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Toronto and Vancouver are the two cities driving the Canadian downtown vacancy rate to 19% with the former being 17.9%. This is not only quadruple what it was pre-pandemic but is the highest vacancy rate of any tumultuous time in recent history.
This certainly throws some cold water on the post-pandemic boast by office building owners
that occupancy in major cities across Canada was on the rise. These new numbers clearly
indicate that remote working has entrenched itself into the psyche and life-style choices of
Canadian workers.
In a recent Q1 2023 office report they are calling this a “once-in-a-generation evolution” that is slowly turning downtown Class B buildings into obsolete assets.
Does this mean cheaper rents?
No, in fact, Class A net rents have trended upward.
Landlords are not using rates as an incentive, but are offering longer free rent periods, customized build-outs and increased amenities.
This decrease in occupancy matched with an increase in rates breaks every rule of economics but can be explained. Companies are decreasing their office footprint but are increasing the quality of the office space they have to entice their workers back into the office for a few days a week. Amenities like baristas, in-office dining, workout facilities, private areas, playrooms, and outdoor offices are what companies are offering to their workers – these upgrades are being asked of the landlords and that cost is being pasted onto the companies asking for them. While downtown office buildings are struggling with vacancy rates, their suburban counterparts have remained steady. For example;
According to CoStar Canada, this is the first time in 20 years that office buildings in the suburbs have outperformed downtown office buildings.
Given all this, the greatest negotiating a company has on rates is downtown Toronto as the
suburbs are not feeling the pain. But, will a decreased rental rate be a win if employees don’t
want to come into the office because it is downtown?
To view an office space we recently leased in 30 days, click on the photo below.
The New Office Space Must Be Worth The Commute
Commute-Worthy: the 2023 workplace
Hybrid offices are the new norm, allowing a balance between remote and traditional in-office workspace. This means there will be less space needed for the company as not all employees will be in the office at the same time.
When workers are in the office, what can they expect from their space? Gone is the open plan with its goal of prioritizing cost over employee satisfaction. Highly tailored spaces are increasingly being asked of landlords from a design perspective as companies fight to 1. Retain talent and 2. Recruit new talent.
Offices are becoming “airport lounge” like in their amenities and services
Offices are becoming “airport lounge” like in their amenities and services; where you can sit with many and collaborate or, if privacy is needed one can find a quiet corner to focus. There are mobile charging points, workstations with electricity & wi-fi access, eateries, cafes and fitness centers with concierge like services.
Human needs and wants are the priority vs the traditional prioritizing of building/office occupancy & efficient usage of square footage. Having healthy, happy, collaborative and invested workers will increase efficiency – this is the new measurement of an office space.
The outdoor office (biophilic design) is becoming very popular with companies. Creating an outdoor workplace brings a range of “wellness” to employees. The greenery, natural sunlight and fresh air give employees incredible happiness as well as health benefits.
73% of employees say that natural light contributes to their job satisfaction.
The summary of all of this is that companies are trying to create a workspace that makes the commute to the office worth it. Are all of these trends the norm forever? NO – as with the introduction to the open office concept years ago, life will happen and companies’ approach to hybrid working could change. If the world goes into another 2008 recession and there are more workers than jobs, fear of not being seen might drive people back into the office thus increasing the need for efficient use of space vs employee satisfaction.
Real estate investment surges to record with Canada rebounding
Canada saw record investment in commercial properties in the second quarter as the easing of the COVID-19 pandemic pushed buyers and sellers off the sidelines.
Source: https://tinyurl.com/4jjabxbf
With the country’s economy rebounding, $14 billion (US$11 billion) worth of commercial real estate changed hands in the three-month period, a 29 per cent increase over the previous quarter, according to a report Monday from commercial brokerage CBRE Group Inc. Investors targeted apartment buildings and warehouses, driving a surge of deals that has Canada on pace to post nearly $50 billion in commercial real estate investment this year. That would be a new annual record, according to the report. “Capital can’t remain on the sidelines forever -- it has to be deployed and put to work at some point,” Paul Morassutti, vice chairman of CBRE’s Canadian business, said in a telephone interview. “Over the last two quarters, there has been a very strong sense that we are at least getting close to some degree of normalcy.”
Even as vaccinations give Canada’s economy a boost, commercial real estate investors continued to gravitate to properties that have been resilient during the pandemic. Warehouses have been popular because of the e-commerce boom. Apartments, long considered dependable assets, have gotten a boost in recent months as surging home prices shut out many would-be buyers. While retail and office buildings saw renewed interest in the second quarter, Canadian investment in those properties lagged behind other corners of the market. “For a lot of investors out there, there was a desire to rotate out of retail and office investments, where there are bigger question marks over those asset classes,” Morassutti said. The CBRE report focused on transactions for individual buildings, leaving out mergers where entire companies change hands. Even with those deals factored in, last quarter’s torrent of investment was enough to make it the third-busiest on record, the CBRE report said.
