Economic downturn in sync with an influx of newly constructed towers heralds empty space in the traditional prestige office buildings of Canada’s major cities. Although longstanding landmarks in the Toronto, Montreal, Calgary and Vancouver skylines now command average rents 18 per cent higher than less iconic competition can muster, real estate analysts predict an emergent tenants’ market will alter that picture.

“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,” says Brett Miller, president of JLL Canada. “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 recently released 2015 Skyline Review looks at Class AAA and A office buildings (which it categorizes as skyline buildings) in the central business cores of 47 U.S. and Canadian cities, drawing somewhat differing conclusions about trends in the two countries. In Canada, pension funds are identified as the major driver of developer — also wielding influence that reaches south of the border where “foreign capital has been a key factor in the current competitive environment.”

Yet, while the rise of Class B buildings as “viable contenders” is one of the five overarching themes of U.S. markets, Canadian landlords see threats from the upper end of the scale. Since 2012, 3.5 million square feet of new prestige office space has come onto downtown markets in Toronto, Montreal, Calgary and Vancouver, and this quality inventory will grow by 14 per cent in the four cores over the next three years. Availability rates have already climbed from 6.8 per cent in 2012 to 9.5 per cent at the end of March 2015, and JLL reports “downward pressure” on rents in Calgary and Vancouver.

Even the youngest of the existing buildings were constructed in the early 1990s creating challenges, and necessitating capital investment, to compete with new arrivals. “This is particularly noticeable in the areas of floor plate design and efficiency, energy performance and amenities offered,” JLL reports.

Ironically, developers are introducing this new market-beating product because they can’t secure the more lacklustre competition. Real estate arms of pension funds underpin 3.3 million square feet of prestige office buildings scheduled to be delivered over the next three years.

“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,” the JLL report states. “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.”

Calgary

The report examines 23 prestige office buildings in Calgary, of which five, representing more than 3.8 million square feet of space, are still under construction. Of these, the 1.4-million-square-foot Brookfield Place East, slated for completion in 2018, is fully leased. Meanwhile, falling oil and gas prices have affected both sitting tenants and prospective lessees in a market where the energy sector supplies three quarters of office occupancy.

More than 2.3 million square feet of sublease space is now in play, accounting for more than half of all available space in Calgary’s business core. Would-be tenants have also waived options for space rights in three of the five buildings under construction. Nevertheless, JLL analysts defer to history in predicting a turnaround within eighteen to 24 months, and call the current down cycle advantageous for tenants despite their business woes.

“Sublease space creates downward rental rate pressure on all CBD buildings, including the skyline, and presents tenants with the opportunity to upgrade their premises and buildings at discounted rates,” the report maintains. “When oil rebounds, vacancies in the skyline buildings will be the first to decrease. A similar flight to quality was witnessed in the last financial collapse in 2009.”

Toronto

The overview of Toronto’s prestige office stock likewise focuses on 23 buildings, of which three, equating to more than 2.7 million square feet, are under construction. Six of the 20 existing towers are currently fully occupied with vacancies of less than five per in five others. However, JLL notes that a shift is coming as 12.5 per cent of existing space is now listed as available for lease even though only 7.4 per cent is vacant right now.

“Older inventory is experiencing a spike in available lease space, above 20 per cent in the case of Scotia Plaza, Brookfield Place, EY Tower and Royal Bank Plaza,” the report states. “With 4.3 million square feet in recent and near-term skyline additions, large tenants have imminent plans to leave the old for the new, driven by consolidation and preference for LEED designed buildings.”

Notably, too, the frontier of Toronto’s skyline is moving — now encompassing five buildings south of the traditional Front Street cut-off — and stretching to the south side of the once perceived barriers of Union Station and the Gardiner Expressway. “The next wave of development will continue to push the skyline south of the tracks and solidify an expanding downtown core,” the JLL report predicts.

Contiguous space in Vancouver and Montreal

Similarly, the boundaries of Vancouver’s skyline territory are pushing outward with the recent completion of Telus Garden and two other towers in the planning stages on Thurlow and Howe Streets. JLL also tracks a somewhat complementary change in tenants’ profiles as technology companies increasingly join the longstanding mix of professional services. The 20 buildings covered in the survey collectively have a direct vacancy rate of 4.8 per cent — up from 1.1 per cent in 2012.

“Large occupiers have been afforded more options compared to recent years as a significant amount of full-floor opportunities have become available,” the report states. “Compared to the 2012 Skyline Report, in which the largest contiguous vacancy was 5,500 square feet, there are currently 13 full-floor direct vacancies, five full-floor sublease and nine future full floors coming available.”

In Montreal, three buildings comprising more than a million square feet are now under construction, while the 240,000-square-foot AIMIA Tower opened last year. This responds to tenants’ demands for more modern LEED-certified space despite the 11.6 per cent vacancy across the 20 buildings in the skyline survey. Indeed, JLL forecasts vacancies will rise to 13 per cent over the next two years.

With nine major landlords holding large blocks of contiguous space in excess of 50,000 square feet, there are opportunities for tenants to consolidate and take advantage of market conditions and competitive rates. However, they aren’t necessarily looking for the same kind of space they’re vacating.

“New developments are giving tenants additional eco-friendly alternatives,” JLL reports.