Colliers Spark - b class building in a class market email

A Knowledge Leader Publication.

Accelerating success.

How to Be a B-Class Building in an A-Class Market

SUMMER 2014

Across all markets in Canada, most tenants prefer to occupy a Class A (or Class AAA) building, which is typically distinguished by accessibility and proximity to transit, amenities such as ground fl oor retail and community space, and location within the central business district (CBD). Tenants requiring these attributes are more willing to pay a premium in order to be in a Class A or AAA building.

On the other hand, there is less tenant demand for Class B and Class C offi ce space. This offi ce space typically lacks strategic locational attributes, has limited access to transit and amenities, and can be aesthetically less appealing. That being said, companies with limited access to capital or that are in the beginning growth stages would prefer to be in a Class B or Class C offi ce space due to its cost-eff ectiveness. These companies may be more willing to accept fewer amenities in favour of the associated cost savings.

Interestingly, Class B and C buildings were, at one point, considered Class A buildings, but due to geographical disadvantages, lack of retail and urbanization, or investment neglect, these buildings have fallen to a lower classifi cation. Although Class B and C buildings are attracting tenants with their cost-eff ective rents, they may be having trouble securing tenants for long-lease terms and attracting new tenants to fi ll up vacant space – thus, these classes of building may be experiencing high vacancy rates for extended period of time. With new offi ce supply being added to inventory every year, there is increased pressure for Class B and C buildings to lower rent or increase tenant inducements. In order to stay competitive in the market, landlords of Class B and C buildings must introduce new strategies to attract and retain tenants.

This Spark report will address this issue and off er two key strategies to help these landlords increase their competitive advantage.

“In order to stay competitive

in the market, landlords of

Class B and C buildings

must introduce new

strategies to attract

and retain tenants.”

Strategies for the B ClassDemand for offi ce space is not solely driven by fi nancial reasons, such as cost per square foot; there are many aspects a tenant considers before making a major real estate decision.

SPARK | HOW TO BE A “B” CLASS BUILDING IN AN “A” CLASS MARKET

Reposition

Repositioning an offi ce building is the most common strategy for Class B and C buildings.

Two actions most often taken:

• Specialization

• Capital Injection

SPECIALIZATION

Although industry specialization requires an initial capital investment, the building can be transformed to cater to a specifi c industry. For example, a landlord who wants to compete in the Information, Communication and Technology (ICT) sector can outfi t their building with fi bre optics, server rooms with separate air conditioning units, and backup generators in order to attract technology fi rms.

Specialization can be a risky maneuver as it identifi es the building to a specifi c sector, and as a result, companies in other sectors often overlook the building. Landlords with existing technology tenants may fi nd specialization a suitable strategy for renewing and retaining current tenants.

What

The property, prior to acquisition, had a vacancy of approximately 65% but was positioned in an opportunistic location for investment and revitalization.

Why

Perimeter Development saw the opportunity to reposition this building, invest capital, and attract a specifi c tenant/industry.

How

Perimeter invested capital to reposition the building as a specialized location for IT or high-tech type fi rms. The building had undergone signifi cant enhancements aimed at attracting this type of industry, including fl oor to ceiling windows, open fl oor plates and fi bre optic cables running throughout the premises.

Results

While the project is still underway, the building is now 70% occupied, cutting the vacancy nearly in half. This is truly a testament to the benefi ts of investing in and specializing C class buildings.

CASE STUDY

Scenario SPECIALIZATION

Location305 King Street West | Kitchener, Ontario

collierscanada.com/research

305 King Street West | Post Renovation


The second common approach to repositioning an asset is capital injection.

CAPITAL INJECTION

Capital injection is the most common way to reposition a building. As its name suggests, it requires a signifi cant investment from the landlord. The invested capital can be used to outfi t the building with a variety of features such as expanded retail on the ground fl oor, community space in the building, new elevators, and new HVAC* and electrical service or electrical systems. Many tenants value all these attributes, and any upgrades would signifi cantly broaden the building’s appeal.

The fi nal product could possibly shift the building’s classifi cation (from Class C to Class B or Class B to Class A), resulting in higher net rents. A caveat of the investment is that existing tenants would have to work amidst the ongoing construction, which may lead to higher turnover in the short run.

CASE STUDY

What

The property was previously a seniors center that housed offi ces for various non-profi t medical groups. Due to the nature of its tenants, the building experienced high turnover.

Who

Omicron and CRS Group of Companies acquired the property.

Why

Omicron originally intended to occupy a portion of the building and lease the balance of the offi ce space and retail.

How

The new landlords invested a signifi cant amount of capital intothe building. They stripped the

building back to its original shell and completely renovated the building. Some of the renovations include: a seismic upgrade to the building, a new HVAC system, new windows and asbestos removal. Also, the landlords built an addition to the building, which will increase the size of the fl oor plates.

