There’s no space like Trophy space. The premiere office towers that make up Canada’s Toronto, Montréal, Calgary and Vancouver skylines boast—by far—the most expensive office space to rent, costing 18 per cent more per square foot than non-Trophy space in those markets in the first quarter, according to JLL’s 2015 Skyline Review.
“After years of institutional investors monopolizing the skyline market, we are anticipating a shift,” said Brett Miller, president of JLL Canada. “With 7.5 million square feet of office space due to come to market there will be a flight to quality. Tenants will flock to the new buildings which offer quality, customizable, and efficient space. As a result, the current skyline buildings which have traditionally been in high demand will be left with available space, driving the skyline vacancy rates up.”
JLL’s proprietary 2015 Skyline Review identifies and tracks micro-segments of 47 city centres across North America, including Canada’s Quartet cities: Toronto; Vancouver; Calgary; and, Montréal. The Skyline features Trophy and Class A buildings where tenants and investors alike focus demand for office space in a flight to quality and efficiency.
Build it, and they will come…
With a sizeable amount of new office space under construction in the Quartet markets, skyline inventory is set to increase by 14 per cent from 2015 to 2018. As the cities prepare for a structural shift, tenants are seeking greater value from their real estate and taking full advantage of the current construction cycle by signing leases in new buildings that can better meet their evolving businesses, employee attraction/retention and sustainability requirements.
An aging skyline
The Quartet Skyline buildings are aging. On average, existing skyline inventory is 22 years old and many landlords are investing in capital improvements across their portfolios.
In fact, on average, including renovations, existing skyline buildings were constructed in the early 1990s and do not offer the same value to tenants as newer buildings. As a result, landlords of many of the older buildings in the existing skyline will find it increasingly difficult to meet tenant needs and will face the challenge of maintaining high occupancy rates. This is particularly noticeable in the areas of floor plate design and efficiency, energy performance and amenities offered.
A desire from tenants to modernize, optimize and rationalize has resulted in new construction across the Quartet Skyline, leaving large blocks of available space in the older buildings as existing tenants make the move to new towers.
The Quartet availability rate has risen from 6.8 per cent in 2012 to 9.5 per cent at the end of Q1 2015, while the total inventory across the Skyline has increased from 51.9 million square feet to 55.4 million square feet during this same period. The availability rate will likely continue to rise until 2018, fuelled by the completion of an additional new construction.
Not everyone gets a Trophy
Trophy assets are typically the most expensive buildings in the market. The average skyline trophy rental rate was 18 per cent higher than the skyline non-trophy rate at the end of Q1 2015.
Recent market conditions suggest a softening in trophy rental rates is around the corner, with markets such as Calgary and Vancouver already displaying downward pressure on rents across the skyline markets.
A driving factor to the current construction boom is the absence of skyline properties for sale, which has prompted pension funds and other institutional investors to turn to new development in order to meet their real estate allocation needs.
Three of Canada’s largest pension fund real estate arms, Oxford Properties (OMERS), Cadillac Fairview (OTPP) and Ivanhoe Cambridge (CDPQ), currently have five office towers (totalling 3.3 million square feet) under construction, all of which will be added to the Quartet Skyline markets over the next three years.
Furthermore, with the spread in yields between existing skyline buildings and new towers at an all-time low, institutions are increasingly viewing development as being a more viable option on a risk-adjusted basis to purchasing when (and if) skyline properties come to market.