There are various factors — some unforeseen, some fleeting, some game-changing — that are directing the office market into uncertain territory for many stakeholders.
It’s becoming increasingly clear that Vancouver and Toronto, in particular, are in a battle to fill up the inventories of expensive, shiny new offices amid higher vacancy and a more aggressive subleasing market. This levelling-up of workspace quality, amenities and tactics will have implications on vacancy, valuations and the strategic decision-making by landlords and the companies and workers they host.
Elevated interest rates, economic uncertainty, remote work and a recent office building boom have pushed big-city vacancy to 25-year highs, but there are specific considerations and actions that owners and tenants can take so they don’t get left behind.
Return-to-office still a challenge
Return-to-office remains a pressing factor and a thorn in the side of many landlords. Toronto, which experienced greater pandemic lockdown restrictions than other cities, has lagged other markets in its overall return to office, but we’re starting to see progress.
The average in-office mandate has climbed from 2.5 to 3.3 days per week since last year, according to a new report from Colliers Real Estate Management Services (REMS), with the national office vacancy expected to peak at 15 per cent by mid-2025.
If we zoom out, we’re hearing about more companies wanting their people back in the office and committing to existing leases or taking on new space. SAP SE, for instance, had been preparing during the pandemic to sublease office space in Toronto’s financial core, but recently decided to retain that space for its own operations.
In the U.S., IBM told its executives and managers to return to the office at least three days a week and remote workers who live more than 80 kilometres from an office have until August to relocate closer, according to CNN. If they don’t, they risk losing their jobs. Companies like this are trendsetters.
In Canada, as of November only 12.6 per cent of the workforce aged 15 to 69 was working exclusively at home, according to data from Statistics Canada. That number had fallen from 20.1 per cent in May 2023. We can expect that number to likely continue dropping into 2024.
Flight-to-quality will prompt office investment
Simply hoping that workers will continue to come back to the office on their own because they fear losing their jobs is only part of the solution; it’s a stick. There’s also a carrot that can be used — and we are seeing that play out.
Millions of square feet of new class-AAA office space has been built and opened in recent years in Toronto and Vancouver, but this latest construction wave is wrapping up.
Tenants that are coming back to the market are saying: if we are going to get our people back, we want them to be in a compelling space that’s commute-worthy.
An inverse relationship is materializing, vacancy rises as classification of space decreases.
In Vancouver, cumulative office absorption since 2021 in class-AAA totalled over 2.2 million square feet (MSF) to the positive, according to Colliers research. In that same time period, the class-B and -C categories saw a decline in absorption of roughly 750,000 square feet.
“Meanwhile, we saw overall available B-class sublease space in Vancouver rise from just under 800,000 square feet in Q4 2021, to nearly 1.4 MSF by the end of 2023,” said Susan Thompson, associate director of research at Colliers. “That suggests tenants are increasingly putting their older space on the market as they shift into newer buildings.”
In Toronto, lease rates for AAA space have continued to rise, reflecting strong demand for newer offices, said Adam Jacobs, Colliers’ director of research. “Vacancy in top-quality buildings is about half that of the overall office vacancy.”
“In Toronto’s financial core, cumulative absorption of AAA office space climbed from 1.2 MSF in 2021 to 1.7 MSF last year,” Jacobs said. “Absorption in the lower classes of office has been going in the opposite direction.”
Make the office an attraction, not an obstacle
In the return-to-work battle, landlords and companies share the motivation to make the building and office an attraction instead of an obstacle.
A great location near enticing food options and transit is great, but so are buildings that have great amenities and programming.
For example, CIBC Square at 141 Bay St. is a flagship office development in downtown Toronto. The first phase of the two-tower complex opened fully leased and the next phase is two-thirds leased.
Altogether, it’s a three-million-square-foot complex that includes several lounges; a beautiful food hall with unique food and beverage options; and an elevated one-acre park that connects both buildings. Moreover, it offers a spectacular fitness facility for yoga, and various classes.
It’s also outfitted with change rooms and a cycle storage area.
CIBC Square has many unique features tenants are gravitating toward and that will help to pull people back to the office environment and set the standard for other offices in the city and country.
Bifurcation in office will either prompt investment or retreat
As more people come back to the office and companies sign leases for the new inventory in Vancouver and Toronto, owners of the older stock will need to focus on not getting left behind. The flight to quality could leave many class-A or -B offices relegated.
Owners of class-C buildings tend to always have a market among companies that don’t need or want flashy, new office space. Those lower-level, often suburban offices, will always be able to compete on price.
But, there’s a large contingent of class-A and -B properties that make up plenty of inventory in our downtown financial cores.
Owners and operators of these buildings really face two choices: accept that they can only compete on price with their lower-class buildings, or invest capital into their buildings to ensure they don’t end up relegated in the market.
That investment doesn’t necessarily require a full conversion to say, a hotel or apartments; instead, capital could be put toward substantial upgrades that provide greater sustainability, a state-of-the-art HVAC system, common area amenities, new technology and other programming that’s proven to be attractive to all users and visitors of the building.
Additionally, owners can lean into designing and offering model suites that reduce the requirement of companies to arrange costly or superfluous build-outs or tailored designs. These turn-key suites can be appealing and sufficiently functional to meet a variety of users’ needs as plug-and-play operations.
Leaning into data will also be part of the solution. Let’s know what tenants want instead of guessing what they might use. For instance, Colliers REMS has been hard at work on Office 2.0.
Office 2.0 includes three re-imagined programs: tenant engagement, ESG and a PropTech Lab. The platform represents a profound shift, with programs that use data to equip property teams with a suite of services and strategies while giving them the flexibility to decide with their clients what is right for their buildings.
The data-driven programming can be tailored for any class of office, in any location.
Valuation considerations and avoiding a race to the bottom
For owners and building operators to maintain the value of their assets during this adventure, it’s essential to find the delicate balance between spending enough capital to keep their buildings competitive and offering an attractive amenity package and competitive rents to attract new tenants.
Owners should be asking themselves what their long-term goals for the asset entail.
It’s important to triage a building’s needs, aiming for the biggest impact, without taking part in a race to the bottom.
That could require a longer-term investment to decarbonize a building — but maybe not. Instead, it could hinge on a capital investment to develop turn-key suites.
It could mean engaging with data offered through building management services to figure out exactly how tenants are using a building and what they would like to see changed or added.
The first step to be prepared for this challenge is to enlist the support of valuation, brokerage and property management experts to help guide the decision-making process around assets and strategies.
The time for guessing is over.
