Toronto: with office, industrial on the rebound, Tinseltown North makes progress toward stability

In December 1995, lease rates, net effective rents and land prices were reflective of a depressed market. It appeared as though Toronto's real estate industry was in an indefinite state of stag' nation with no identifiable sign of resurrection. Economists and urban planners spoke of the new economy, revitalized communities and dysfunctional space, while the industry struggled with financial survival brought on by the 1991 recession.

After four years of uncertainty, there are finally signs of permanent recovery, although, not in the traditional sense. Royal Le Page Real Estate estimates that over $1 billion was invested in the Greater Toronto Area (GTA) during the first half of 1996, representing the largest gain since the late-1980s. Expansion, previously driven by speculation, has been replaced with cautious and selective investment. The public and private sectors are no longer limited to simply observing the changes which have occurred throughout the last five years, now they are active participants in the revitalization of Toronto's real estate industry.

Renewed development activity in downtown Toronto was recently considered unlikely; however, there are currently several mega-projects planned or just beginning construction. According to John Davidson, an economic development officer with the city of Toronto, projects which were once thought to be too complicated or highly politicized are now in the serious planning stage.

The most well-known of these projects is the development of the CN Rail Lands. Situated between Bathurst Street and the CN Tower, this 50'acre site has been studied for at least 10 years. Finally, the Crown Corp. and Canada Lands Co. Ltd. are now engaged in negotiations with a number of large Canadian and U.S. developers and investors to construct a variety of residential and commercial properties.

Davidson estimates the CN Development will generate a total investment in the $1 billion range; however, there are several additional projects currently being planned

* The National Trade Center, situated within the Exhibition Place area of west downtown, is a $180 million project that will include over 700,000 sq. ft. of trade-show and commercial space.

* The Pavillions of Kings Landings is the first condominium project to enter the market in at least a year. Phase one includes approximately 126 units.

* The city is currently negotiating Tedco Power Center with a number of national "category killer" retailers.

* Festival Hall Developments has planned a 500,000 sq. ft. entertainment-oriented complex which will include a 4,000-seat Famous Players theatre.

* The Lorenzetti Development Corp. is expected to begin construction during 1997 on a $335 million, 300,000 sq. ft. retail complex.

* The CN Tower will be expanded to include new retail- and entertainment-oriented portions. In total, the expansion is expected to cost around $100 million.

Recently, Toronto introduced the Downtown-East and -West initiative as a response to the imbalance of the jobs-to-housing ratio, and in recognition of the need to stimulate development of dormant industrial facilities. The King/Spadina and King/Parliament areas of downtown Toronto are expected to generate over $1 billion in new investment. As a result of changes to zoning restrictions, a variety of mixed-use projects, including residential lofts, retail, office, restaurant and entertainment uses, will be allowed. The intent is to attract "new industries" while building a tax base that addresses the realities of corporate and social restructuring.

The provincial government is also responding to economic pressures by introducing changes to the Landlord and Tenant's Act. Although final details have yet to be released, the changes to the Landlord and Tenant's Act will remove rent controls. Landlords will be allowed to raise rents according to the market, once a tenant moves out. The complete removal of all current restrictions is possible; however, the conservative government is studying the issue with the promise of tabling legislation in late-1996 or early-1997.

Investment returns to the city

According to Andrew Barnicke, director of investment real estate at ].J. Barnicke in Toronto, restructuring is in the final phase. The major Canadian real estate companies are now capable of active participation. Barnicke also cites examples of renewed foreign investment by European and U.S. companies. The acquisition of a prominent Toronto mixed-use office building, The Atrium on Bay, is the most notable.

Throughout the past five years, Canadian real estate markets were dominated by pension funds, banks and institutional investment companies. After the collapse, many of these firms found themselves in the position of directly managing all types of real property. Ownership of most Toronto office complexes, along with regional shopping centers, moved from developers such as Olympia and York to these financial institutions. As a result, the availability of new capital was reduced to almost zero. These firms had effectively met their allowable ratios of real estate holdings.

Michael Pittana, managing director at V&A Properties, adds that Canadian real estate markets are in a very good position for recovery. As evidence, Pittana points to the fact that there is a trend in Toronto to a yield-driven market. Barnicke adds that capital is flowing back in through REITs and other instruments.

Given this positive environment, demand has increased for properties in which risk is amortized over many tenants or where a high-profile location ensures the presence of triple-A retailers. This includes existing residential, multi-unit projects, triple-A office buildings and regional shopping centers, all of which meet new criteria.

Those sectors exhibiting low vacancy rates are likely to maintain their appeal to investors as are properties offered for sale at below-replacement values.

CB Commercial reports that sales of office buildings in the GTA totaled $344.3 million in the first half of 1996. Cap rates range from 8.7% to 13.8%. Sales in the industrial market totaled $256.4 million with cap rates ranging from 9% to 13%, and apartment sales amounted to $382.6 million during the first two quarters of 1996 with an average price per suite of $45,154. Cap rates range from 7.2% to 11.1%. Retail sales were relatively low as supply is limited, but retail sales totaled $117.8 million. The average price per sq. ft. was about $123. Capitalization rates range from 8.6% to 12.8%.

Low rents move office back downtown

CB Commercial reports that "the first half of 1996 witnessed the absorption of approximately 2 million sq. ft. of office space in the GTA. This resulted in the drop of the overall vacancy rate of more than one percentage point from 18.5% to 17.28%."

