable; however, Canada ICI cannot make any guarantee regarding the accuracy or completeness of the information provided.