Businesses have been taking advantage of the reams of office space in Canadian downtowns, moving out of older buildings and into the newest office skyscrapers since the COVID-19 pandemic – sending the vacancy rates of the outdated properties soaring.
The newer office towers with coveted amenities and concierge service are known as class A. They have always commanded the highest rents and are typically leased by large, established businesses such as the big banks and law firms. The more basic B class offices, as well as the older C class properties with outdated heating systems in inconvenient locations, have traditionally competed with lower rents, but are now facing greater pressure to cut prices and offer even more incentives.
The slump in office demand amid the growth of remote work has widened the divide between these no-frills buildings and the new gleaming towers with gyms, cafés and the latest HVAC technology.
“It’s the best versus the rest,” said Paul Morassutti, chair of CBRE Ltd., a commercial real estate firm.
In the year before the pandemic started, there was not that much of a difference in the vacancy rate across the three classes in the country’s downtowns because demand for office space was so strong. Businesses were expanding and a new group of tech companies were moving into Canada.
In fall of 2019, premier offices across the country’s downtowns had a 10-per-cent vacancy rate, and the Bs and Cs had a rate of 12 per cent, according to commercial real estate firm Altus Group. In downtown Toronto, the country’s largest business hub, the vacancy rate was 4 per cent for class A buildings, and 5 per cent for the more basic and older stock.
But remote work has led tenants to reduce their office footprint or get rid of space on the sublet market. At the same time, more office towers have been completed, pushing additional space on the market. That additional space has forced the top building owners to offer incentives to retain and get new tenants, leading to an exodus from the less desirable buildings.
“There’s no doubt that everyone has moved if they can afford it to the A class. It’s a trend, 100 per cent. It’s real, it’s happening,” said Mark Rose, chief executive with commercial real estate firm Avison Young.
Today, there is a big difference between the As and everything else. In downtown Toronto, the vacancy rate for the top stock was 16 per cent in the third quarter, while the vacancy rate for B and C was 22 per cent, according to Altus.
In downtown Ottawa, class A had a 14-per-cent vacancy rate, compared with class C’s 33 per cent. In Kitchener, Ont., the top offices had a vacancy rate of 20 per cent, and the C buildings had a rate of 35 per cent.
The high vacancies and slow return to the office have sparked talk of turning underused skyscrapers into apartment buildings.
“C buildings are going to struggle,” Avison’s Mr. Rose said. “The C buildings need to be either converted or there needs to be reinvestment which may make no sense and, therefore, that’s something that does become obsolete.”
Avison estimates that about 169 office buildings across the country have the potential to be turned into apartments based on four criteria: Built prior to 1990; small floor plates; class B and C; and half occupied.
CBRE’s Mr. Morassutti agreed that there is a portion of the Canadian market that has a grim outlook. CBRE is currently conducting its own analysis on which buildings could be converted, although Mr. Morassutti and most commercial real estate experts say conversions are complicated and costly, and are probably not feasible without some taxpayer help.
Government assistance is occurring in Calgary, which has been dealing with high office vacancies for about a decade since oil prices plunged and energy companies eliminated their office space. The city is providing $75 a square foot if an office building owner wants to convert their space into housing units or another city-approved conversion such as a postsecondary school.
Calgary’s vacancy rate for class A was 24 per cent in the third quarter, according to Altus, and for class Bs and Cs, it was 34 per cent. So far, there are 10 class B and C office buildings being converted to apartment units. The city is getting ready to announce three more approvals and reviewing several other proposals.
“It’s really helping to deal with vacant office space,” said Sheryl McMullen, manager of investment and marketing for the city’s downtown strategy.
Ms. McMullen said it feels like every week she gets a call from another city asking for advice on how to run an office conversion program. Her team has heard from policy makers in Halifax, Ottawa, Montreal, Edmonton and Regina in Canada, and in Portland, Ore., Chattanooga, Tenn., San Francisco, San Antonio, Tex., Denver and Chicago in the U.S.