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Future proofing: Strategic Group’s repurposing approach

The below article by Wallace Immen was published in the Globe and Mail. It explores the trend of repurposing older office buildings into new uses. Strategic Group’s leadership in office-to-residential repurposing is a perfect example of what is being done today and how it may be done in a post-COVID future. CEO Riaz Mamdani spoke with Mr. Immen about our strategy and how it is paying off. 

Future proofing: Upgrade fading offices or convert them to residential?

An aging 12-storey office building in Edmonton sat vacant after its tenants moved to a more modern building. The initial choices for landlord Strategic Group in a market with a glut of office space were to renovate in hopes of attracting enough office tenants to cover the operating costs or tear the building down and start fresh. But there was a third option: convert the building in a desirable location to a fully rented residential building.

It’s a reuse many owners of smaller, older buildings are contemplating across Canada in an office market destined to change in a post-COVID-19 economy, says Steven Paynter, principal at architecture and design firm Gensler.

“We’ve heard from clients in Toronto, Calgary and Vancouver that to future proof their buildings they will need enhanced air filtration, and more indoor and outdoor space for social distancing when they’re not working remotely,” along with elevator and energy efficiency improvements, Mr. Paynter says. “It means older Class B and C buildings might not be worth the investment to bring up to current needs.”

The shift to more modern and sustainable Class A buildings was happening even before the pandemic lockdowns. In Toronto, for instance, more than 10 million square feet in new office buildings is coming on stream in the next few years, according to data from commercial real estate information company CoStar Group Inc.

“A majority of that space is preleased; however, the tenants are coming from older buildings,” says Roelof van Dijk, director of market analytics for Canada at CoStar. Owners of downtown Toronto offices are already offering the most space for sublet in four years. There were 1.4 million square feet in leased downtown offices available for sublet in the three months ended June 30, more than double that of a year ago.

While the increase has so far only raised downtown office vacancy rates to 3.6 per cent, that’s the highest since the beginning of 2018. “We were expecting it to go up to 6 per cent before COVID-19 showed up, with the number of new commercial buildings coming on line,” Mr. van Dijk explains. “Now we are calling for somewhere between 7 and 9 per cent [in downtown Toronto]. Who’s going to take this space is the question mark.”

According to Mr. Paynter, “the answer can be that bad office generally makes for great residential.” Gensler has developed a scorecard to help asset holders evaluate conversion potential of underperforming buildings.

“A lot of hurdles that put buildings at a disadvantage in an era of open-concept offices, like small constrained floorplates divided into individual offices, can actually make them more desirable for residential,” he says. Once the interiors are removed, “you can get 10 to 12 units per floor in a good mix of sizes, which is what developers are mostly looking for in new residential buildings.”

Floors are thicker in commercial buildings and there are generally more and larger elevators than in a residential buildings. While a lot more plumbing and electrical needs to be added, office buildings tend to have higher ceilings, allowing addition of plumbing and ducts while maintaining a good ceiling height.

Once a building is vacated, “We can just go and attack the building all at once,” Mr. Paynter says. “It can take just a few weeks to remove a floor and a month to build it back. You’re seeing a 50 per cent savings over building new.”

Depending on the site, an office tower of up to 20 storeys could get converted in little more than a year.

A building still needs to have the right bones, though. If it isn’t easy to strip and rebuild, it may not be a strong candidate. Potential negatives include large lobbies, which can feel oversized, and very high ceilings, which would have to be lowered or they would feel very strange in a studio apartment, he notes. Very large floor areas and windows on fewer than three sides of the building area also drawbacks to dividing spaces into attractive residential units.

Calgary-based Strategic Group started planning residential conversions of four of its office properties as early as 2017 as the sagging oil economy deflated office demand in Alberta. “In Calgary we have a vacancy rate in excess of 26 per cent and even prior to COVID-19, we didn’t project a recovery of the office market for as long as 12 to 15 years,” says the company’s chief executive officer, Riaz Mamdani. “It created an opportunity to think a bit differently.”

The first project was e11even, an Edmonton building built in the early 1980s at 111 Street near Jasper Ave. It was completely vacant after the former tenant, Alberta Health Services, consolidated to a different building. That meant interior demolition could begin immediately rather than having to wait until leases expired.

“It’s certainly environmentally better. We have essentially changed 500,000 square feet of useless office space into places where people live and we’ve saved 50,000 tonnes of demolition material compared to tearing the buildings down and building new,” Mr. Mamdani says. “With a creative approach, we will have full occupancy earlier than waiting a dozen years for an office market recovery.”

(The strategy wasn’t enough to prevent 56 of Strategic Group’s 171 office, retail and residential properties from being placed under court-ordered receivership in January. While a court rejected Strategic’s appeal to restructure and put the properties under the supervision of receiver Alvarez and Marsal Canada Inc., Mr. Mamdani says he believes the residential strategy will ultimately help the portfolio recover.)

Residential conversion does entail some long-term risks as well, Mr. van Dijk cautions. If the downtown office market shows signs of rebounding strongly in coming years, it might be better to just hold onto a small building in a prime financial district location and ultimately build a bigger and better office tower.

But if the office market is permanently altered by the pandemic, it could also slow the trend toward downtown high-rise living. “If people start working regularly from home, might people just prefer to live in larger places in the burbs for less if they don’t need to be downtown?” Mr. van Dijk asks.