More Collaborative Approach Needed To Address What Ails The Office And Residential Sectors
More Collaborative Approach Needed To Address What Ails The Office And Residential Sectors
Canada’s various real estate markets are facing myriad crises. Office landlords are reckoning with the erosion of net operating incomes, condo developers are sitting on landbanks unable to get development financing, ringing alarm bells for future unemployment in the construction industry, and the country faces the lurking threat of a tariff war with its biggest trading partner.
Each issue threatens the economy independently, but a more collaborative approach to addressing them may offer a mutually beneficial opportunity. To understand the potential opportunity, let’s examine each challenge individually.
As office vacancy increases, so do the landlord’s expenses, as costs that would have been covered by a tenant, such as insurance and maintenance, become the building owner’s responsibility. A well-capitalized investor, such as an institutional pension fund, may be able to weather the storm. Still, the financial reality of this situation is coming into sharper focus as office occupancy appears to be plateauing well below pre-pandemic levels.
Meanwhile, notwithstanding the supply and demand mismatch in residential markets, which should bolster increased development, the current economic environment renders new residential development relatively unattractive.
Speaking at a recent event at the University of Toronto’s Rotman School, Brad Lamb, a prominent condo developer in Toronto, noted that a sale price of about $1,600 per square foot is required to get shovels in the ground for new developments in the Greater Toronto Area. At the same time, existing stock is selling for about $500 per square foot less than the construction-feasible price. This means that construction starts are grinding to a halt even as demand for units continues to grow.
The slowdown in housing construction is likely to exacerbate affordability and availability concerns and will also increase unemployment in the construction trades as projects are completed and no new ones commence construction.
Simply put, large-scale office landlords need an off-ramp for some of their assets while the government needs to ramp up housing production and underpin construction employment.
If approached proactively, these current weaknesses can offset each other. Converting office spaces to residential units, though often seen as not financially viable, offers a faster and less expensive solution than building new residential structures from scratch.
Residential developers in Toronto lament the cost of development levies, suggesting they can account for up to 30% of the building cost or $70,000 per door. However, these levies have already been paid for existing office buildings. By aligning the needs of these three issues, housing can be produced quickly and with financial efficiency.
Furthermore, office conversion opens the door to a new type of residential development. Over the last decade, many residential units were designed for investors instead of occupants. Modern office floor plates have larger ‘core to window depth’ than conventional residential high rises, limiting fenestration. This creates an opportunity to create larger units, which may include considerable storage, separate workspaces and utility rooms—luxuries currently reserved for homeowners with a picket fence around their yard.
Municipalities could collaborate with large-scale office landlords to make these conversions financially viable, fast-tracking the release of much-needed housing. Moreover, the current tariff environment may result in a surplus of building materials, which are too expensive to export to American markets. These materials could be redirected to support conversion projects in Canada.
This would help strengthen our pension funds, benefitting all working Canadians, by mitigating financial losses that result from shifting asset allocations from office to multifamily. It would also fast-track housing production, nurture employment within the construction industry, and drive economic growth within national borders.
In strong, growing markets, it can be difficult to identify the point of financial compromise needed in deal-making. When all parties want to maximize their respective profits, division is common. Conversely, mutual attempts to limit losses can have a unifying impact.
As Charles Darwin once pointed out, “In the long history of humankind (and animalkind, too), those who learned to collaborate and improvise most effectively have prevailed.”
Source CoStar. Click here for the full story.
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