Office towers in Toronto's Bay Street financial district in 2022.Nathan Denette/The Canadian Press
Globe and Mail reporters Jason Kirby, Rachelle Younglai and James Bradshaw recently delved into the number of office vacancies in Toronto – five million square feet of available space across 47 office towers, to be exact – sharing insights from their exclusive analysis and the landlords who own these empty buildings. On May 16, Kirby and Bradshaw answered reader questions about the story.
Many readers asked in the Q&A about the effect of vacancies on the larger economy, whether the office spaces be transformed into living spaces to solve Canada’s housing crisis and the implications for pensions, seeing that the country’s largest pension funds are prominent landlords in the Toronto market.
Here are some of their answers. Questions have been edited and condensed for clarity.
Why haven’t lease rents gone down?
It appears that landlords have not reduced lease rates on available space. Why is that, and do you expect a change in the next year or two?
Jason Kirby: Landlords are reluctant to lower actual lease rates for a number of reasons. Lower leases would impact the value of the building, and they want to maintain the cash flow they get from those leases. They also likely believe (hope?) that this void of vacancies is temporary – that Toronto is a growing city with a lot of businesses moving here and starting up, and that eventually that will reflect in vacancy rates coming down.
Having said that, landlords are offering deep concessions to keep and attract tenants that don’t show up in the top-line numbers. Want a complete office renovation? You got it. Need a new kitchen for your staff? Done. Those concessions can add up in cost, but preserve the net effective lease rates.
East versus west
How does Toronto’s office vacancy rate compare to other Canadian cities, like Calgary or Vancouver?
James Bradshaw: Toronto’s rate, which has hovered around 17 per cent, is a little below the national average for major cities. Calgary and Vancouver are at opposite ends of the spectrum: Vancouver at the low end at 11 per cent downtown, and Calgary the highest at 30 per cent (these are recent figures from CBRE).
Montreal, Halifax and Winnipeg are similar with averages around 18 per cent. Ottawa is 14.2 per cent, Edmonton is nearly 23 per cent. But those are averages and, as our reporting found, that can mask some significant differences in how different types and ages of buildings are performing even within one of those cities.
Is there anything that Calgary is doing that Toronto can learn from?
Kirby: Calgary has a 30 per cent office vacancy rate, with the vacancy crisis originating in the oil price collapse last decade. Calgary is much further along in addressing the problem – 17 old office buildings are being converted into more than 2,300 new homes. Those 17 buildings account for about 2.3 million square feet of office space, but Calgary is planning to remove 6 million in total by 2031. But, Toronto is only just beginning that process.
Downtown Calgary and the Bow River on May 31, 2023. The city is much farther along in dealing with vacant office spaces, converting old office buildings into residential units.Jeff McIntosh/The Canadian Press
Can we turn vacant offices into condos?
Can the vacancies be turned into residential spaces, or even mixed-use towers with office floors, family-sized apartments and retail spaces?
Kirby: Canada, and Toronto in particular, is suffering from a lack of housing supply, even though there’s all this surplus office space. Calgary is already well down the path on converting office space to residential space. The city’s office sector was struggling well before the pandemic because of the collapse in oil prices last decade. The pandemic only made that worse.
Calgary is already in the process of converting more than a dozen office buildings to other uses. The City of Toronto has launched its own process to address empty space. The city held an open house on May 15 about the issue. Officials acknowledged vacancy rates are too high and think it will take 12 years before space is absorbed. The question of conversions also came up, and the biggest impediment are land use planning rules that require developers to replace any office space that is removed on a one-to-one basis – so if you convert an office building to residential, you have to replace it with more office space. Obviously that isn’t feasible.
What will vacancy rates do to pension funds?
What are the implications of falling vacancy rates on Canada’s largest pension funds, which as the article notes, are often prominent landlords in the Toronto market?
Bradshaw: Pension funds that own significant office real estate – and retail properties like malls as well – have been feeling the pinch. In the most recent round of annual financial results, for example, we saw Ontario Teachers’ Pension Plan lose 5.9 per cent on its real estate investments, and OMERS (which invests on behalf of municipal employees) lose 7.2 per cent. But real estate is only a part of those funds’ vast portfolios – think 12 to 15 per cent of total assets in most cases.
And those pension funds have some advantages: They’re very long-term investors, so they can usually be patient and not sell in a down market, and they don’t tend to put as much debt on these properties as other large investors so high interest rates don’t sting as much.
Right now, most of the largest pension funds in Canada are fully funded and then some. Pension fund CEOs have been repeatedly telling me they think the worst of the real estate pain is behind us. So unless things take a major turn for the worse, this is more likely to be a minor blip for most pension funds, and not a threat to their ability to pay pensions on time and in full, well into the future.
How are big real estate funds dealing with vacancies?
Rising vacancies are impacting cap rates and valuations. How do you see commercial real estate funds deal with their balance sheets? Are the vacancy rates impacted by high-grading?
Bradshaw: That’s the hot topic right now, without a doubt. What we’re hearing often is that there are real haves and have-nots emerging.
If you look at a real estate giant like Brookfield, they’ve had a lot of success refinancing loans without a meaningful spike in borrowing costs, simply because of their scale, influence, relationships with lenders around the world. Others are having to get more creative as their financing comes up for renewals.
We’re seeing some property owners looking to alternative sources of financing like private credit and real estate debt where banks are wary of renewing. We’re seeing some owners just hand back the keys – which can be a decision to cut losses and walk away, or a negotiating strategy to jumpstart talks with lenders. Where owners have the capacity, they’re also repaying debt to bring their overall leverage down.
But yes, we definitely see companies upgrading to the newest, highest-quality AAA buildings, and that trickles down – tenants in Class B move up to A buildings, etc. It’s the lower end of the scale that is struggling mightily and seeing vacancies north of 30 or 40 per cent.
Are pandemic lockdowns to blame for the vacancies?
The catalyst for these vacancies was obviously pandemic lockdown syndrome. But is that the real reason or just the “tipping point”? Also noted, U.S. “corrected” faster. How’d it do that?
Kirby: The pandemic shone a light on trends that were already underway in the office sector. If you look at the original story, there’s a chart showing office utilization rates, which is a measure of occupied space per employee. In the years well before the pandemic began, utilization rates were already trending down.
Technology was already making it easier for office workers to do their jobs remotely, and to attract younger employees, companies were already embracing more flexible work arrangements that didn’t require staff to come in to the office five days a week. The pandemic just amplified that trend.
To the second question, cities in the U.S. have corrected faster in part because there are more buildings changing hands. Institutional investors like pension funds are much bigger landlords in Toronto than in New York, and the institutions don’t face the same debt pressures with high interest rates that developer-owners do. So you see more landlords forced to sell in U.S. cities. More deals equals more transparency about actual valuations.