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Welcome to Altus Insights Podcast Series. This podcast brings together some of our leading brainiacs at Altus Group to discuss, debate, and on occasion complain about the evolving state of Canada's residential and commercial real estate. Join Ray Wong, Marlon Bray, and Avi Zelver for monthly podcasts covering the latest market and construction cost trends across major markets in Canada.
Marlon Bray: So welcome to the penultimate Altus Insight podcast. So today we're joined by Jaysen Smalley from C B R E to discuss office capital markets. He has worked on over 50 billion in real estate transactions in all asset classes across Canada. Jaysen leads the office sector for Toronto's national investment team, the office sector, which is certainly seems to be the hot button topic of the day with the post covid world where you know, you can nap at home rather than going to the office and actually work.
So Jaysen, do you wanna do a quick introduction to yourself? I did the high level things there, but you wanna say hi and so forth?
Jaysen Smalley: Yep. No, good morning Marlon. Good morning, Ray and Company. Happy to be here. Happy to talk about everything. Office. I'm Vice Chairman at C B R E Investment Capital Markets here in Toronto and have worked here over 20 years, about 21 years now.
So our team trades office as well as retail, industrial, multi-res land, et cetera, right across Canada. So I would say we're fortunate to see quite a bit. Alma mater here. So we've worked together in the past and we just fortunate that we see a lot of volume and see a pattern to what's going on and. With that, you start seeing, okay, how's this market trending?
Where are things going in the future, et cetera. So
Marlon Bray: we've seen a steady increase in some of the core class, say office building transacted as rollback plaza, which obviously 1.2 billion was, was pretty in the news. And then four K P M G and Palm Cathedral in Montreal and the Amazon building in Vancouver listed on the market.
So, What is your take of office investment demand, and are we seeing significant market discounts on these assets?
Jaysen Smalley: Yeah, we were fortunate to be a part of some of the transactions. You mentioned R B C Plaza traded in Q one of last year, Q 1 20 22. Significant complex, 1.5 million square feet. We sold that for Oxford.
C P P to a company called Ponta Gadea. That's a smash based fund. And really for them it was a, you could say almost like a call on Toronto. They do want to grow in this market. It's a global real estate fund. They are very excited about Toronto's growth, population growth, just a diversified economy, safety of capital.
So that's, and at the time, maybe just comment on the, on that pricing, this was a bit of 5% cap rate. And I think from that point in time, if you look at where interest rates were, we've seen interest rates move up about 450 basis points or so from a policy rate. Bonds have gone up about a hundred basis points, and at the same time you've seen.
Spreads credit spreads go up 50 to a hundred basis points. Certainly for something like R B C Plaza, the price today is gonna be less than it was. The spot price today is gonna be less than it was in Q 1 20 22 just as a function of cost of money. With regards to tour K P M G. That we sold in downtown Montreal.
That nice tower, great tower. That was also once upon a time that was also owned by Oxford and C P P. We sold that to B G O Bentall Green Oak, and then we worked with Bentall Green Oak to sell to a private investor. It was interesting that B G O was quite a bit ahead of the market, so that was 2021.
Transaction and I would say B G O was quite forward looking to get ahead of probably a little bit more challenging market that we're in right now. That asset, what was bought by a group called Group Mock in concert with the Saputo, uh, group. And, uh, group mock in particular has been very active across Canada over the past three years.
And one might say that they're being quite contrarian, investing in office. At this point in time, they like the bet, they like the opportunity to buy at, I would say higher relative yields. They like the opportunity to buy it well below replacement costs and build a high quality portfolio when once upon a time, it'd be quite hard to do that in bulk, and they've been able to do that over the last two to three years and fill a bit of a void in the market.
Raymond Wong: Yeah, yeah, yeah. When you, we look at the overall sales, uh, office transaction activity, the record for office transactions in Canada was just over 9 billion back in 2019. So pre pandemic, right. And last year, based on Jaysen's comments about those transactions we're. Probably six and a half billion dollars.
So right now we're only year to date on closed transactions, just shy of 2 billion. And that goes to, I think, Jaysen's comment on that flight to the quality of assets that are selling. And we saw bulk of it in 20 21, 20 22. And that's also reflective of the leasing activity. As Jaysen mentioned, and as well as most of the lease activity that we've seen for the last two and a half years.
