Leased office space across Toronto continues to tighten, but not fast enough for the landlords trying to lure tenants into their buildings.
"Even as office space gets tighter in Toronto, tenants are still the winners at least for the foreseeable future," said Paul Morse, senior vice-president and general manager of Royal LePage Commercial Inc.
Across the Greater Toronto Area (GTA), the vacancy rate in the fourth quarter of 2004 dropped to 10.4 per cent from 10.5 per cent in the third quarter, according to Royal LePage's latest market report. "The office market will continue to strengthen in 2005," Morse said in an interview.
The office vacancy rate has been gradually declining since the middle of 2003, according to Ray Wong, national research director for CB Richard Ellis. "We're hitting the bottom of the marketplace. Rental space is gradually leased up, but it is still largely a tenant's market. Landlords are offering attractive inducements to locate in their buildings."
Although more space is being leased, Toronto's vacancy rate is still twice what it was in 2000, just before the boom fell on the technology and telecommunications sectors, said Royal LePage's Morse.
In Toronto's suburban markets, the vacancy rates are about five percentage points higher than in downtown Toronto, Wong said. The incentive packages from the landlords in the outlying areas are better than central Toronto and may include free rent, cash, redecorating costs and tenant build-out allowances.
Neither Wong nor Morse expects the Toronto office space market to tighten quickly. "It's positive, but gradual," said Morse.
Toronto's burst of economic growth of 5.3 per cent in 2004 - predicted by the Conference Board of Canada - didn't translate into major new leasing projects. Property owners had expected a quicker recovery in leasing activity, but it didn't materialize, Wong said.
In the last three months of 2004, office vacancy in Toronto's downtown market - with the largest inventory of space and highest rental rates in the GTA - fell below 10 per cent to 9.7 per cent for the first time in two years.
In the fourth quarter in the downtown core, the amount of new leased space increased by more than 425,000 sq. ft. compared to a 95,000-sq.-ft. increase in the previous quarter. The increase was mainly due to the transaction that saw ING Canada take 331,000 sq. ft. at 700 University Ave.
There is a total of about 63.5 million sq. ft. of space available to be leased in the downtown core, of which about 57 million sq. ft. is occupied, according to Royal LePage.
Businesses are more cost conscious than in previous leasing cycles, said Royal LePage national research director Stuart Barron. "They're watching the bottom line more closely and not rushing out to get into new space. And when they move into a new space, they're leasing less than before. " "They're more efficient in the ways they use their space," CB Richard Ellis's Wong said.
Employers have steadily cut back on the amount of space for each employee. Since 1992, the average amount of space per employee has dropped from 220 sq. ft. to 175 sq. ft., a 20-per-cent decrease, said Wong. Even when employers increase the number of employees, they lease less space. More firms are using office cubicles to cut space.
With businesses cutting costs, the cheaper rents outside the downtown core continue to draw more tenants. "Companies realize they don't have to be downtown to conduct business, especially with the communications technology now available," Wong said.
Wong believes the financial services and law firms will remain concentrated in Toronto's downtown core. But, with Canadian bank mergers now a distinct possibility, consolidation within the bank sector would result in additional prime space for rent.
The move toward lower rents by firms is most evident in the western end of Greater Toronto, particularly near Toronto Pearson Airport. "Western GTA continues to grow more than other areas," Barron said. Additional new space is being added much faster there than in other parts of the city and faster than it can be absorbed.
The increase in newly built office space is keeping the vacancy rate for GTA West at 12.2 per cent - higher than in the rest of Toronto. Barron described leasing activity in much of Greater Toronto as "a shell game," with business relocations often freeing as much or more space than firms lease.
The proximity of the Toronto airport, access to the 400 highways and lower rents are the major factors driving growth in the western part of Greater Toronto, said Barron.
According to Royal LePage, the average rent in western GTA is $24 per sq. ft. compared to $40 in Toronto's downtown core.
Unlike the late 1990s, when the technology and telecommunications sectors and financial services were booming, there is no single industry driving office-space demand in today's leasing market.
It was these industries that drove the office vacancy rates in the GTA in the late 1990s as low as 5.1 per cent across the entire GTA area and 3.1 per cent in Toronto's downtown core.
"We're not going to get back there anytime soon," said Morse. "We don't see that kind of demand."
Consolidation and acquisition are now the major drivers in the leasing market. "It's two steps forward, one step backward," Morse said. "We'll likely see only one-per-cent to two-per-cent swings in the vacancy rate over the foreseeable future."
But the clouds are clearing for property owners. "We're seeing a slow, steady turn toward a landlord's market," Barron said. "There isn't a lot of new space being built."
When vacancy rates hit seven to eight per cent, rents will move up aggressively. Landlords in some buildings and office complexes are already moving up their rates. With Toronto's high taxes and operating costs, landlords want better returns on their investments, Morse said.
When space got tight in the 1990s across the GTA, "buildings were popping up all over the place," Morse said. Through a combination of luck and cost conservatism, Toronto dodged the bullet that could have seen the commercial real estate market collapse such as happened in the early 1990s.
"We're definitely not moving to a super-tight market as we did in 2000. Deals will still be there," Morse said. "It's not the roller-coaster ride of the 1990s when the swings in vacancies caused instability in the market and scared off capital."
The increase in foreign investment is a sign stability is returning to the Toronto real estate market. "They're here looking for steady cash flow and a better return than they get elsewhere, and see the market as undervalued.
"I won't be surprised to see a new building coming onstream in the next five years in downtown Toronto," Morse said.
(Charles Wyatt can be reached at wyatt@businessedge.ca)
