The trend market analysts commonly call “flight to quality” presents some uncharacteristic leasing challenges for an older order of iconic office towers. Buildings long entrenched in the upper echelon now share skylines with newcomers capable of luring blue chip tenants to greener pastures. Meanwhile, emerging new types of tenancies in the technologies sectors don’t necessarily fit comfortably into the traditional financial industry footprint.
“It’s the Oldsmobile problem — they don’t want to be seen driving their grandfathers’ cars,” quips Sandy McNair, president of the market research and analytics firm, Altus InSite. “All those buildings we would have thought were the top-of-market are the buildings that are hurting the most. The pool of tenants that can move into these buildings is relatively small.”
A spate of new towers in the downtowns of major Canadian cities respond to tenants’ demand for buildings that can effectively accommodate the technology and occupant densities their businesses require. That includes design features, such as facades and floor plates that maximize delivery of natural light and personal HVAC controls, typically unavailable in their existing quarters.
“Despite slower economic growth, there is a sizable wave of new office supply being delivered in the downtown markets in cities like Montreal, Toronto and Vancouver, and also Calgary and Edmonton despite their current problems,” reports Chris Langstaff, senior vice president, research and strategy, with LaSalle Investment Management. “Pre-leasing for these new buildings has been strong and, once completed, demand for these modern, well-located, transit-oriented buildings has also been strong. We see in the leasing statistics that this is happening at the expense of older, lower quality buildings.”
Investors pursue core assets
The developers of new buildings have similar agendas. Market dynamics — low cap rates, product scarcity and the growing dominance of pension funds seeking stable, long-term assets — has prompted some key investors to build new stock that surpasses what they could buy, even if they pull tenants from their own buildings.
McNair notes, for example, that British Columbia Investment Management Corporation (bcIMC) owns Commerce Court, a stalwart of Toronto’s financial district, and is also a major investor in the burgeoning South Core, which has now pushed out the frontier of the city’s traditional prestige office area. “The reasoning is: if we don’t do this to ourselves, someone else will,” he suggests.
“Large institutions have been quite active in culling what, for them, are non-core assets and redeploying that capital into larger, even more core or trophy assets,” Langstaff concurs. “Canada Pension Plan Investment Board, Oxford Properties and Ivanhoé Cambridge are recent examples.”
Tenants, and the workforce they employ, have likewise evolved since the older competition first came onto the market. Until the recent building boom, even the newest high-status buildings dated back to the early 1990s — an era in which today’s Gen Y professionals were preschoolers and energy and environmental performance did not register with the wider public.
Formerly non-existent sustainability certification programs have become almost a prerequisite for tenants’ corporate sustainability and responsibility compliance, while urban growth and infrastructure pressures create other dynamics. McNair ties South Core’s allure in part to transit patterns and the perceived untapped capacity of Toronto’s commuter train service versus an overcrowded subway system.
“In Toronto, centre ice has effectively moved from King & Bay to Union Station,” he asserts. “The new buildings tend be just a little bit on the edge of centre ice so there’s sort of a different vibe to them and the areas where they are located.”
Outfitting the battle for talent
Overall, it leads to a package of concerns McNair sums up as the “battle for talent” and the role a company’s quarters can play in employees’ work satisfaction. “New buildings are really quite different, but the other meaning of flight to quality that’s just as valid is the quality of the management,” he submits.
Class A buildings outside the financial district’s epicentre, Class B and brick-and-beam office buildings may be better positioned to withstand the double-whammy of economic downturn and an influx of enticing new competition due to their smaller and more varied occupancies. In better economic times, corporate tenants moving to new buildings might have been expected to backfill vacated quarters with their own workforce, whereas now they’re leaving large blocks of empty space behind.
“In the past, even in a soft market, those towers would have experienced less vacancy than the rest of the market and would have had higher rents than the rest of the market,” McNair says. “This new scenario will get solved. It’s just a question of how long and at what price.”
A recession could complicate that process, but market watchers see the flight to quality as a separate dynamic more related to a natural reordering of status. Clearly, though, addresses with long prominence in the office tower hierarchy will continue to have market cachet. There has already been plenty of investment in staying competitive and a marked emphasis on management and relationship building.
“I think we’re in an era of concurrent big winners and big losers. A recession just ups the pressure to get it right,” McNair muses. “The pain isn’t evenly distributed. The pain is in significant pockets.”
Barbara Carss is editor-in-chief of Canadian Property Management.