So it goes into that sort of discussion that there is still demand for, especially for office, especially for core assets in uh, downtown locations.
Jaysen Smalley: To pick up on, on what Ray commented there on quality. Vancouver's been a really tough market to get into as an investor and the leasing market, although it's slowed down somewhat recently, it's still in North America, the the tightest vacancy rate.
Marlon Bray: Actually, that's where I spent last week on vacation in Vancouver. So I got to walk down that street quite a lot. That's where my hotel was. That's all led to where I was heading with the next questions. But we're still seeing the sale of these core office assets now. It's that chase to quality. But do you think that's gonna carry on even with the challenges of remote and hybrid work?
'cause I know a lot of people just seem to be struggling to figure that whole thing out.
Jaysen Smalley: Yeah, so there's a couple things to unpack there. I think that from the nature of. I'll call it the nature of the product that's being brought to market on a marketed basis for the second half of this year. I think it's gonna be a little bit more value driven, either higher yielding type assets, assets that could be converted to residential.
A lot of the core type assets, whether it's here in Toronto or Montreal, or some of the other major markets. I think a lot of that will be done more direct. Or off market. The one category that we've been active in, and you may see some more product than is data center. So we have, our team was a part of the Urban data center portfolio for Allied.
So that's a bit of a different category and I think that a lot of the larger institutions are being careful right now. They're, I'll call it, this is a wait and see type market, and there's expectations that. Interest rates will decrease. And there's expectations that for them, they're happy to sort of sit on it for a little while longer.
And you know, probably they're open to selling smaller assets, maybe non-core assets. But then I think bigger, they're just being a little more careful on.
Raymond Wong: Just to reinforce Jaysen's comments with the change in the vacancy rate, and we only saw a a, a slight increase from one Q to two Q and definitely flattening on the Southwest space.
We're also seeing the increase in the sort of the direct space by landlords, which represents a bit of a, to extend in some of the sublets terms expiring. When you look at the overall return back to the office, the benchmark people are using right now, probably between 40 and 50%, but only for Tuesday, Wednesday, and Thursday falls off for Monday and on the Fridays, but the trend is definitely going up.
But whether or not it's gonna be transformation on. How we use space and how the space is being laid out. There's some positive things in there, but I don't think we're we're out. It was yet in regards to work from home, getting people back in. But I thought from going into one Q to two Q, it was a relief that we didn't see that 40 to 50 basis point increase in, in the vacancy rates across Canada.
What we've seen in the last two years.
Marlon Bray: And I suppose you can't have an office discussion 'cause I, I know Jaysen mentioned the word conversion in there and obviously it's set places like LinkedIn on fire. It's the new most exciting thing. I kind of see the conversion to residential, maybe more of a niche fingers in terms of the overall housing market volumes.
And then I think you guys have both touched on that move to the Class A or the chase to quality. And I see the Class C office hopefully just vanishing and being replaced probably. 'cause I think a lot of the Class C office is in the wrong place these days anyway. How do you guys see that market sort of playing out both the conversion and hopefully if places like Toronto or don't make you replace work use, maybe some of the Class C just gets replaced with residential.
Jaysen Smalley: Yeah, it's interesting the markets like Calgary. It, um, it took them four years to. Recognize they had a problem and then three years to put policy into effect. I hope Toronto doesn't follow that same timeline 'cause it takes a while. I think that the, the key here is not that, you know, certainly we're looking at office situations that could be converted.
We just did one recently in Ottawa. We're looking at a couple here in Toronto. They're pretty specific. It's not a big part of the market. Having said that, there's a lot of other office sites that can be redeveloped to residential, particularly if office replaced then isn't required. Just recently, and this is pretty recent, there's been a couple examples of office buildings somewhere 60, 70, 80,000 square foot buildings that have not required office replacement.
I think that would be healthy for generally the, the marketplace that the city recycles, maybe older, perhaps smaller floor plate buildings and recycle those for housing that, that we know we, we need. In this market. So maybe we can pick up on some of the learning that's happened in in Calgary and at the same time we can attack sort of the housing affordability problem.
Raymond Wong: It's, and it is interesting you mentioned Calgary, Jaysen, n Q one and Q two, the overall downtown vacancy rate did decrease. I I it, that was the only market across Canada that shot saw that decrease and we're definitely seeing a little bit more diversification on the tech side. I'm not really sure if the conversion projects will, which have started, have impacted those numbers.
