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Different Roads to the Same Castle

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Downtown Calgary office historical and projected vacancy.

Low rents, building-rich amenities and a “flight to quality” are luring many businesses back to Calgary’s core following an exodus that saw nearly a third of all towers sitting empty just three years ago.

Yet real estate experts say the diversity of these downtown-bound companies is the real story behind a resurgence that will still take years to fully realize.

After five years of downtrodden conditions, the downtown office market marked its third-consecutive quarter of positive absorption in the first quarter of 2019 – the first time it’s done so since 2012, according to Avison Young.

Alexi Olcheski, Calgary-based executive vice-president and principal with the commercial real estate firm, credits the gradual turnaround to favourable leasing conditions, as well as creative landlords adding building amenities such as tenant lounges, concierge services and conference facilities.

“With the nature of the type of clients we’re trying to attract to Calgary, we need to show ourselves as a progressive and dynamic workforce. Along with that, you have to offer those types of services,” he says.

Olcheski also points to incentive programs on spaces under 5,000 square feet that are luring tech startups, smaller engineering firms and even non-profits with flexible turnkey solutions.

“The clients of mine who have taken advantage of these programs have come from a number of different industries – or what I would call non-traditional downtown industries,” he says. “They represent a young, dynamic workforce who want the benefits of being downtown, such as dining, nightlife and entertainment.”

Adam Hayes, Calgary-based managing principal and broker with commercial real estate firm Cresa, is seeing a similar pattern of non-traditional clients moving south of the Centre Street Bridge.

“We’re seeing a new wave of tenants emerge downtown, being technology, cannabis and coworking spaces,” he says. “While these companies do not absorb the amount of space required to offset what energy companies have shed, it’s the start of modest diversification for the core.”

Altus Group, a leading Canadian commercial real estate services and software company, estimates 33.6 million of the 44.3 million square feet in downtown Calgary is now currently occupied. The remaining 10.7 million square feet still available represents a 23.1 vacancy rate that is beginning to stabilize despite being a far cry from the low of 3.4 per cent in 2012.

Altus Group vice-president of data operations Ray Wong says tenants’ conditions are giving companies from all industries across Canada a reason to take a second look at downtown Calgary.

“If you were a non-energy company looking to come into Calgary, it was difficult to come in during the boom periods because you had to compete with oil and gas for local talent,” he says.

“Now, because of the shift in the energy sector, these companies are starting to see opportunities in Calgary where they can take advantage of higher office vacancy rates and more competitive rental rates. And they’re less worried that they’re going to lose their workforce to the energy sector. It’s going to feel more balanced moving forward.”

Wong also expects many suburban-based companies to take advantage of prices and move downtown. He highlights Parkland Fuel’s decision in the third quarter of 2018 to expand and relocate to 111,000 square feet in BP Centre from the suburban northeast.

“When the vacancy rate was at 3.4 per cent, it forced a number of tenants to relocate to the suburbs because there wasn’t anything available and the price downtown was getting out of hand,” he says.

“Seven years later, a lot of these companies are moving from the suburbs to downtown – paying similar rents or slightly lower, but closer to amenities.”

Look no further than the sublease market, says Hayes. Many companies with natural lease expiries have been chasing low-cost sublease options to try and keep their balance sheets in check. As a result, these companies have been able to increase their standard of living while decreasing their costs.

“This ‘flight to quality’ is leaving these companies’ older premises vacant in the market while driving vacancy down in the top product,” says Hayes, who estimates class AA vacancy at 16.92 per cent, down from its peak of almost 21 per cent at the end of 2017.

Meanwhile, class B vacancy, which are largely west-end buildings, sits at 38.14 per cent. Some tenants who entered into new transactions in 2012-14 were forced into buildings they would have not chosen in a normalized market – from either a cost or lack of inventory perspective. With those contracts now expiring, many of these tenants are coming to the core, says Hayes.

Looking forward, Olcheski optimistically forecasts 150,000 square feet of positive quarterly absorption for the rest of this year and to the end of 2020, corresponding with a 0.5 per cent quarterly reduction in vacancy rates.

“It’s a slow climb into higher absorption,” he says, noting, comparatively, that downtown experienced nearly 5.5 million square feet of negative absorption from 2014-16.

“We believe the major hurting is done. We feel both are at a stabilization point.”

A key to keeping vacancy rates steady will be mitigating new inventory to the market, says Wong. Telus Sky will be the last to come online, adding 435,000 square feet of space – 285,000 of which will be immediately available. Wong estimates Sky will only marginally increase downtown office vacancy by 0.2 per cent.

He notes, however, 5.5 million square feet of new inventory has come online over the past five years, including Calgary City Centre (853,000 square feet), Eau Claire Tower (613,000), 707 Fifth (564,000) and Brookfield Place (1.4 million). Take these new builds out, and he expects the vacancy rate would be about 13.4 per cent – which considers downsizing and M&A activity, as well.

While it appears vacancy rates are holding steady in the mid 20 per cent range, there is more than meets the eye, notes Hayes.

What is not often considered is “ghost space” – space that’s being leased by companies, but unoccupied and not on the market for sublease. Also referred to as “shadow vacancy,” Hayes estimates this unused space could account for up to another 10 to 15 per cent, which would drive the availability rate closer to 35 to 40 per cent.

“Why this is very important to consider is ghost vacancy is generally carried by larger energy companies, which would be the first to grow when the commodity markets turn,” he says.

“They have to first occupy all their ghost vacancy before they would ever need a square foot of the posted vacancy, which will inevitably prolong a recovery of the real estate market.”

In addition, to get back to equilibrium – pegged at 10 per cent vacancy – Calgary needs to see upward of 20,000 jobs created, adds Hayes.

“A herd of mice cannot create that amount of jobs,” he says. “We need the elephants such as infrastructure companies and integrated energy companies to invest capital, kick off new projects and hire people accordingly. That likely only happens with a sustained recovery in the oil and gas commodity markets and a return of capital and confidence to the sector.”

An added challenge is the average square foot for an employee has been steadily dropping for about 10 years now, says Wong. Companies are looking more to collaboration and coworking spaces, as well as offering telecommuting options.

“And if Calgary sees more companies move from the suburbs to downtown, it’s going to create a situation of simply trading spaces wherein citywide vacancy rates on a whole stay about the same,” says Wong.

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