Threat of new office space cools rent hikes

It will be two years before the doors open at three new office towers in downtown Toronto, but already the new space is influencing the country's largest market.

Rents in Toronto's prime towers barely budged in the first quarter, even though vacancy rates dropped to their lowest levels in more than five years. It's a sure sign that existing landlords are working hard to hang onto tenants in the face of growing competition.

"We expected rates to move up a lot more than they did," said Ray Wong, head of research for CB Richard Ellis in Canada. "The fact is owners would rather renew early that risk losing tenants to the new buildings."

The average rent for Toronto's downtown towers was flat during the first three months of the year, even though the vacancy rate tumbled to 5.6 per cent from 7.4 per cent, numbers released yesterday by CB Richard Ellis show.

Mr. Wong expects that vacancy rates will fall even further this year and next, but said the prospect of new space has kept a lid on large rent increases, although the best towers continue to command higher prices.

The new buildings have brought a new dynamic to the market, said Allan Schaffer, who heads the Ontario business of GVA Devencore, a brokerage firm that represents tenants. "Landlords will fight hard to keep a good existing tenant," he said.

Still mid-sized tenants with leases that expire before 2009 can expect to pay more for the same space and even large tenants should not expect too much in the way of a price break. "There are no bargain basement prices, " he said.

Joe Nestic, a senior vice-president with Menkes Developments Inc., owner of the new Telus Tower, said he is talking to all major tenants with leases expiring in two to three years, as well as some smaller firms. Given the state of the market, he said every major tenant is at least considering the new developments in their plans. Even if they don't move, he said they could use the leverage of the new space to try and get a better deal.

"There's going to be lots of activity in the next few years and lots of deals," Mr. Nestic said. "Today is a good time to be a tenant and a landlord. There are lots of opportunities."

Those opportunities are largely because of the downtown building boom. Three new projects have broken ground - Menkes' Telus Tower near the Air Canada Centre as well as the RBC Centre in the city's entertainment district and the Bay-Adelaide Centre. All three have signed major tenants, but are still looking to fill substantial blocks of space. These projects, together with a mixed-use building also near the ACC, will bring 3.3 million square feet of new office space to the market in 2009, increasing the city's downtown office stock by about 7 per cent in a single year.

Mr. Wong expects the new towers will push vacancy rates to 11 per cent in 2009. The market should be able to absorb the space, he said, provided that there is not a significant decrease in demand.

The situation in Toronto is in sharp contrast to Calgary, which is expected to gain 4.3 million square feet of new downtown office towers by 2011. But rents are still rising because most of the space in the planned new buildings is already leased.