Jaysen, you were also involved in, not just on the residential conversion, but we've also seen some conversion of some of the office up in America. Over to industrial type uses and one being that mall north of Steels at, I think Don Mills, that retail and now they're allowing for some residential use. Can you comment on other types of conversions and how does that impact the sale versus, as well, when you're going from office to alternative use?
Jaysen Smalley: Yeah. One that, that I was a part of in Mississauga 24 55 meadowvale. That was an asset that Carra ended up buying, and it was called a two story office building, challenging floor plate, just a bigger floor plate. And we saw an opportunity to convert it to industrial as at that time, this is going back a couple years, we really started seeing rents pick up.
And so you could see the math working and at that point in time, I knew there was an opportunity when you call one investor, Pitch them one business plan and then you pick up the phone and call another investor and pitch 'em an industrial plan, and the price is substantially higher. So it's finding ways how to unlock highest and best use.
We have a couple sites actually in the markum area that certainly could be more data center driven. And that's again, a nichey type market, but it's all predicated on rental rates. One other example I'll give you is 77 Wade. That was going to be a, call it an eight story mass timber office building. The developer pivoted to life science, so we brought in a pension fund.
Capital partner for that. And that is a purpose-built life science building in the junction area. So it's all again off what should be higher rental rates that make sense from a economic development standpoint. And life science rents upwards over $70 net. For that type of product. Good to see sort of Toronto, embark on more life-sized product, which we don't have.
It is an opportunity for the city, for that sector of the economy to, uh, start seeing some clustering of that use. So I think overall the office market, as we see vacancy rates in that. Sort of overall sort of 15% downtown, we're gonna see that spike up as new products being delivered. We still have somewhere between four and a half to 5 million feet in 2023 and 2024 yet to be delivered.
Um, you know, our vacancy rate is going to go higher. But beyond that, we're not gonna see a new supply for quite some time. We see tech tech's on a, a bit of a pause here, but a tech's gonna come back. And you're gonna start seeing more funding at attack. Actually, in the San Francisco market, they're starting to see demand pick up again and in the AI market in particular, so we're tracking that in Toronto here.
That's a, you know, open AI is one company that's taking a long space there, so we're sort of watching these trends. There was a bit of a arms race for amenities, tele amenitize office assets. And bring back workers that want a better space than their house. So they wanna pay for that commute and just having better amenities, whether it's fitness or certain type of terraces or lounges or certainly beverage.
So we're seeing in the US market that getting certainly in markets like New York, Chicago. I would say San Francisco as well. You're seeing some owners really take their assets to another level from amenity perspective, so I expect to see that a little bit more here in Canada as well.
Marlon Bray: Generally fairly positive.
then, and then raised from a negative question in here that I've just noticed that we skipped over, but. Which was my sponsors is more of a US side of things. Do you see significant increases in possible credit defaults with office assets and the appetite for lenders to finance these assets? And I think that's where we probably should separate the US and Canada whenever we talk about this sort of thing.
'cause two completely different markets
Jaysen Smalley: for sure. And I think in the US market you see a lot more non-recourse debt. Variable debt, certainly higher leverage. And the nature of the investors, they're not, let's say pension fund. You're seeing a lot more diversified type investors, but a lot more private investors that maybe are happy to take a little more risk.
So the Canadian market's always been a little bit more controlled. I. The US markets tend to go on these sort of boom bus cycles somewhat. So we are, you've seen some high profile trades in the papers, whether it's Blackstone or Brookfield actually hand the keys back, quote unquote, to certain office buildings.
You haven't seen that here in Canada. I would say there's certain specific situations that I would say owners are working through with their lenders. So that's a lot of perhaps extensions of loans. And I think again, it's a function of the ownership in Canada just being a little bit more well-healed institutional capital, and for the most part, There is certainly negative sentiment from a lot of lenders in the Canadian market because of higher vacancy rates, because of higher interest rates, because of hybrid work.
And furthermore, I think a lot of lenders had a pretty big bulk of office already. As far as new office loans, certainly over a hundred million. They're being a little more careful and I think for larger lows. Owners are really trying to probably extend with their current lenders more than anything. So I think at this point in time you're not seeing credit risk.
And even in the US you can see that the Fed really actually contained a lot of the bank failures today. There was a couple bank failures and certainly Credit Suisse as well, but within a, I don't know if that was a two month period of time, I. That was contained significantly by the US Fed, and I think that was positive for the market.
