High rents tough on tenants but driving the development of new office buildings
Thanks to demand, the rent in two under-construction office towers will likely be about $10 a square foot more than existing commercial space in downtown St. John’s, but landlords will likely have to get used to competing for tenants again, say local experts.
Charlie Oliver, owner of commercial real-estate firm Martek Morgan-Finch, said the demand for office space downtown — coupled with the absence of any new space available — has driven rents higher over the last few years, and will jump again when two new buildings open in 2014.
And while rising rents are tough on tenants, said Oliver, developers won’t construct new buildings without sufficiently high rents to recoup their investments, and that’s why it has been more than two decades since any new office space was built downtown.
“The numbers weren’t there. So you had buildings like Atlantic Place, which we manage, which had substantial vacancies until it was taken out about seven years ago by Southwest Properties,” he said.
“Since that time, we’ve done a retrofit in the building, leased it up, and it’s taken up an awful lot of the demand, and that was the only supply in the downtown core.”
Now downtown St. John’s has virtually no Class A office vacancy — Class A being a somewhat nebulous industry designation for the newest and nicest office space — and businesses have looked elsewhere: the Tower Corporate Campus on Waterford Bridge Road, for example, or by the Avalon Mall or even out of St. John’s altogether, in Mount Pearl. Now, expected rents are attractive enough for two new buildings, one by Fortis and one by East Port Properties, that will add between 350,000 and 400,000 square feet of office space downtown to the 1.14 million currently available.
Where current Class A rent runs between $18 and $24 a square foot, says Oliver, the new space will likely go for $30 to $35 a square foot.
Despite the pricey premium the new buildings should command, that much new space should help swing downtown’s office vacancy rate to a healthier three to five per cent, which gives tenants options but doesn’t leave landlords with too much empty space.
Neil Hardy, Atlantic vice-president for commercial real estate research firm Altus Group, said despite rising rates, a negligible vacancy rate can cause headaches for landlords, too.
“A lot of tenants, especially long-term tenants, have needs, and those needs can include expansion requirements,” he said.
“So when you have no space whatever for those tenants to expand, it creates quite a bit of frustration for those tenants. So although it’s a good thing to have a full building, it’s not necessarily a good thing in terms of being able to assist your tenants in reaching their spatial requirements.”
And for the tenants, there’s the sticker-shock that results from renewing a lease at a 33 per cent increase in rent from just five years previous.
The jump in rent at the new buildings may mean some market resistance to filling them once they open two years from now, said Hardy.
“But for tenants who are moving in who need large spaces, if you’re looking for anything over 20,000 or 30,000 square feet, there just isn’t anything,” he said.
“So if that situation is still the same in 2014 when these buildings come online, quite honestly, there’s nowhere else to go.”
He thinks that the new buildings will not be fully leased when they hit the market, meaning a temporary spike in vacancy, but he expects the rate to settle around five per cent by 2015. And as landlords look to fill the new spaces, he expects they’ll return to tenant inducements.
“Tenant inducements are active in soft markets, where the landlords are competing for tenants,” he said.
“The tenant inducements could be anything from the landlords taking over the cost of the tenants leasehold improvements, to giving free parking, to giving rent-free periods. For the last three years, we have seen no landlords actively offering tenant inducements, because it’s been such a good market. But I can see in that period from 2014 to 2016, as well as the high vacancy, I foresee that there may be the requirement in the market for the landlords to offer some inducements. It may not be very high, but I think that type of inducement may re-enter the market.”