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What to do with a tired office space

By: Kathy Kerr, Globe and Mail

Owners of office buildings in high-vacancy markets are kicking the tires on the idea of converting problematic B and C class buildings to apartment or condo properties, but analysts in the commercial real estate field predict there will be no large trend to actual conversions.

Even in Alberta, where the vacancy rates in Calgary and Edmonton are in the high teens to mid-20s, the economics look positive for only a handful of conversions, say executives at commercial real-estate giants Avison Young and CBRE.

Mark Fieder, principal and chief operating officer for the Canadian operations of Avison Young, says there hasn’t been a trend for conversions for the past 10 or 15 years in Canada, and most Canadian cities don’t have the right market conditions now. Mr. Fieder says only in Calgary or Edmonton could a trend develop. A lot of his company’s client base is looking at opportunities there. But he says there are a number of impediments even in the Alberta market.

“The big issue in Alberta, both in Edmonton and Calgary, is vacancy rates on the residential side recently are quite high [too]. For the last two or three years they’ve gone up significantly,” he says. At the end of 2016, apartment rental vacancy rates in both cities hovered around 7 per cent. The cost of conversion is also a major negative factor, say experts. Construction costs are relatively high and 40- to 50-year-old buildings can present expensive challenges. Many don’t have a suitable floor plate to convert to apartments and there can be surprises on the mechanical side, as well.

“Once you start peeling back the layers, I think buyers will find it becomes uneconomical. Some of the buildings just don’t lay out well for apartments [in terms of] balconies, parking,” says Brad Gingerich, senior vice-president for CBRE in Edmonton.

The B and C class towers most likely to attract conversion are in the city centres. While the vacancy rates of those older properties are significantly higher than the average, some as much as 50-per-cent vacant, they also face competition from new housing stock in both city cores.

“We’ve seen a lot of purpose-built rentals in both Calgary and Edmonton, and that’s a game-changer for groups trying to convert office buildings,” says Mr. Gingerich.

For companies thinking of investing in an old building with an eye to doing a conversion, the cost of buying, even in the B and C class, is another issue. Real estate has largely retained its value despite the recession, says David MacKenzie, vice-president of multi-family investment for Avison Young in Calgary, which means the cost of acquiring a building plus the cost of conversion construction becomes too expensive to be cost-effective. “I think you’d be highly challenged to acquire even an older office building at the right number to be able to compete with the existing submarket of new-built, purpose-built condos and apartment buildings,” he says.

And yet there are fans of conversion in the West and some companies are moving forward with projects.

Cory Wosnack, a principal and managing director for Avison Young in Edmonton, says the new purpose-built residential buildings in the Edmonton core are all of a similar, relatively expensive class. Repurposed B and C class towers could add diversity to that housing stock, he says.

“We have a handful of [office] buildings that have full or near-full vacancy and these buildings are going through a very serious investigation to see them taken out of the office inventory and into residential. And there are various forms of residential: condos, rental apartments, seniors aging in place, student housing or hotel.”

Mr. Wosnack says the Edmonton real-estate market would welcome having some of the older B and C class buildings taken out of the office inventory.

“Having a 17-per-cent vacancy rate would indicate a very weak market and yet much of that vacancy really doesn’t compete for today’s tenants. It’s a drag on the market statistically and it’s creating a false impression.” Calgary-based Strategic Group has one office conversion under construction and another in the design and concept stage in Edmonton. It has four buildings in Calgary in the concept and design stage. The company has 56 buildings in Alberta and is also active in the residential market.

“In 2014, we witnessed the market turn to a new day,” says Randy Ferguson, Strategic’s chief operating officer. “We began to contemplate the longevity of our B and C class office space … and to think about those buildings that are best positioned in markets where people would enjoy living. Can we find efficiency in converting those buildings to another asset class?”

Mr. Ferguson’s view is that both Edmonton and Calgary are underserved for residential rental property, having lower apartment stocks per capita than elsewhere in the country, even though the cities have demographics including many young people wanting to live downtown.

Strategic’s first conversion in Edmonton will be Harley Court, a building in the city core, around the corner from a grocery store, close to light-rail transit. The second will be the Centre West Building, a tower in the government district not far from Harley Court, which Strategic acquired with a plan to do a conversion.

But even in Calgary and Edmonton, Mr. Ferguson doesn’t expect a wholesale trend toward conversions, simply because of the many impediments.

Artis REIT, based in Winnipeg, is in the stage of getting permits for one downtown building conversion in Calgary, Sierra Place, and is reviewing the economics on three other buildings.

Dennis Wong, Artis’s executive vice-president of asset management for Western Canada, agrees the inventory of suitable buildings in the right location is small. Sierra Place is a 92,000-square-foot property across the street from a C-Train station.

“These are all one-off projects,” says Mr. Wong. “In the last Calgary Real Estate Forum there was a panel, and they did an analysis of the number of class B and C buildings. … There was only a handful that met the criteria.”

Read the Globe and Mail article here.

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