A major Canadian office landlord says about 30 per cent of downtown Toronto’s buildings are obsolete and likens leasing office space in the city to playing a game of snakes and ladders.
Michael Cooper, chief executive of Dream Office REIT, said the past few years have been challenging for landlords as tenants reduced their office footprint to deal with the shift to remote work.
He estimates that a wide swath of downtown office towers are obsolete because they have high operating costs and require an infusion of capital to make them attractive to tenants, especially in an environment like today where tenants can be very picky.
“Probably 30 per cent of the space in downtown Toronto requires a ton of money, a lot of investment and it’s questionable if you put the investment in that the building will be worth enough to justify it,” he said. “That’s what I mean by obsolete – when you put a lot of money in but you’re not actually going to increase the value.”
When demand was much higher in 2019, tenants were happy to take space in any building just to have a presence in the country’s financial capital.
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But now that nearly 20 per cent of downtown Toronto’s office space is available to lease, prospective tenants have a lot of choice. They are being courted with a buffet of incentives such as a few months’ free rent and extra cash to refurbish their space.
“It’s tough to get a deal done,” said Mr. Cooper, who said filling his buildings is like “a game of snakes and ladders.”
“When you get the lease done, you’ve done a little bit better, you’ve gone up a step. And then you’re working on another one and you have another step. Then you got another one, and you have another step. And then you find out one of the tenants that’s in your building that you thought was going to stay, they tell you they’re leaving. So now you slide back down,” he said.
Dream Office Real Estate Investment Trust owns and operates 17 office buildings in downtown Toronto as well as office buildings outside of the city’s financial district and in Alberta and Saskatchewan.
“So all the work we did. We’re just in the same place we were before,” Mr. Cooper said.
Dream’s portfolio of office buildings had an occupancy rate of 84 per cent as of the end of June, according to its regulatory filings. That compares with 85 per cent a year ago and 94 per cent in June of 2019.
In downtown Toronto, the occupancy rate was 88 per cent midyear versus 98 per cent in June, 2019, when tech companies and other businesses were desperate for space in the city.
A key measure of Dream’s office building profitability – net operating income – was $27.8-million for the second quarter, up slightly from $26.7-million a year earlier, but down from $34.6-million for the same period in 2019.
Mr. Cooper still believes in the value of office buildings and called Dream’s properties “wonderful buildings. But it doesn’t mean that the financial returns now are that exciting,” he said. “It’s very difficult.”
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The rise in remote work has hurt office markets throughout Canada and the United States. The share of employees in Toronto’s financial core rebounded to about half of prepandemic occupancy levels by the spring, but has been stuck at those levels since, according to measurements from consulting group Strategic Regional Research Alliance.
The country’s most populated city is also dealing with a lot more office space. A number of large buildings opened during the health crisis, flooding the core with more space when employees were told to work from home.
Now buildings that are decades old are struggling to compete with the brand new buildings, which have the latest amenities. Even older offices in the top locations are not as cost-effective as the latest crop of skyscrapers.
Commercial real estate brokerages have floated the possibility of turning some of the unwanted space into housing units. But it’s not feasible to turn many older buildings into condos given the lack of proper plumbing and other infrastructure for individual housing units.
“Maybe one out of 20 buildings makes sense as a conversion,” he said, adding that the others should be torn down and new residential buildings should be built.
Investors have soured on office landlords. Dream’s units are trading at $10 per unit. That is about 76 per cent lower than in January, 2020. Dream is not the only office REIT that has lost significant value over the course of the pandemic. Allied, Slate Office and True North Commercial are also down about 70 per cent, with Slate Office near penny-stock status.