Canada’s Office Market Boom Draws New Investors

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Tuesday, April 26th, 2016
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The demand for space in downtown Toronto is incredibly strong and incredibly deep,” Michael Emory, Allied’s founder and chief executive officer, said in an interview. “Our occupancy is at about 97pc — we have no large space to lease. The only way we have to accommodate larger space is to build.”

The real estate investment trust is currently marketing and leasing at least three major projects in Toronto that span 2.3m sq ft, the most new office space ever for the 28-year-old company, said Emory, 60, sitting behind a long marble table in the glass-walled boardroom of the company’s Toronto headquarters. Allied is taking advantage of the exodus from the older towers in the city’s financial core.

The shift in strategy comes as the reit faces the challenge of growth in Toronto: the historic buildings it targets are in limited supply, while foreign companies are driving up land and office prices. Meanwhile, the slide in oil prices means Emory may need to cut rental rates for future tenants of its Telus Sky tower in Calgary.

Allied’s stock is up 16pc this year, compared with an 8.9pc gain for the Bloomberg Canadian REIT Index.

One of the reit’s biggest projects is The Well, a C$1.4bn (€1bn) project in Toronto’s west end. The 7.6 acre (3.1 hectare) site, currently surrounded by condominium towers and trendy restaurants, is set to become 3.1m sq ft of residential, office, and retail space, the largest private mixed-use project in the country. Allied is in talks with six potential office tenants and Emory expects to lock at least one down by year-end.

The company is selling the right to build the residential portion to two companies, according to two people with knowledge of the deal. The price will be close to covering the C$136m Allied paid for the land with its partners, RioCan Reit and Diamond Corporation, said the people, who asked not to be identified because the matter is confidential.

“It’s not on the PATH, which is one of the challenges,” Emory said, referring to the underground walkway that connects office dwellers with shops, banks and public transportation. “On the other hand, it’s in a neighbourhood that has much more texture, character and appeal than the monolithic uniform core.”

Allied announced technology firm Shopify Inc. has committed to 112,000 sq ft, or 44pc, of the office space at the reit’s King & Portland project. The space will accommoda te 600 to 700 employees of the Ottawa-based startup.

Employment in Toronto rose 3.4pc in March from a year earlier, compared with 0.7pc for Canada as a whole.

Emory is seeing enough demand in Toronto that he’s optimistic of filling the 1.2m-sq ft Union Centre, a two-minute walk from the subway station of the same name that carries thousands of downtown workers daily. Allied is talking to several large tenants who could take as much as 600,000 sq ft, he said.

Allied is wooing office tenants at a time when they’re leaving older buildings in search of newer digs, according to brokerage CBRE.

The vacancy rate for downtown Toronto class B buildings, or properties that are older and have fewer modern touches, jumped to 7.8pc in the first quarter, the highest since 2006. Developers of new space are taking those tenants, keeping vacancies for top-quality buildings relatively unchanged around 5pc, despite 1.1m sq ft hitting the market in that period.

Among the perks offered in new buildings: 70-foot-high lobby ceilings, more natural light via floor-to-ceiling windows, and the ability to integrate unique touches, such as the reclaimed wood benches in Allied’s headquarters.

The outlook is different in Calgary, which has been slammed by the oil downturn. Allied has about 10pc of its portfolio by square footage in the city, though only a few energy tenants, said Emory. One is Cenovus Energy Inc., with about 30,000 sq ft.

“Calgary is going through a very severe downturn in the office market — full stop. Everybody knows it,” Emory said.

“The biggest issue for us in Calgary is Telus Sky.”

Allied is lowering its forecast rent from future tenants at the C$440m, 60-story Telus Sky by 20pc, cutting the return on the building to 6pc from a previously disclosed
7.2pc, Emory said. The mixed-use tower, under construction and set for delivery in 2018, includes 450,000 square feet of office space, only 38pc of which is committed to Telus Corporation.

“It’s not a train smash, but it’s an indication of the kind of erosion that’s possible,” Emory said. Although Allied isn’t slowing down construction or considering walking away from it, Emory has paused on actively looking for additional tenants because the average market rents are too low.

“This isn’t going to be a V-shaped recovery,” he said.

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