Predictions for Canada’s Economic and Commercial Real Estate Outlook for 2023
As we charge forward into 2023, continuing the path post pandemic, we look at how we see 2023 unfolding for the Canadian Commercial Real Estate market. While we don't have a crystal ball, we look at some of the key fundamentals to look at what could be in store for us in CRE.
1.Canadian Economy Slips into Recession
Canada’s economic downturn may be deeper than expected resulting from excessive household debt.
The base case scenario for Canada’s economic outlook in 2023 is for a recession owing to a
moderate contraction of real GDP growth. The downturn will largely be driven by the household sector
as higher interest rates and inflation continue to erode the purchasing power of consumers.
However, an even longer and deeper recession is a growing risk should aggressive interest rate hikes
by the central bank ultimately break the back of highly indebted consumers and worsen a housing correction
that is already underway.
2. Monetary Policy Will Pivot
A deceleration of inflation will allow the Bank of Canada to cut rates over the second half of 2023.
Due mostly to a let up in global supply chain pressures and the limited threat of a wage price
spiral, inflation has likely peaked and could return to the target level of 2% by as early as spring
2023. With the economy facing a potentially deeper and longer recession, a door will open for the
Bank of Canada to pivot to a less restrictive monetary policy which could include interest rates
cuts over the second half of the year.
3. Industrial Cap Rates Will Hold Firm
Despite higher interest rates and slim going in yield spreads, industrial cap rates will hold steady and could even compress further.
Strong investment demand for industrial has pushed cap rates for this property type to all-time lows
in 2022. Although interest rates have moved significantly higher over the past year and yield spreads
with risk free bonds are razor thin, the expectation for strong income growth through better than
inflation net rental growth is likely to keep investor demand strong for this product amidst limited
product coming to market. As a result, cap rates should hold steady through the course of the year
and could even compress further should there be a material easing of interest rates.
4. Industrial Will Continue to See Outsized Rental Rate Growth
A persistent undersupply of product suggests that industrial rental rates will continue to grow faster than the rate of inflation.
Continued strong demand from logistics, e-commerce and retail tenants looking for space to
facilitate their just-in-time inventories in tandem with lagging new supply will continue to drive
better than inflation net rent growth. This will be especially true in markets such as the Greater
Toronto Area (GTA) where new supply faces persistent development hurdles and in Montreal, where
average net rents still appear to be under market. Industrial demand is also likely to continue
spilling over into previously non-traditional distribution markets in the Greater Golden Horseshoe.
5. Hybrid Work Drives a Flight to Quality in Toronto’s Downtown Office Market
Submarkets with newer product will continue to poach tenant demand from traditional office nodes such as the Financial Core.
The growing adoption of hybrid work will continue to increase demand for modern office buildings
with flexible workspaces and attractive amenities. As a result, office nodes with newer product
such as the Downtown South Core in Toronto will continue to poach demand from traditional office
nodes such as the Financial Core, where older buildings and floorplates are not conducive enough
to attract talent when workers do come to the office. As demand migrates and the recession
deepens, some tenants will also take the opportunity to reduce their office footprints thereby
accelerating an increase in overall office availability.
6. Retail Resilience Will be Tested
Pent-up demand driving consumer spending will be exhausted which will constrain the recovery in retail leasing volumes.
As consumers draw down the stockpile of savings they accumulated during the pandemic and
simultaneously see their purchasing power weaken from higher interest rates and inflation, a
sharp pullback in retail spending is expected to occur in 2023. The pullback will come just as
the retail sector was regaining leasing momentum following the impact of pandemic-related
restrictions and lockdowns. As a result, some retail centres, particularly enclosed centres such
as malls, could face another round of challenges to keep tenants in place.
Lucie Brusse & Paul Morrison
WALL STREET BETS AGAINST THE OFFICE SECTOR
As the effects of the pandemic fade and future lockdowns are seemingly unlikely, many businesses have begun to ask their workers to return to the office.
As of today, more workers are back at their desks than a year ago, so things must be getting better – Right?
They are, in fact, getting worse.
Office landlords are now faced with businesses forced to accept hybrid work from their employees, businesses that are laying off employees, and higher interest rates. This has resulted in tenants asking for reduced square footage as their leases come up for renewal.
As a sign of what investors think of the office rental market, Wall Street has the shares of all the largest landlords trading at pandemic levels or lower. This is significantly lower than the market as a whole. Basically, investors are betting that the office market is going into a major slump.
