Market Commentary

GTA Market Overview

GTA Market Overview - Q2 2009

Poor business confidence has reduced office space demand in all submarkets. With few exceptions, the Toronto market is softening. Vacancy rates are now flat to moving up in the majority of market nodes, although headlease supply is still relatively tight across the GTA. The general sentiment is that the market will continue to soften in the near term.

Rental rates are falling in most segments, in some cases dramatically. The softer submarkets are seeing rent reductions of 10-50% from the market top.

Our Q1 2009 market data indicates that 70% of all markets surveyed showed flat to increasing vacancy rates compared to 67% last quarter.  93% of markets showed flat to increasing sublease supply compared to 67% last quarter. Quality sublease supply, or subleases that are 3 years or more, were flat to increasing in 23 of 27 markets surveyed, or 85%, compared to 78% last quarter. In summary, our market data confirms the negative market trend.

Meaningful new absorption has shown up in only 3 submarkets which reported vacancy falling by  1% or more, down from 5 submarkets last quarter.

44% of markets showed an increase in the number of problem buildings, which is the same as last quarter.
Landlords with high vacancy rates are much more cooperative and less adversarial. Everyone is nervous about business prospects for the remainder of 2009. Landlords with low vacancy rates remain on the sidelines and are trying to keep face rates firm.

Tenants are in cost cutting mode with many budget items including rent on the chopping block for 2009. They are pleased to see finally some good pricing adjustments to the worst economic conditions seen in decades.

The impact of the weak Canadian dollar, continuing tight credit conditions, auto sector layoffs, terrible U.S. property and credit markets, and low energy and commodity prices remain serious concerns. Low interest rates and a somewhat stable Canadian stock market are the only bright spots.

Decision makers are worried that the carnage south of the border is going to be protracted, with a continued direct impact on us.

Relatively good GTA real estate fundamentals remain a stark contrast to the bleak conditions in the Canadian and U.S. economies.

Designers and contractors show steady activity with construction prices starting to fall somewhat.
Significant new supply of 4,805,776 square feet is underway downtown, with 72.2% of the overall supply pre-leased. With delivery of the new downtown projects rapidly approaching, the battle lines have been drawn and the price war has commenced between Class “A” landlords downtown who must lease serious holes in their older Class “A” buildings despite weak demand.

The massive overhang of older stock vacancy is generating long periods of gross free rent as landlords choose to hedge against serious lease-up time risk.

With both sublease and headlease supply increasing, tenants are finding themselves with much more room to maneuver, with some exceptions such as downtown brick and beam remaining very firm.

Competition among landlords remains strong in most segments, and most landlords have recently adopted a more urgent, competitive posture. As a result, 2009 building proformas are being regularly revisited.

Based on the poor economic outlook and weakening office fundamentals, landlords are prepared to be more creative. Lease takeovers, long gross free rent periods and other inducements are now back on the table after an extended absence.

Blend and extend style leases continue to be popular across the market. Many tenants remain receptive to hedging their rental rate risks, choosing early lease renewals if they can average down their costs.
New subleases are now streaming on to the market, increasing sublease lease up time and making it very difficult for distressed tenants to take quick actions to reduce overhead costs.

Sublease prices are expected to continue falling with furniture and technology thrown in for inducements. Sublandlords are finding they are able to recover much less than anticipated.

In addition, good quality “built” inventory is now becoming available on the headlease market, creating additional competition for subleases.

The majority of landlords have moved to increase standard commission rates on the office leasing side, the first increase in nearly 20 years. This trend is expected to continue.

Window dressing of rates is expected to continue as the market chases proformas. Effective rental rates will continue to retrench over the coming months.

Landlords continue to “buy” posted face rates while going after good quality tenants with other inducements, such as out of term free rent.

Pricing for landlords is expected to continue to soften as they weigh somewhat reasonable office market fundamentals in most markets against both the current economic doom and gloom, the increase in sublease supply, and the serious drop off of demand.

Conclusions
Excellent negotiating conditions will continue for tenants across the board. There are now many more alternatives to choose from in the weakest segments. Tenants are finding prices are well off the recent peak in some segments. The foundation for the GTA market still remains firm and reasonably healthy, but weak demand is driving pricing down quickly.

Prices are continuing to retrench from their high water marks in most submarkets setting up what could be a slow summer. After a good run of rent increases, landlords are willing to be considerably more flexible. Landlords have reconciled their bullishness against the bleak economy, providing a good window of opportunity for savvy tenants to reduce costs.

Cheap financing and newly adjusted capitalization rates should inject much needed life into the investment market.

Our coverage includes a total of 1060 buildings in market nodes and provides a very comprehensive market view of the GTA.