Ottawa's softening downtown office market

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There's a "perfect storm" coming to the nation's capital, says Sandy McNair, president of Canadian real estate research firm Altus InSite, and it will have serious implications for Ottawa's office real estate market.

"I think it's going to go from one of the most stable markets to one of the markets that's greatest at risk," Mr. McNair said.

This assertion has sparked hot debate among members of the real estate community in Ottawa – while some agree with Mr. McNair's predictions, others vehemently disagree.

Mr. McNair's central argument is that the federal government's leased presence in the National Capital Region is set to shrink by 11.2 million square feet of office space by 2016.

"The federal government occupies 63 per cent of the entire office market [in Ottawa] and is arguably at a turning point not seen in several decades," he said. "There have been many announcements over the past 20 years that the federal government intended to shrink their footprint in the Ottawa area, but I think this time it's different."

Mr. McNair cites the federal government's announcements last year outlining its commitment to reduce spending (the 2011 budget outlined a plan to cut spending by 5 per cent across all departments).

Another major factor, Mr. McNair said, is the six new office towers the Crown is building, set to be completed between 2013 and 2015. Five will be located outside of Ottawa's downtown core – three across the river in Gatineau, Que., and two in the east end of the city. As well, the government added more than two million square feet of new office space to its portfolio with the 2010 purchase of the former Nortel campus, located in Nepean.

When government employees are moved to these new government properties, Mr. McNair said, it will create more than five million square feet of vacancies in buildings the government had previously leased. As well, he believes that the new buildings will be occupied at a much greater density, in keeping with the current trends in the private sector.

Mr. McNair predicts that Ottawa's office market will soften overall, as owners of B or C buildings currently leased by the federal government are left without tenants.

"I think it's going to make Ottawa more like other markets, because Ottawa has been under a bubble for 20 years or more where the normal laws of gravity haven't necessarily applied," he said. "We're now at a place where the high-tech sector is pretty quiet and I think the federal government is only going to go in one direction – they are going to improve the quality of the space they occupy and overall, occupy less space."

Nathan Smith, senior vice-president of Cushman & Wakefield Ottawa, acknowledges that government cutbacks will likely mean a halt in growth. However, his company thinks that even if there is a 5 per cent reduction in employees, it's unlikely that will have any large impact on the overall occupancy.

"Do we believe the federal government is going to significantly reduce its footprint in the national capitol region? Absolutely not," he said.

"You trim from each department, but all of those leases you have are still in place," Mr. Smith said. "They expire when they expire, you're not going to get out of a space that has 300 employees because you're taking 20 out of that department."

As well, Mr. Smith says there will be a lag between when the cuts happen and when they are able to move their employees because of the long leases the government typically has with Ottawa landlords. When it comes to density issues, Mr. Smith says that the federal government is already "industry-leading," at or below 100 square feet per person, so that won't be a major issue.

As for the six new builds the government has on the horizon, Mr. Smith believes they are being constructed to replace properties currently owned by the Crown, which means it won't have a great effect on properties they are leasing.

"They're not going to empty a leased building that has five years to go [on their lease]in order to occupy these new buildings," he said. "It's a strategic plan the government has to renew it's own portfolio."

John Seymour, vice-president of business development for Ottawa office developer Colonnade, says that although he isn't convinced the numbers will be quite as dramatic as Mr. McNair predicts, he leans toward the opinion that the federal government's footprint in downtown Ottawa is going to shrink.

"It feels like this government is more devoted to ensuring that there are some job cuts in Ottawa in the next little while," he said.

Regardless of how long it takes for the government to move employees to the new buildings, landlords need to plan for that eventuality, Mr. Seymour said.

"The feeling is if it's an older building, a smaller building, those are the buildings the government is going to say, 'Thanks, but no thanks, we're not going to continue to be in those,'" he said. "The hard part for landlords is the federal government said, 'We don't want major renovations going on while we're in occupancy,' so they'll have to wait until such time as the lease comes to an end and then be prepared to reinvest."

Kelvin Holmes, managing director of Colliers International Ottawa, believes the federal government is preparing to leave Ottawa's downtown. In fact, he welcomes that departure.

"It's so exciting, I wish it had happened ages ago," Mr. Holmes said.

"The downtown core is chock-a-block full of public-sector tenancies, which is stifling new development," he said. "It makes it difficult for private-sector companies to find the right kind of space they can grow in, it's a barrier to more residential development, it's a barrier to good retail and restaurant development in the downtown core."

If the City of Ottawa looks at this as an opportunity and develops the right strategy to transform the downtown core, Mr. Holmes said, the federal government's exodus could be a great catalyst for change. Many of the "ineffective" B-class buildings that are going to be vacated should be torn down to create mixed-use residential/office developments with retail on the first floor. Creating a downtown employees want to live and work in is the way to attract the kinds of engineering companies that have set up shop in Montreal, he said.

"There's no reason those same companies couldn't use Ottawa as that jumping off point for the engineering projects that are happening in Northern Ontario and Northern Quebec," Mr. Holmes said. "But we don't have the environment that they want to go to. If you're in downtown Montreal, it's a vibrant place to live and work, and Ottawa is not."

Mr. Holmes says that the biggest hurdle to this kind of development is "a very conservative status quo" that doesn't want to take the leap.

"There is going to be some short-term pain, but we've got to reposition our core, because if we don't do it now, it's just going to get more expensive as time goes by," he said.

"We've got to get out of this mindset that the only tenant that's going to get a building out of the ground is the federal government."

The space debate

The amount of space the federal government leases in Ottawa will shrink dramatically by 2016. Here's how Sandy McNair of Altus InSite thinks the numbers will add up:

• 5,100,000 square feet: Vacancies due to new properties purchased or being built by the government.

• 1,000,000 square feet: Density in the new buildings to increase by 20 per cent.

• 4,700,000 square feet: Headcount reductions at three per cent per annum.

• 400,000 square feet: Density increases in other buildings due to relocating or restacking.

• 11.2 million square feet: The total amount of shrinkage by 2016

Source: Altus InSite