GTA industrial and office space: A tale of opposing trends
Steve McLean, (REAL ESTATE NEWS EXCHANGE) — “Like the pandemic, it’s like a once-in-a-100-year situation that we’re dealing with.”
That was JLL Canada chief executive officer Alan MacKenzie’s reply when asked if there was any precedent for the strong performance of the industrial market in the Greater Toronto Area, while the office sector remains in a slump.
JLL recently released reports covering first-quarter performances in those two areas and MacKenzie and senior research manager Scott Figler offered RENX their insights and forecasts.
Industrial performance remains strong
While the GTA industrial vacancy rate inched up 10 basis points to 1.7 per cent in Q1 2021 from its Q4 2020 performance, it has remained below two per cent for 10 consecutive quarters.
It’s the tightest Mackenzie’s seen in his 32 years in the real estate business. He expects vacancies of zero to 0.5 per cent over the next two years because supply can’t keep pace with demand, which is split 25 per cent for e-commerce, 25 per cent for logistics and distribution, 15 per cent for retailers and 35 per cent for other uses.
Three-quarters of the approximately 10 million square feet of industrial space under construction in the GTA has been pre-leased:
- S&S Activewear took almost 280,000 square feet at a property at 6675 Langstaff Rd. in Vaughan that’s under construction.
- In Durham Region, where a wave of speculative new product was recently delivered, Lear signed a 185,000-square-foot deal at Carttera’s 1652 Tricont Ave. in Whitby.
- In nearby Oshawa, Aosom.ca and Canatom signed major deals at Panattoni’s 1121 and 1147 Thornton Rd. S. site.
Q1 sales volume hit almost $1.3 billion, more than double the same period in Q1 2020 and almost five times the volume of Q2. The largest purchase was Triovest’s $125-million acquisition of a logistics centre at 100-110 Iron St. in Etobicoke.
Amazon purchased the former Pickering Markets flea market property on 40 acres at 1400 Squires Beach Rd. in Pickering for $40 million.
Deliveries in the first quarter totalled 1.6 million square feet, primarily consisting of Panattoni’s 1121 and 1147 Thornton Rd. development and Beedie’s Legacy Business Centre strata development at 2340 and 2370 Meadowvale Blvd. in Mississauga.
Deliveries this year are expected to reach 10.5 million square feet. That will fall short of the 11.9 million square feet of new supply in 2020, but would be well above the 6.5 million square feet averaged between 2014 and 2019.
Industrial rents and land prices continue to rise
Rental rates climbed to $10.39 per square foot during the quarter, up 9.8 per cent year-over-year.
“Up until 2015, there was very little rental growth and rents are now pretty much double what they were five years ago,” said Figler.
“If you’re an investor or developer in the industrial space right now in the GTA, you kind of have no risk because the rents are rising faster than the costs,” said MacKenzie.
Uncertainty in the office and retail sectors has somewhat dampened investor interest in those sectors, but industrial land has been a hot commodity and well-capitalized developers are investing, which is driving up prices.
Figler said industrial, commercial and investment land comprised almost one-quarter of total sales in 2020 and is up to 26 per cent this year.
Investors are also continuing to acquire land in nearby secondary markets including Guelph, Kitchener-Waterloo, Cambridge and Hamilton to build industrial space on spec. JLL recently opened a Kitchener-Waterloo office to service that demand.
Downtown Toronto office vacancy
The downtown Toronto office vacancy rate rose from 5.1 per cent in the fourth quarter of last year to 8.4 per cent in Q1 2021. The vacancy rate a year earlier was 1.9 per cent.
The vacancy rate was somewhat artificially inflated because the increase included the 1.52-million-square-foot first tower at CIBC Square, which was 99 per cent pre-leased — but not occupied — upon delivery during the quarter.
“Anywhere else in the world, if your vacancy rate is where Toronto’s is right now, that’s considered a healthy market and probably a landlord-favourable market,” said Figler, an American who has previously worked in the United States and South America.
“The sky’s not falling. It’s actually a good thing for the health of the market.”
Figler said it was very difficult for companies to expand in downtown Toronto until last year, unless they pre-leased space in a new building. Now there are more opportunities.
Office occupiers have largely been shut out of their spaces for more than a year due to provincial guidelines and/or safety concerns due to COVID-19, and many are trying to figure out what their future footprints should be.