Results

While undergoing the renovations, a large offi ce tenant, Morneau Shepell, expressed interest in occupying the building. Omicron has revised its plans to occupy the building and will instead will instead make way for Morneau Shepell. The improvements by the landlord increased the classifi cation from Class C to B.

Scenario CAPITAL INJECTION

Where411 Dunsmuir Street | Vancouver, British Columbia


411 Dunsmuir Street | Exterior Rendering

*Heating, ventilation and air conditioningg

approved the conversion of the offi ce building into 243 residential strata lots and one commercial. The approval

came with a comprehensive list of conditions, which wasn’t fi nalized until late 1994 and the Electra building condos were listed for sale. Although requiring a signifi cant amount of capital, this strategy proved to be successful due to the high demand for residential condominiums in Downtown Vancouver.

Source: Mawani, Jabeen (1997) From Offi ce to Home: The Adaptive Reuse of Offi ce Buildings to Residential Use in the Core of the City of Vancouver. UBC: Vancouver.

collierscanada.com/researchcollierscanada.com/research

CASE STUDY

Scenario REPURPOSE

Where989 Nelson Street | Vancouver, British Columbia

Typically, landlords decide to build new offi ce inventory when vacancy rates are low, in order to capitalize on higher rental rates. When a market experiences a dramatic increase in new high-grade offi ce supply, landlords of older, lower-grade buildings tend to experience higher turnover of tenants. When supply increases in a signifi cant way, vacancy rates increase and put downward pressure on rental rates. With lower rental rates and plenty of choices,

tenants gravitate to higher quality properties. This is referred to as the “fl ight to quality”. During this time period, landlords of older buildings often look to reposition themselves through capital injection or specialization. Some owners see the advantage in completely repurposing a building.

ACTION ITEMS

With many major Canadian cities

expecting millions of square feet of new AAA offi ce space to hit the market over the next several years, repositioning or repurposing a lesser class building is becoming increasingly important to stay competitive in the marketplace. Reviewing your portfolio to understand the strengths and weaknesses of each building will help determine whether capital investment and strategic planning are required to meet changing tenant demands.

The Electra Building | Circa 1961

The Electra Building | Downtown Vancouver

SOURCE: condoinvancouver.ca/electra

With the recession of the early1990s fast approaching, Downtown Vancouver saw nearly two million square feet of new supply, which caused vacancy rates to nearly double by 1992 to 16%.

This phenomenon resulted in Class B and Class C offi ce buildings decreasing their asking lease rates in order to stay competitive, or risk a period of high vacancy. One building, the BC Hydro Building (now called Electra), decided not to compete in the oversaturated offi ce market, but instead decided to convert to residential condominiums, an asset that was in high demand in Downtown Vancouver.

Harrowston Developments Corporation, with the understanding that BC Hydro was going to vacate the building over the next few years, purchased the BC Hydro Building in 1989 for $56 million with the intention to renovate and lease the building as a multi-tenant offi ce building. By 1992, the building was assessed at $40 million and Harrowston thought the best alternative was to sell. As time passed, off ers for the building were not suffi cient to mitigate the loss in value, so the company decided to convert the building into residential condominiums. In 1993, the Vancouver City Council

Repurpose

Colliers International Market Intelligence

This document/email has been prepared by Colliers International for advertising and general information only. Colliers International makes no guarantees, representations or warranties of any kind, expressed or implied, regarding the information including, but not limited to, warranties of content, accuracy and reliability. Any interested party should undertake their own inquiries as to the accuracy of the information. Colliers International excludes unequivocally all inferred or implied terms, conditions and warranties arising out of this document and excludes all liability for loss and damages arising there from. This publication is the copyrighted property of Colliers International and /or its licensor(s). © 2013. All rights reserved. This communication is not intended to cause or induce breach of an existing listing agreement. Colliers Macaulay Nicolls Brokerage Inc. (Vancouver). *Personal Real Estate Corporation. PO#11672

Uncommon Knowledge is the essential ingredient in all services off ered by Colliers International Market Intelligence.

We take a forward-thinking approach to market data and trends to create information of value beyond everyday market analysis. We frame this in a real-world context directly applicable to business decisions to maximise the relevance of our off erings.

For more commercial real estate market information, please visit:

www.collierscanada.com/research

Contact Us:

CURTIS SCOTT B.A.Market Intelligence Coordinator | Canada200 Granville Street, 19th FloorVancouver, BC CanadaV6C 2R6Dir : +1 604 662 2667

Email: [email protected]

ALEXANDER CHANGFOOT

Market Intelligence Coordinator 200 Granville Street, 19th FloorVancouver, BC CanadaV6C 2R6Dir : +1 604 661 0867

Email: [email protected]