Yahoo Finance Toronto's office sublet inventory hits record high as businesses look to shed space
As office tower owners continue to grapple with the uncertainty brought on by the COVID-19 pandemic, their tenants are facing some stark choices of their own.
For many, the shift to work-from-home and various hybrid arrangements have changed the calculus on how much space they need, leading to a surge in square footage hitting the sublet market.
A report conducted by Avison Young on the Greater Toronto Area’s office market showed sublet activity was up 26 per cent in the fourth quarter of 2022 from the same period a year ago, with inventory now at record levels.
“The amount of available sublet space increased once again, rising 566,000 square feet during the fourth quarter to 7.7 million square feet (msf) — up 1.6 msf year-over-year, and surpassing the previous peak level of 7.4 msf recorded in April 2021,” the report said.
By comparison, the CIBC Square complex under construction in Toronto’s Financial District will total 3 msf across two towers once completed.
Avison Young said there is still a great deal of uncertainty among tenants regarding their office space needs, and that as a result many are deferring their decisions to sign leases whenever possible and hedging their bets with shorter terms, to preserve flexibility.
Joe Almeida, managing director at Avison Young in Toronto, said that for those who have ultimately decided the space is not worth keeping, breaking a lease is rarely an option, since neither party can do it alone unless a specific clause in the contract allows it.
“It’s very difficult to terminate a lease because it requires both the landlord and the tenant to agree on terms that they would find amenable to each other,” Almeida said in an interview. “You can’t break a lease the way people think about it in a residential lease.”
Almeida said tenants who want to terminate often quickly realize that their only option is to put the space on the sublet market.
The most prominent example has been the e-commerce company Shopify, which signed on to become the anchor tenant of The Well, a major mixed-use development in Downtown Toronto built by real estate investment trusts RioCan and Allied Properties, but announced in mid-December that it would no longer occupy the office.
The 15-year lease agreement meant Shopify likely had a legal obligation to continue paying rent until the lease expired and thus could have been vulnerable to a lawsuit for breaching the terms if it stopped payments.
Shopify’s 348,103-square-foot space — spanning seven floors — hit the sublet market in January, and thus is not tallied in the fourth quarter figures released by Avison Young.
According to Almeida, Shopify has not publicized the amount of rent they are asking for, a practice he said “is common in these situations.”
In some cases, Almeida said, there can be a financial upside to subletting, but there is also no guarantee of recouping the full rent, especially in the current environment.
“If you look at the industrial market, someone who leased some space five years ago may be paying $8 net. Today they could go out and sublet the space for $18 net,” he said. “In the office market, we haven’t seen that kind of growth in the last five years, so they would put it on market and try to get the best possible recovery that they could, but in some cases that may fall short of what their obligation on the lease is.”
Many leases also contain clauses that cap any profit a tenant can earn by subletting.
“Some landlords will say that the tenant must split any profits with the landlord 50/50 and others are silent on that,” Almeida said. “You really have to understand the rights and obligations that are contained in the lease. That’s when you want to make sure that you’ve got professionals, giving you advice like your real estate broker and your lawyer.”
During the last quarter of the year, layoffs in the technology sector and external economic concerns in addition to ongoing remote and hybrid workplace strategies have impacted the evolution of the office space market.
Those factors have exacerbated Downtown Toronto’s slow recovery from the pandemic. The Strategic Regional Research Alliance, a consulting firm, found office occupancy in Downtown Toronto stood at just 42 per cent of pre-pandemic levels in mid-January, up from 38 per cent in December.
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“In Downtown Toronto, availability and vacancy both posted notable increases during the fourth quarter, rising 140 bps and 80 bps, respectively, to 16.1 per cent and 10 per cent at year-end,” Avison Young’s report said. By contrast, the downtown office vacancy rate stood at 2.1 per cent in the first-quarter of 2020.
While the market was absorption positive — meaning that more space was leased than what was vacated — Avison Young noted that was a lagging indicator and could reverse as the inventory of new space becomes available.
Toronto isn’t the only market with an active sublease market.
According to another Avison Young report, Metro Vancouver’s sublease vacancy rose to 581,669 square feet at the end of 2022, up from 476,105 square feet in 2021. The increase represented the largest annual increase between 2017 and 2022.
In Downtown Calgary, meanwhile, the sublet market remains flooded with inventory, despite a decrease in 2022. 2,559,773 square feet of office space was available on the sublet market at the end of the fourth quarter, down from 3,136,056 square feet a year ago.
• Email: shcampbell@postmedia.com