Overall downtown office leasing increased from 487,000 square feet in Q4 2020 to two million square feet in Q1 2021. Lease renewals accounted for approximately two-thirds of all activity, highlighted by high-profile occupiers including Scotiabank, Citi Canada and Facebook.
MacKenzie said renewals normally account for one-third of leasing activity.
Other notable direct lease deals included: the Ontario Ministry of the Attorney General signing a renewal for 248,000 square feet at Dream Office REIT’s 720 Bay St.; French University of Ontario taking 62,000 square feet at Daniels Waterfront at 130 Queens Quay E.; and Ransom Music Group taking 23,000 square feet at TAS Design Build’s 860 Richmond St. W.
Downtown office subleases are increasing
Downtown Toronto sublease availability rose 10 basis points to 3.4 per cent from the previous quarter, as many companies have attempted to sublet space as a cost-saving measure.
“Much of that sublet space that has added to the overall vacancy in Toronto hasn’t been leased out or moved,” said MacKenzie. “What has leased is the higher-quality sublets with longer remaining terms, like five-plus years left on the sublet, to make it more interesting for the tenants that are taking the space.”
While there was a small amount of sublet space added in the last quarter, it was less than in the previous three quarters. Figler believes Q4 2020 may have been the bottoming out point.
“We’re still going to see more added vacancies, but it’s not going to come from subleases. It’s going to come from end-of-contract renewals where tenants are able to downsize a bit and not get penalized for it.”
During the most recent quarter:
- PC Financial sublet 27,470 square feet to engineering and construction company Kiewit Corporation at 25 York St.;
- the Canadian Broadcasting Corporation sublet 23,000 square feet to game developer Zynga in the Canadian Broadcasting Centre at 250 Front St. W.;
- and Virtu Financial sublet 19,670 square feet to Hybrid Financial at Cadillac Fairview’s TD Centre at 222 Bay St.
The Toronto Stock Exchange took its 45,000-square-foot sublease at EY Tower at 100 Adelaide St. W. off the market as it now plans to reoccupy the space. Other companies have been doing the same thing, according to MacKenzie.
The major downtown office deliveries in the second quarter will be: 1.07 million square feet, all of it pre-leased, at The Well; and 1.11 million square feet, 68 per cent of it pre-leased, at Menkes’ 100-125 Queens Quay E. that could spill over into the third quarter.
MacKenzie expects a stable downtown office vacancy rate for the next six to 12 months, but thinks demand will pick up as the economy rebounds and immigration returns.
Health and wellness considerations
While sustainability and health and wellness concerns were already growing in importance for tenants, the pandemic has heightened this. AAA office buildings used to be the highest structures in the downtown core, but MacKenzie said smaller buildings are now achieving AAA status because of health and wellness standards.
MacKenzie said B- and C-class buildings on the periphery of downtown that aren’t sufficiently capitalized to make significant improvements in those areas may have difficulty backfilling empty space when tenants leave and rents may need to be lowered.
MacKenzie said JLL represents a number of tenants that want to relocate to new buildings under development with features such as touchless washrooms, doors and elevators; more efficient air exchange systems; increased natural light; windows that can open; and access to outdoor space.
He cited Portland Commons, The Well and Waterfront Innovation Centre as examples.
Suburban GTA office markets
The GTA North East’s office vacancy rate rose 90 basis points to 11.8 per cent in Q1, the third straight quarterly increase.
The GTA West rate increased 200 basis points to 16.1 per cent. That was impacted in a major way by Bell Canada making 615,000 square feet available for sublease at the Bell Mobility Campus at 5025 and 5115 Creekbank Rd. in Mississauga.
“There’s not as much of an uptick in vacancies and there’s not as much change in rents,” Figler said of the suburban GTA office performance. “If we haven’t seen any huge movement in the metrics by this point, I think there’s a sense in the market that we’ve probably made it through the worst.”
Figler has seen a shift to more use of a hub-and-spoke model, where companies maintain a primary office downtown and smaller spaces in the suburbs, but not a major flight to outlying areas.
He gave a hypothetical example of a company that had 50,000 square feet of space downtown keeping 35,000 square feet there and moving 7,500 square feet to Mississauga and 7,500 square feet to Markham, where rents are cheaper and the locations may be more convenient for some employees.
However, that model doesn’t make as much sense for companies with young talent, such as the tech sector, where most employees live downtown and don’t want to work in the suburbs.
“There’s a serious risk of making a move to save a little bit of money on the balance sheet but losing your top talent while doing that and destroying your company,” Mackenzie said.
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