I think the uncertainty is the clouds sort of dissipating a little bit and um, if we're coming to the peak, I'll call it, of interest rate increases, I think people can start looking forward to when there's a cut and whether that's. Early to mid next year is probably a consensus opinion in North America, and so that's what people are waiting on.
But for the most part, I think generally things are okay on the lending side, but big loans right now you probably the best case scenario is just getting them extended with the incumbent lender.
Raymond Wong: Jaysen, do you see more pressure on the public or public funds or the ownership with. Perhaps public demonstrating more of, um, sort of cashing out on, on, on profits with, with the access, a little bit more pressure to sell versus the private side where they can maybe hang on a little bit longer and sort of outlast the store.
Jaysen Smalley: Yeah, that's a good question, Ray. I mean, simply put, public pricing or repricing is right there on your. On your screen for you to see. A lot of these publicly traded companies, their share prices are down significantly. It's challenging to raise capital in this type of environment. So what do you do at the Allied Data Center transaction?
It's probably the most, maybe high profile that was 1.35 billion that allowed Ally strategically to focus on. Really their core portfolio data centers was a key part of it, but was not a growing part of their portfolio. So I think that that sales certainly sets up allied nicely. I think, uh, going forward, if you look at other groups like h and r, h and R has been quite frankly, selling down some of their office dreams pretty consolidated to the Toronto market.
Downtown. True North has perhaps more. Credit type tenancy. They did cut their distribution. So I think some of these rates that are cutting distributions, you can see that it's to preserve capital, but it's, it certainly affected their share price. So I would see all these groups are looking where they can to do a little bit of sell down, but do it in a, I'll call it a strategic way, you know, so it's not a, it's not a fire sale by any stretch.
It's, I think it's very kind of strategic. A Canadian approach to it, but there's not a lot of pure play office.
Raymond Wong: That's the thing with what we've also been hearing is especially when the interest rates make their movements on transactions that are already in progress, that it's get, sometimes there's a bit of a challenge to get that deal over the finish line, whether or not there's a tweak here or there. I guess we're gonna see continue with those type of challenges, especially with the bid asset expectation, not just on the office side, but the other assets in the market.
Jaysen Smalley: One thing just to to pick up on is because of the financing market is challenged, you're seeing more vendor takeback type structures. Certainly we did a lot of head lease type structures, which were coming outta Covid, something that everyone was bought into the vendor Takeback loans. Again, it's something where the market is getting used to them, given that the debt markets are just a little bit.
Probably a more cautious mode. So if you do want the highest price for your asset, whether it's, we've seen more top ups, vendor, takeback, top up, so that's typically somewhere between 10 15% of total purchase price in a vendor. Takeback financing, full vendor takebacks. We are looking at a couple deals that we'll come out with.
With a full vendor, take back 60 plus percent loan to value. And again, these institutions are recognizing the point in time recognizing that to get the biggest bang for the buck, they're gonna have to put on somewhere between three and five year type duration type money and interest rates are on these vendor takebacks are typically in that four point a half to 5% range.
Marlon Bray: So response that let's to finish on a positive note. The rumors the office is dead, been long proved as wronged and it's the work sky is falling. And I think we're going for a little bit of an evolution right now, but I think long term, everyone seems to be in agreement. The class A office is that that move to quality's just gonna carry on.
It's just what things look like will be a better use of where those offices are so housed these days. So bringing you guys, in terms of conclusion, how do you guys see the prospects for office demand over the next four, five years? So, General just figuring things out, but overall positive considering the market.
Jaysen Smalley: Yeah. Ray, you want me to take that one first?
Raymond Wong: Yeah, I, I actually can see what you were gonna say about this.
Jaysen Smalley: Yeah. I, I listen. I think first of all, from the fundamentals and real estate isn't too much rocket science, but it's supply and demand. So Toronto's seeing upwards of 22 million feet being billed.
From our last development cycle in that 2009, 2010 time period, toll today and next year around 22 million feet. So built a little city like that's a lot of office. So for that reason, that amount of space, and that was a large part driven by tech and it was a big tech push. About a third of that new builds were tech type tenancy.
