With commercial office vacancy rates in the low single digits in cities such as Toronto, Calgary and Vancouver, the leasing market pendulum has swung firmly in favour of landlords. Expect them to become increasingly picky when it comes to who gets to occupy space in their buildings and on what terms and conditions, real estate experts say.
"These days, it is not unusual in downtown Toronto to find two or three tenants battling for spaces as small as 20,000 to 30,000 square feet," says John O'Toole, executive vice-president at broker CB Richard Ellis Ltd.
"The days are over when landlords offered significant leasehold improvement money to persuade a tenant to take space," adds John Arnoldi, managing director of Toronto operations for Colliers International. "The fact is they don't have to; landlords right now are in the driver's seat."
Today, especially with new or newly renovated buildings, landlords often have a distinct vision in mind as to what kinds of tenants they want.
They often see their building as an almost self-contained community, says Tom Farley, president of Canadian operations for Brookfield Property Corp., which is currently building the Bay Adelaide Centre and owns the newly renamed Brookfield Place, formerly BCE Place on lower Yonge Street, both in Toronto.
"Ideally, you want a tenant mix that reflects the main tenant drivers in a particular geographic market," he explains. "In Toronto, the major core tenants are financial services companies; in Calgary, they are energy companies; and in Vancouver, the driver is the resource industries and to a lesser extent high tech."
Competition can indeed be fierce among landlords to attract a major company in those specific fields. "Once you have one of those as a major tenant, taking maybe 100,000 square feet or more, then it becomes easier to fill the rest of the building," Mr. Farley says.
That is because, like bees to honey, the companies offering support services to that major tenant are keen to have space in the same building. Proximity enables them to provide better service and establish closer working relationships, Mr. Farley says.
"That is why you see so many major accounting and legal firms in bank towers and other major, landmark type developments in the downtown cores of those cities."
Landlords can even go so far as to design floor plates to match the specific needs of certain kinds of tenant, Mr. Arnoldi says. Floor plate design is crucial in determining how space can be subdivided into private offices and meeting rooms.
"Brookfield's new Bay Adelaide Centre is a case in point," he says. "That building is designed specifically with service companies in mind because the floor plate allows lots of private offices and meeting rooms.
"By contrast the new Telus building downtown has the heating and utilities installed under the floor plate to allow for large open spaces, which is what Telus needs. So far, that building is having more difficulty finding secondary tenants. Dividing up the space is just too expensive and difficult for service companies."
The wisdom of Brookfield's design is apparent in its ability to find eager takers for large chunks of space, Mr. O'Toole says. He points out that KPMG has already signed for 250,000 square feet of space and the law firm Goodmans has taken 177,000 square feet.
"There is also another law firm negotiating for about 125,000 square feet. It is proof of how critical design can be to speed leasing of office properties."
Good tenants, however, can be of any size; it often comes down to the quality of their covenant and the term of the lease they are willing to commit to, Mr. Farley says.
"In most buildings, you do want smaller tenants who can occupy space optioned for future use by larger existing tenants or space larger tenants have given up through downsizing of their operations."
A 10-year lease signed by a small professional services firm may, in fact, be more attractive than a five-year deal with a provincial government department even though landlords can always count on the province to pay its bills, Mr. O'Toole says.
"Where covenants really matter is in new or newly renovated buildings and in times where vacancy rates are relatively high," Mr. Arnoldi says. "With high vacancy rates, landlords offer considerable leasehold improvements. They can be as much as $60 a square foot for a big law firm. The landlord wants the best covenant; the best security it can get to make sure it gets a steady, long-term rental stream to pay for all that upfront spending."
Michael Emory, president of Allied Properties REIT, which owns 2.5 million square feet of former industrial space in downtown Toronto and now ranks as the city's largest landlord, says that while covenants of smaller tenants might not be as solid as larger corporations, he has found they do offer some distinct advantages.
"Not to deride institutional tenants, but we have found smaller companies with a high creative component to their business to be terrific tenants for a number of reasons," he says. "First, they tend to employ a young, sophisticated work force, who become evangelists among friends and acquaintances for the kind of brick and beam ambience we offer. They tend to make the area the focus of their lives when it comes to shopping, dining and entertaining, which helps us attract retail tenants to ground floor space. And they seem to take more pride in the building, which results in lower maintenance costs."
Mr. Emory says that since 2003, when Allied went public, it has not had a single office tenant default on a lease.
"Granted, the quality of our leases is not as good as in those bank towers but that just means we have to be more active with risk management and work more closely with our tenants."
© The Globe and Mail