The downtown east region currently has the lowest vacancy rate at 10.33%. In the city's financial core, rates also dropped to 12.51%. Not surprisingly, triple-A office buildings generated the highest absorption rate of all downtown product types. CB Commercial estimates, in its CB Directions (Fall 1996), that "triple-A office towers continue to be attractive to tenants with the vacancy rate sliding to 7.74%. Net effective rents for this product are estimated to be in the low- to mid-teens by the onset of 1997." Colliers International says that over 90% of downtown absorption has occurred within the financial core, mostly at the expense of Class-B space.

Vacancy rates in the midtown areas remain relatively high. The Yonge Street/St. Clair area has outperformed midtown office markets as the vacancy rate has dropped from about 20% during the first quarter to 15% in September. Rates in the midtown north and south areas are stable at over 21%.

Similar to many North American cities, corporate migration to Toronto suburbs increased exponentially from 1985 to 1994 when supply grew by over 20 million sq. ft. Most of this new inventory was absorbed by tenants seeking to reduce operating costs incurred by occupancy in Class-A buildings downtown. As of 199495, the availability of affordable Class-A space in Toronto's downtown core negatively affected suburban vacancy rates. In effect, the "suburban trend" had reversed as tenants moved back into the financial core where rental rates were very competitive. In 1996, the financial core continues to bear witness to reduced vacancy rates; however, the west and east suburban markets are also improving.

While vacancy rates in the north suburban area have increased, moving from 18% to just over 20%, CB Commercial rates the suburban west market as the "star performer with an overall vacancy rate now down to 16.65%, from the 18.31% rate recorded at the end of the first quarter of 1996. The year-to-date absorption rate for this market is at 4.82%."

Industrial charges ahead

A competitive Canadian dollar and increased manufacturing activity have stimulated absorption of industrial space beyond expectations. At the end of 1994, most analysts set the GTA's vacancy rate at about 15%, and it was anticipated to decrease to 12% by 1996. By June of 1996, CB Commercial, in its Fall Summary of The Industrial Market, set the vacancy rate at about 7.25%. Lease rates are stagnant at about $3.50 per sq. ft. as is the case for the average asking price of industrial facilities. CB Commercial reports that prices of industrial facilities "remained steady at $40.28 per sq. ft., although the towns of Richmond Hill and Markham commanded the highest average sales price per sq. ft., $65.48 and $60.35, respectively."

Jim Mclntosh, vice president at Colliers Macaulay Nicolls Inc., says that over 80% of all industrial activity within the GTA has occurred in the western and central regions. Led by build-to-suit projects and some "spec construction," Mississuaga continues to attract a significant amount of development activity.

Orlando Corp. is charging ahead with several spec buildings, totaling just under 400,000 sq. ft. In addition, colliers reports that Orlando also completed a 327,000 sq. ft. design-build project for Cans t ar Sports. Other developments include a 110,000 sq. ft. warehouse and just over 100,000 sq. ft. in two separate buildings for two additional clients. Slough estates constructing a number of projects totaling approximately 145,000 sq. k. Internorth is building a 140,000 sq. ft. building; Mantella's project equals 110,000 sq. ft. And the Menkes project is about 125,000 sq. ft.

New formats boost retail

The GTA is Canada's largest retail center, representing 14% (or $30 billion) of all retail sales in Canada. The invasion of new retail formats, including the category killers and large specialty superstores, since 1990 has effected a profound change in Toronto's retail marketplace. An indication of the popularity of this retailing format can be seen from its square footage growth. From 1990 to 1994, the square footage devoted to this new format grew by 132% from 2.2 million sq. ft. to 5.1 million sq. ft.

Consumers are motivated by low prices, large selection and convenience. The bigbox retailers offer most of these features; however, they do not entertain consumers nor do they feed them. As a result, "eatertainment" has arrived in Toronto as the latest concept to emerge from a chaotic retailing environment.

"The arrival of Planet Hollywood late this year on Front Street adjacent to the CN Tower and the opening of a 12,000 sq. ft. Michael Jordan's Restaurant on King Street in the Entertainment District signals," according to CB Commercial, "the (beginning) of the `Theme Dining' invasion into Toronto. Often located within the city's theatre or sports district, this concept attracts both residents and tourists. There are a number of new entrants including MotownCafe, Fashion Cafe, Official All-Star Cafe, Harley Davidson Cafe and the Rain Forest Cafe." CB Commercial also reports that a "Marvel Mania" theme, based upon the comics, is planned.

The search for new and innovative retail concepts is not limited to downtown Toronto markets. In the suburbs, regional centers, community plazas and power centers are to be complimented by the entrance of high-tech amusement facilities such as the new concept developed by Sega-Palladium. Currently under construction in Mississauga within the city's core, this concept is a prime example of the "new retail environment." Additionally, Cineplex Odeon and Famous Players are expected to introduce redesigned "concept theatres."

While the arrival of the power center and the new eatertainment theme is at least a welcome improvement, Toronto's core retail market remains dominated by regional shopping centers, community plazas and inline street retailers. Rental rates among regional shopping centers and community plazas remain relatively stable in comparison to last year. Aside from the trendy Queen Street West and the prestigious Bloor/Yorkville areas, rates are virtually unchanged.

Visitor boom helps hospitality

In 1995, the expansion of Toronto's theatre district and the opening of several sports and eatertainment establishments in the city's downtown core combined to draw approximately 22 million visitors to Toronto, an increase of about 3.5% over the previous year. Not surprisingly, investors looking for new acquisitions are attracted to this sector. Data supplied by CB Commercial reveals that average room rates increased from $87 in 1992 to $92.59 in 1996, an increase of 6.1%. Subsequently, investment in hotels also rose significantly from about $20 million in 1994 to just over $200 million during the past year. As of June 1996, the brokerage firm reports sales totaling approximately $120.9 million. Purchases of hotels and hospitality-related products are expected to continue, paralleling the development of new attractions.

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