So I think that has to be absorbed. I think Marlon, you're right in that, that there, there will continue to be a flight to quality. There'll continue to be this kind of separation, this bifurcation and demand for space that's somewhere you wanna work. Like it's got great amenities, it's well located, it has transit, all the things we talk about and they'll continue to be this, this separation and and demand for between.
Top tier type office buildings and the lower class office points. I think as far as capital, and I think that's the more interesting sort of question as well as who starts to fill in. Again, office demand, particularly for larger assets, there's only so much private capital can show that, that that hole.
We have seen some value funds. Raising money. So I think that's another leg to it. I think foreign capital is another leg to it. You know, quite frankly, even, even REITs, I mean, once upon a time we had REITs jump into this market. We had five or so competing reit. We look back several years ago when cap rates were at eight plus percent in the suburbs.
We saw one deal like that recently. Atria. We've seen deals in the mid S, but there may be about this year, maybe late next year, maybe you start seeing some res pop back into it because of the higher yields. But first it starts with the fundamentals as far as working through the new office supply. The second part is just the capital formation.
I think that'll go from privates to then value funds and foreign capital, and then. Probably once the market starts seeing vacancy rates stabilize and real rates pick up. I think I quite frankly think 2025 will be a good office here. And then lastly, I'll just leave with the point that Canada population growth will continue, but people will have to live somewhere.
They also have to work somewhere, as we see bleeding companies in every sector. Require workers to be back three to four days a week. They all want their people working the same days. They don't want someone, I don't want Ray in on Tuesday, and you're in Marlon on a Thursday. I want you guys working on the same day.
So for that reason, it's hard to see a dramatic drop in office meeting requirement. I think part of this. And I'll leave you with this, that the pullback and demand, and also the rise in sublets is a function of a weaker economy or expectations of a weaker economy, and also an overshoot by the tech sector who is just running super hot 17, 18, 19 and is now pulling back somewhat from where it was.
I'm midterm positive, long-term, bullish. Short-term, we're gonna have some choppiness in the office market.
Raymond Wong: And I agree with everything you said, Jaysen, and just throwing a demographics that it was a tech sector, the financial sector sort of cooling into the downtowns, and that was right across Canada from Montreal to Vancouver and Toronto.
But it was that lack of, or that that fight for talent. And to a certain extent, you still have that the mending haven't changed downtown, um, union Station, Toronto continues to be a hub. That is where people want to sort of be. But you know, the challenge right now with the change in what we're going through with the pandemic was that people want to avoid that two hour commute.
So Vancouver is having a little bit. Better track record with people coming back in the office. And same thing to a certain extent with Ottawa, but places like Montreal and, and Toronto continues to be, challenges 'cause the commute. But I think as the economy starts to pick up and, and companies start to hire again and look for talent, I think allow that talent is gonna.
Want to be a lot more interactive. They wanna be there in person. I think from a wellness standpoint, it's just better for all of us. Not to stare at a screen, but just to interact on a face by face basis. With that, I, I agree. We're gonna have some choppy waters in the next little while, but I think gradually we'll look at how.
Office evolves, we're gonna see the, the final number of people returning. And again, let's not kid ourselves there. There will be some people that will not come back in the office based on their function or based on the responsibility that they may not need to be there. But again, I'm a little bit more optimistic on the office coming back, but I think we're just gonna have some challenges in the short run.
Marlon Bray: It's kind of ironic that you're like, rah, rah, rah, go to the office and you're sat at home in your basement. It's Monday. And I've sat at home too, proving the point that no one goes into the office on a Monday. I'm coming to the fear. By the way, the best days to go in the office would actually be Monday and Friday.
'cause the commute's the best, so you can actually get in a lot quicker. And it was the same in Vancouver when I was there. Friday's dead. I mean, Monday's dead. Friday was actually reasonably busy while I was there, but Monday was just like a ghost town. So it was great to go around. So Jaysen, thanks for joining us today in the podcast, uh, talking about the office market.
Uh, so tomorrow myself, I'm Ray are recording the final podcast, which will be on industrial in southwest Ontario. So a little place just outside the center of the nun universe known as of the g t a and the last vast relative affordability before we're all gonna end up living in rural Manitoba if things carry on going the way they go.
So tomorrow we'll have the final podcast Again, Jaysen, thank you very much for your time today. We really appreciate it.
Jaysen Smalley: Thanks for having me. Yeah, look forward to connecting soon.
Marlon Bray: Cheers. Bye.