Some office buildings will not come through this. Newer office buildings offer greater ability to re-shape with larger floor plates, for example. They can easily adapt to the physical and mental health of the next generation of occupants where these are a priority for them. Better air quality, natural light, multiple accesses, and large spaces for social distancing as well as up-to-date technology that allows for “touchless” journeys throughout the building allow buildings to adapt to “office live after the pandemic”.
Newer buildings also offer better micro-mobility (bikes & scooters) and on-site amenities such as package & food delivery reception, showers, gyms, coffee shops, and private sitting areas.
Older buildings are liable to face serious issues. Borrowing and construction costs are too high to upgrade, so many are simply becoming obsolete. As values for their properties decline, landlords are liable to have to make tough decisions. Owners, smart enough to have paid off their loans might have a chance to repurpose their buildings into residential complexes or storage facilities.
As an interesting note, while much of the discussion has been focused on urban/downtown office markets, suburban office demand has performed comparatively better than its urban counterpart. Less dense suburban locations, along with home offices and coworking spaces may increasingly become part of a more distributed office model. This is because employers look to increase the flexibility of how their employees can work.
Suburban offices offer workers the perfect hybrid situation where they can work from home and walk from home to the office. This is the convenience factor for both the employee and employer!
Lucie Brusse and Paul Morrison
Artisan Space - The Cotton Factory has it figured out
Empty offices are keeping people away, not fear of Covid.
As more and more people are making their way back into the office, they are facing a new challenge – empty seats.
Workers who have hailed the call of their bosses to “get back into the office for teamwork, creativity, and better outputs” are braving gas prices, parking, and/or the dreaded public transit – all with the goal of wanting to see people instead of zoom calls.
When they arrive at the office they are having coffee alone, sitting alone, and doing zoom calls with their co-workers who are at home – talk about “Lunchbag Letdown”!
Bosses are a bit at fault here as many owners and managers have been selling this “back to the office” without a real idea of how it will work and how to manage it.
The worst thing is for employees who need that “office” community and lifestyle who are alone. They might come in on a Monday while others come in on a Tuesday, Wednesday, or Thursday. There has to be a schedule to ensure that people are back at the same time.
The Cotton Factory in Hamilton, Ontario provides its tenants with a “Building Community” that allows the businesses in the building to provide that “community” to their workers. From shared coffee stations, eating rooms, meeting rooms, and events – The Cotton Factory allows businesses to extend this “community” to each of their workers so they never feel alone or isolated – even if their own co-workers are still at home.
“Our CoWork space features an abundance of natural light…….Built to inspire creativity, collaboration, and community……We’ve worked hard to create a culture that inspires focus, cultivates and fosters connections, generates referrals, and drives success”.
Scan the QR Code on header to take an informational tour of the Cotton Factory
Or reach out to us directly to view brochure;
Lucie Brusse and Paul Morrison.
Is Commercial Real Estate The Next Target For Hackers?
Can that smart HVAC system you put into your building to save energy and costs be an open door for IT hackers?
Building owners have not had to deal with Cybercrime like financial and large retail stores have. However, that is all changing as more and more buildings adopt smart technology. Many building owners are still, today unprepared for any attacks that might target them.
There are three (3) things that these owners can do to better prepare themselves to handle such attacks:
- Accept that they are at risk and understand what that risk entails
- Have comprehensive cyber insurance to protect against catastrophic loss, and
- Make sure they are in compliance with all cyber insurance requirements
The kind of attacks that building owners must be concerned about center around the operational areas of their building such as HVAC, lighting, smart controllers as well as any and all smart technology. The attackers enter through these, usually unprotected web connected systems, and make their way into the central hub and then into the IT systems.
Imagine hackers holding a building’s elevators, heating systems, lighting or any other elements hostage because they control the buildings network – has it happened yet? If has it would not be in a buildings interest to let their tenants or public know.
If it hasn’t happened, it most certainly will. Building owners may not want to deal with this issue but, unfortunately it simply isn’t going to go away. As more buildings implement smart technology the more attractive these sectors will become to Hackers.
The most important thing building owners can do to protect themselves is to get a consultant who understands these kinds of threats and can help to ensure the building has the right kind of insurance and that the building meets all compliance as stated in the insurance policy. Any building who does not have cybersecurity insurance is taking a risk. It should be clear that buildings with cybersecurity insurance who are not in compliance with their policies are taking the same risk.
Basically, get the insurance and make sure the building is compliant with all requirements of the policy. Policies may include inadequacies depending on the specifics of coverage, which could leave a business exposed depending on the origin of the threat and the type and degree of applied security.
Lucie Brusse | luciebrusse@royallepagecommercial.com
Paul Morrison | paulmorrison@royallepagecommercial.com
GTA CRE Registers a 40% Increase in Transaction Dollars in Q1 2022 Compared to Q1 2021
Strong investor demand, a lack of inventory and low borrowing costs have fueled the Toronto commercial real estate market.
