Managing Partner explains the issues still plaguing this commercial real estate sector and where glimmers of hope might be appearing
Canadian real estate investors continue to struggle with a double-digit issue. National office vacancy rates are currently stuck between 17 and 20 per cent, with some slow movement on the margins. Different regions, office types, and position relative to urban centres have their own distinct dynamics, but for investors looking at commercial real estate assets the issue of double digit office vacancy remains something they may have to grapple with for the near future.
Darren Murray, Managing Partner at Hazelview Investments, explained how that vacancy rate shakes out across the country. He outlined where signs of relief for office investors may be found and the role of office style and amenities in investment returns. Despite a clear view of those overhangs, Murray emphasized his view that there are causes for optimism in the office market.
“At a high level, I'd say things are slowly improving in the office market, but there's still a long way to go,” Murray says. “We have seen a bit of a marginal decrease in that national vacancy rate certainly over the course of q1. 17-20 per cent vacancy is quite stretched, and obviously you have different sub-markets, but the slow declines are a positive for the market. It’s starting to stabilize but there’s a long road ahead.”
Murray noted that within certain Canadian markets the balance between suburban and urban office vacancies may skew somewhat differently. Vacancies in the suburbs of Toronto and Montreal are somewhat more elevated while their downtown office occupancy has made more of a comeback. In Alberta, however, it’s the suburbs that have remained more resilient. Murray attributes that to a holdover from office construction in that province due to the oil boom. The biggest determinant of vacancy, however, continues to be the quality of the office itself.
Class A “trophy assets” in the hearts of Toronto, Montreal, and Vancouver continue to do well, Murray explains. Vacancy rates on those properties have stayed low — around ten per cent over the past two years. Tenants have tended to prefer these premium spaces, especially those that offer some ESG credentials around sustainability and energy efficiency. Location relative to transit is essential, as well.
In the case of underperforming class B and C buildings, Murray highlights that some owners are working on revitalization projects and amenity additions which are having a tangible impact on vacancy rates. He notes the example of a downtown Calgary office within Hazleview’s portfolio that boasts a 97 per cent occupancy rate — compared to an average occupancy in the mid-70s for that city. While he notes that a number of factors have influenced that occupancy rate, he cites some of Hazelview’s investment in material improvements to the office. The lobby, gym, cafeteria, and social area have all been newly renovated and upgraded. They also added a golf simulator to the office, adding the sort of touch that makes people genuinely want to come into the office and makes tenants want to lease.
While there has been some talk since the onset of the pandemic about turning unoccupied offices into more in-demand forms of real estate like multifamily housing or even industrial, the fact remains that those retrofits appear far more costly than making improvements to office amenities. The simple facts of floorplans, windows, plumbing, and insulation mean that many owners simply lack the capital to do this kind of work. If and when office spaces are brought offline in Canada, Murray notes that it is far more likely to simply be via demolition than via retrofit. He adds, however, that the Canadian office market is currently “under-demolished.”
One of the other issues facing office investors right now is that the 17-20 per cent vacancy overhang has also kept the volume of transactions down. Aside from a few major pension funds transacting, there have not been enough sales in key markets for buyers or sellers to truly understand the price of what they hold. While that bid-ask spread remains so wide, investors may be less keen to involve themselves in a space where price remains quite unclear.
Despite a higher rate of work from home days than many other developed countries, Murray sees a light at the end of this tunnel. He notes the mandated back to office policies coming from major employers like RBC, CIBC, and Amazon as well as a more general trend towards better office utilization.
“We are seeing people come back to the office. So that is the light at the end of the tunnel that I see there,” Murray says. “Obviously pricing needs to be a bit more visible, but from the fundamentals, people need to come back to the office and that is slowly happening.”
