Downtown Sublease Surges Since Onset of COVID-19
Canada’s biggest office tower developers are pressing ahead with their multibillion-dollar skyscrapers even as a growing number of tech companies are pulling back and putting their office space on the market.
Before the pandemic slammed the economy in March, insatiable demand from tech companies helped drive down office vacancy rates to record lows in the major cities while driving up rents. But now, for the first time in years, the sector’s appetite for downtown real estate is diminishing. Developers and institutional investors say they are confident that demand for space will return. But nobody is certain what, exactly, offices will look like and which changes forced by the pandemic are short-term trends and which are fundamental shifts.
Over the past few months, Shopify Inc. has called the era of “office centricity over” and smaller tech companies have started to put their space up for sublet, creating turmoil in Canadian commercial real estate. In downtown Toronto, companies such as Ritual Technologies, CrowdRiff, Tulip and Rangle.io are all trying to get rid of some of their space, according to the companies and brokers. That has increased the space available for sublease on the market to 862,470 square feet from 687,917 square feet at the end of March, according to data from commercial realtor Cresa.
After years of heady growth, food delivery app Ritual has lost significant business and slashed staff. It no longer needs as much space as it once had, in part because of structural changes taking place in its work force. “It’s not that half the people will work from home forever, I just think that everyone is going to work from home more, ongoing,” said its chief executive Ray Reddy. ”My sense is we’re likely not going back to a time where 100 per cent of people are going to be at offices, for maybe not ever.”
Meanwhile, Mobify, Wishpond, Vision Critical, Stemcell Technologies in downtown Vancouver have put some or all of their space on the market, according to listings and brokers. That has contributed to the available sublet space more than doubling to 280,000 square feet, according to Cresa. “I have never seen the sublease space go up as fast. Never. Ever,” said Ross Moore, a senior adviser with Cresa, who has worked on leases in Vancouver for nearly three decades.
Although these tech firms represent a tiny fraction of the total office space in Vancouver and Toronto, the two cities had the lowest office vacancy rates in Canada and the U.S. before the pandemic, with a good chunk of the market driven by tech companies.
“It is absolutely a shift,” said Allison Marsales, who heads office leasing in the Toronto region for Cushman & Wakefield. However, she added, “It is not a significant amount of space and there is no indication that there will be downward pressure on [rental] rates.”
A drop in demand from the tech sector would certainly affect the office market, but it would not necessarily kill new development projects. Further, real estate developers and office landlords suggest that employers will reduce the density of their office space, bringing in fewer staff at one time and allowing more space for each person. This trend could counterbalance some of the moves to jettison space.
Westbank, Oxford Properties and other major real estate developers told The Globe they were pushing forward with buildings under construction, while planning major office projects – with delivery dates five years in the future or more. “People think 80 days of a virus is going to change the way humans have evolved for 100,000 years. It’s a ridiculous construct,” said Ian Gillespie, CEO of Westbank. "Humans need each other to build together, to be creative together.”
Mr. Gillespie said the company is continuing work on proposed office towers in Vancouver and Toronto, and Westbank plans to announce five-million square feet worth of new projects in Vancouver and in San Jose, Calif., in the coming months.
Oxford Properties also has a series of developments under way in Toronto and Vancouver and said it has no plans to change course despite Shopify – along with Facebook and other tech companies – announcing their work forces could work remotely permanently.
What got lost in the high-profile pronouncements was that none of these firms are actually reducing their space, according to Eric Plesman, Oxford’s executive vice-president for North America. “A lot of people are determining what that impact may or may not be. Facebook said the opposite and said there would be an increased need for space.”
Twenty office towers are under construction in downtown Toronto, including four skyscrapers with more than a million square feet of space. In Vancouver, 13 office properties are under construction, according to data from commercial realtor CBRE. Their developers, which include Allied REIT, Ivanhoé Cambridge, Brookfield, Oxford Properties, Cadillac Fairview and Westbank, are also pushing forward.
All these buildings were conceived when office vacancy rates were falling, immigration was increasing and companies were desperate to be in the major cities to attract workers. These buildings are due to be completed over the next few years, which would add millions of square feet of new office supply at a time when no one is sure how long it will take for the economy to recover.
Among the projects still under way is the massive office and residential complex called The Well, a project by Allied and RioCan REIT. Shopify has not asked to get out of its lease, RioCan chief executive Ed Sonshine said. Even if the e-commerce company wanted to reduce its footprint, it would have to pay considerable penalties to do so. “Shopify can’t break its leases with Allied or the Allied-RioCan joint venture,” Allied chief executive Michael Emory said.
He said Shopify’s announcement that people could work from home permanently did not mean much for the future of office space. “The recent working from home announcements, whatever they prove to mean in actual fact, will have little to no impact on the developments under way or on the office markets in Toronto and Vancouver generally,” he said. He noted that vacancy rates in the two cities remain low, with little likelihood of increasing in the next 24 to 36 months.
There are signs the market is currently healthy. Unlike malls where rent collection has been dismal, office building landlords say they have received more than 90 per cent of their rent for April and May.
Slate Asset Management, which owns 84 office buildings in Canada, said it has brokered 30 new leases with investment firms, health care and other businesses over the course of the pandemic. Dream Office REIT, which owns 32 office properties, mostly in Toronto, said it has also brokered new leases at the same rates it was offering in February.
On the flip side, lawyers and leasing brokers for tenants have been renegotiating spaces and lower rates for their clients. “We are working with our clients to right size their office premises and sublet their excess space,” said Stan Krawitz, vice-chairman with Savills Canada, who has been working on deals under which the tenant pays less rent or reduces the size of their premises in exchange for a longer-term lease.
When the next wave of projects breaks ground, the configuration of individual offices and communal spaces is likely to be different, according to an architect who has designed spaces for Shopify and other tech companies. “I think it’s right that [Shopify] put things on pause,” says Andrew Reeves of Ottawa-based Linebox Studio. “Right now, people are running around trying to figure out an Office 2.0 solution … but there’s not enough data yet to make good decisions.”
Mr. Reeves predicts that lower floors of towers will become more valuable, since many users can walk upstairs and avoid elevators – and the danger of COVID-19 transmission. “The idea is, let’s reinvent the first four floors and make that primo space. We have these big marble lobbies; maybe this can be leasable space.”
Anne Martel, co-founder and senior-vice president of operations for Montreal’s Element AI, says the company has no plans to sublease its space. “Going to a completely remote arrangement is not something we’re considering; we have a collaborative culture,” she said. “For us it will be a slow return to a new normal.”
But the company’s office space “was designed for people to bump into each other, the opposite of what you will want in the coming months,” she said. Element is planning to stagger work hours in order to maintain distancing and to rethink its layout, but not to give up any space in the short term.
In the longer term, “I certainly think that people will give up office space,” she said. “At the renewal stage, we’ll be asking the same questions as everyone else.”
RACHELLE YOUNGLAI: May 29, 2020