823 transactions resulting in $9.3 billion were registered in Q1 2022 compared to $6.7 billion in Q1 2021(1). Despite a disastrous 2020 and 2021, the office market has shown some encouraging signs with $1.9 billion recorded in that quarter, becoming the highest quarter the office sector has seen since 2015, a far cry from a mere $700 million in office sales in Q1 2021.
The industrial sector continues to linger at record low levels in the GTA. $1.6 billion in sales were recorded, up 10% from Q1 2021. You might think 10% doesn’t seem a significant increase as compared to office, but the industrial sector simply doesn’t have the supply to record higher numbers whereas the office sector does.
With the continued global supply train issues and ensuing increase in transportation costs, manufacturers are keeping production local thus driving up demand for cold storage, warehousing, and other industrial usages – it is doubtful there will be a cooling off period for the industrial sector in the next quarter.
According to Altus all asset classes (except the hotel sector) in 2022 have started off strong and are still highly desirable by both investors and end-users. According to that same survey the Toronto market is the most preferred geographical area for assets followed by Vancouver, Montreal, and Ottawa. Of particular interest in the Toronto market were food anchored retail strips and industrial land.
HYBRID WORKING IS HERE TO STAY
Employers in Canada will need to consider not only how and when to bring their employees back to work, but also whether they should.
Over the last two years, the pandemic has given many workers time back in their days, by eliminating their commute. Many aren’t willing to give that up entirely. "The No. 1 reason employees prefer hybrid work is to avoid commute time," Gallup said in their report. "People are not in a hurry to add back the time it takes to get ready for work, travel to the office and return home every day."
A PwC study released in 2021 found that only 15% of Canadian workers wanted to work entirely from home, with another 18% looking to work entirely in the office. The remaining 67% of workers were looking for some compromise, with 25% of the 2,000 employees surveyed looking for an equal split of work at the office and home.
As we expect to see office vacancy rates climb in the coming years, our clients wonder if this will mean lower rates on their lease renewals or new leases.
We expect it will take some time to see lease rates drop. Reason being, dropping lease rates equal a building’s valuation dropping. Rather than lowering rates, we expect to negotiate more tenant incentives and free rent.
This gives the Tenant a lower overall rent expense, and the Landlord keeps their building value intact.
With so much still in question on where we will land moving out of the pandemic, it is incredibly important to have time and strategy when negotiating a new lease or renewal.
For years, Industrial classed commercial real estate has seen gradual growth in the cost per square foot, allowing tenants a “comfortable” increase at lease renewal – Not anymore! Business Owners are seeing their profit margins significantly effected by their leasing costs.
Why is this? Part of the answer is location. Up until now, Industrial real estate was primarily built in the suburbs surrounding major cities, with tracts of land easily and affordably attained. Now, decades later, the cost of that land has skyrocketed and so has the industrial lease rates.
Covid had nothing to do with that, it was already happening. The pandemic did exacerbate the problem by compressing vacancy further, thus pushing rates even higher.
Vacancy rates from Vancouver to Toronto to Montreal (and everywhere in between) are hovering around 1.5%; A vacancy rate that puts landlords in the driver’s seat – and they are hitting the gas pedal.
You might be thinking that this is a dream come true for a commercial real estate agent. Quite the opposite, as higher prices with little to no vacancy means there are no readily available solutions for our clients. We are unable to provide them with better options and better rates because they simply do not exist, and that, is our worst nightmare.
We really have to put on our creative thinking cap and work together with our clients to strategize a solution which can include anything from purchasing a church and converting it into industrial space to outsourcing their warehousing and move to an office space for their operations. We, as commercial real estate advisors have had to become almost like business advisors as we look at the whole of a clients business and see if we can come up with “out-of-the-box” solutions to make their business fit to the realities of real estate availability and costs.
Outsourcing warehousing to a third party may have been a “no-go” years ago but today it is a viable option for consideration as it solves two of the biggest issues facing some businesses today:
Cost of space
Cost of staff
Cost of location (proximity to transportation and workforce)
With outsourcing warehousing, business owners don’t have to staff it, operate it, insure it or ship it. These are secondary savings that flow from the primary savings on lease costs. With costs increasing across the board and shipping expectations shorter, outsourcing this portion isn’t so “out there”, it might just make good business sense.
This is but one example of how creative business owners and commercial real estate agents must become to meet the challenges we all face today. Whether it’s outsourcing, looking for new ways to re-purpose underutilized space or building multi-floor industrial, never before have we needed to re-think what we see as industrial space.
For a deeper dive into some of the options that may exist, take a look at these two articles, and then let’s talk.
Rents rise amid demand for fulfillment space
How the demand for warehouse space is pushing industrial real estate into new territory