COVID-19 brings fresh commercial office watchwords to the forefront

Commercial office watchwords attuned to COVID

Market analysts look for harbingers in downtown sublets and suburban demand
Tuesday, August 18, 2020

Sublets and suburbs are commercial office watchwords for real estate analysts striving to gauge COVID-19’s impact on future demand, income and value. For now, many typify a second quarter uptick in downtown sublet activity as a spurt, not a glut. However, they project the trend is likely to continue, and they’re watching for signs of downtowners migrating farther afield.

Speaking in a webinar last week, Raymond Wong, vice president, data operations with Altus Group, noted that sublet now represents a sizable portion of all available downtown space in Vancouver and Toronto — at 39 per cent and 27 per cent, respectively — but it’s a large share of a small amount of inventory. The past three months have brought piecemeal additions rather than the emptying out of buildings, and have triggered no discernable discounts.

“When the vacancy rate exceeds between 6 and 7 per cent and sublets represent more than 40 per cent of the availability rate, that’s when we see some softening of the rents,” he submitted.

Based on those parameters, CBRE’s second quarter statistics suggest landlords in the two cities have plenty of room to manoeuvre. Downtown vacancy rates of 2.7 per cent in Toronto and 3.3 per cent in Vancouver are among the lowest in North America, making an influx of sublet space less than foreboding.

In Vancouver, JLL analysts speculate there will be plenty of interest in a couple of multi-floor blocks of downtown Class A space, “which are usually few and far between”. Together, they account for approximately 81,000 square feet of the 406,000 square feet of downtown sublet space added to the market in the second quarter, but Avison Young reports the “vast majority” is in chunks of no more than 10,000 square feet. Otherwise, its 2020 midyear Vancouver office market report draws few conclusions.

“It remains to be seen if landlords are inclined to take control of sublease offerings through contractual rights or if they will consent to transactions at discounts to prevailing market rates,” it states. “Whether the impact of work-from-home protocols results in a material increase in sublease or head lease offerings as companies reconsider their medium- and long-term office space needs remains to be seen.”

Avison Young’s second quarter office market report for the Greater Toronto Area points to the potential upside. “The uptick in available sublease space could help the market by providing room to transact,” it theorizes — attributing the second quarter slip in leasing volume more to the lockdown’s logistical impediments than to a dip in demand.

In total, it tallies 177 sublease listings amounting to 1.2 million square feet available in downtown Toronto at midyear. More than 80 per cent of these were for spaces no greater than 10,000 square feet, while nearly 77 per cent still had more than two years remaining on the lease term, including 37 sites with more than four years before lease expiry.

Still, that pool seems likely to deepen. “I think we are going to see a lot of sublet space come on over the next three to six months,” Wong speculated.

Vectors for loosening downtown markets

Momentum for previously uncontemplated moves outside the core and the advancing completion of new office space present other vectors for downtown markets to loosen. With new construction heavily pre-leased — more than 7 million square feet in Toronto, for example — Wong suggests developers are well positioned to fill the remainder.

“This is the type of space that companies are really looking for,” he asserted. “There is a lot of demand for new office space. Our concern is the backfill.”

Economic and public health uncertainty could destabilize the demand for that space, which was commonly assumed to be strong just six months ago. More recently, that’s been replaced with now stale conjecture about what retrenchment to home workspaces and requirements for larger footprints per worker will mean for commercial office demand, and whether the two trends will balance out each other.

The latter hopeful prospect is inextricably linked to sustained or growing employment levels — a reality that has landlords monitoring economic rebound from COVID-19 against the ticking clock of lease expiry and the pending arrival of more than 9 million square feet of new office space now under construction in downtown Toronto and 3.8 million square feet in progress in downtown Vancouver.

“As completions take place and backfill hits the downtown, that will the push vacancy numbers (up), with employment numbers coming back a little later.” Wong projected.

Other market observers underscore the robust economic diversification that should serve Toronto and Vancouver well.

“The tech sector growth story that has driven demand in recent years is far from over,” contends BentallGreenOak’s midyear 2020 Canada Perspective. “Big tech is only getting bigger, and the foundation has been laid with robust start-up ecosystems in Canada’s largest cities. The tech sector benefits more than any other sector from agglomeration economies and Canada will continue to remain a source of low-cost engineering talent.”

Envisioned scenarios of a significant portion of the workforce permanently ensconced at home and/or networks of suburban office hubs serving those who no longer want to be in a dense downtown environment are still just envisioned scenarios. With the exception of a handful of high-profile tech corporate announcements, analysts surmise many decision-makers are in a holding pattern.

“Deal activity was very muted in the first half of 2020 with tenants generally opting for short-term extensions or deferring commitments wherever possible,” Avison Young affirms.

However, Wong reports tenants with expiring leases are now looking outside their conventional comfort zones. “A lot of discussions are happening right now. They’re looking at all the options,” he said.

“Across North America, demand for suburban office space could benefit in the current climate, as select tenants look for affordable space in a safely distanced environment,” concurs Jean Laurin, president and chief executive officer of Devencore.

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