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As Toronto's downtown office market defies the doomsayers with steadily improving vacancy numbers, some of the best space in Canada's most prestigious tower sits empty.

The 12,000-square-foot space on the 72nd storey of First Canadian Place may offer the best view of the city that money can buy, but it's sitting on the market waiting for an owner with a dramatic flair to sign a lease.

It's more than just office space, it's a chance to literally look down at the rest of Canada's lesser-situated tenants as well as rub shoulders with neighbours Osler Hoskin & Harcourt and Xstrata PLC.

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The high-profile vacancy is an example of the issue facing some of the city's largest landlords. Tenants have been increasingly attracted downtown by new environmentally friendly buildings, but the storied bank towers just can't compete on features.

They are losing tenants to the new buildings on the block, which have made available in the past year about 3.5 million square feet of brand-new space. To get back in the game, the owners of the older bank towers need to spend billions on renovations and bring rents lower to attract new tenants.

"We've never seen this much space in the big towers," said Bill Argeropoulos, vice-president and director of research at Avison Young. "There's a softness there that is affecting the market."

The downtown as a whole appears to be doing just fine - Cushman & Wakefield estimated the vacancy rate at 5.8 per cent in the core at the end of the third quarter, which it called "a far cry from the double-digit numbers forecasted at the height of the recession" and better than the city-wide rate of 9.4 per cent.

But while banks may be doing well, the story is a little different when it comes to the skyscrapers they place their logos upon, with vacancies at 7.8 per cent and rising in the older bank towers. The towers - which are classified as Triple-A space - are also burdened by higher taxes than competing towers that are considered Class-A.

Vacancies could reach 20 per cent in the next two years in these Triple-A buildings, even as the overall downtown leasing numbers improve. That will drive down rents across the city, making it a good time to be a tenant but a trying time to own prime downtown real estate.

Tenants used to wait until their leases were nearing the end before they'd try to renegotiate for better terms - now they are demanding to lock in at today's lower prices, up to three years before their deals expire.

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"That's probably double what is normal," said John O'Toole, executive managing director of CB Richard Ellis in Toronto. "A lot of major leases were dealt with early, and people are now looking out to 2015. That suggests they could look at renovated bank towers and also the prospect of another new building downtown."

The work has already begun, with the 35-year-old First Canadian Place in the midst of a $100-million-plus recladding that will see its marble façade stripped off and replaced with white-patterned panels of multilayered glass. It's a cosmetic move, but will also save energy costs as the glass helps temper the building's temperature.



"As these buildings retrofit and aggressively set their prices to meet the market, they may be able to shift the demand," said Paul Morse, senior managing director of office leasing in Toronto for Cushman & Wakefield. "But they face great challenges in the immediate term."

There may be challenges, said GWL Realty Advisors Inc. president Paul Finkbeiner, but they are small compared to the early 1990s when the whole core was facing vacancy rates near 20 per cent.

"Sure, there are some pockets of space opening up in the bank towers," he said. "We'll retrofit, we'll do whatever is needed to fill the space. It's hard to make too much of any numbers right now - some tenants are doing well, some may not make rent. But there are a lot of tenants kicking the tires on existing space and it's feeling pretty good."

He's hedging his bets on two fronts - working on tenant retention in the company's Commerce Court buildings, and building a new tower south of the downtown that will open in a few years.

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"Let's be realistic - those towers have some space," he said. "But it's pretty great space."

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OFFICE STATUS

Canada's office sector fared relatively well through the first three quarters of the year, as a limited amount of new construction kept inventories down and low interest rates helped owners keep their heads above water. Here's how the country's different cities stacked up, according to CB Richard Ellis.

Canada-wide, 9.8 per cent

Canada's overall vacancy rate for downtown and suburban office markets remained relatively flat compared to the rest of the year.

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Vancouver, 10.1 per cent

The overall rate climbed slightly, "with the majority of the increase reflecting new construction completions in the suburbs; Burnaby and Richmond saw several new properties come on stream in the third quarter. Vacancy in Vancouver's downtown core tightened in the third quarter."

Calgary, 14.4 per cent

Despite the highest vacancy rate in the country, CBRE said the market is seeing a "frenetic pace" of leasing activity. The addition of Eighth Avenue Place this quarter increased the vacancy figure quite dramatically. If leasing activity continued at this pace, in the absence of new supply, Calgary would [be]poised to post a single-digit downtown office vacancy rate early next year."

Toronto 9.4 per cent

Toronto's overall office vacancy rate inched upward in the third quarter, rising from 9.1 to 9.4 per cent. Several new buildings have added 3.5 million square feet of new space to the market, while the city's traditional banking towers undergo renovations to modernize them as tenants leave.

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Ottawa, 5 per cent

The office market in suburban Ottawa - particularly Kanata - has stabilized after a slow year. "Ottawa's office market is experiencing a shift in activity, with the outer-lying areas of the city receiving more attention than the downtown business core. Over the next few months, large blocks of space will come on stream in the downtown while suburban areas will see vacancy rates continue to stabilize."

Montreal, 10.6 per cent

The market is showing "increased strength" with larger spaces becoming more difficult to find. "Montreal's office market performance has been very dynamic this quarter, with many transactions currently under negotiation. By 2012 we expect to have a very strong landlord market in Montreal's office sector."

Halifax, 8.7 per cent

Businesses are moving from the downtown core to the suburbs. "Halifax's real estate market is undergoing a significant shift. In the last several years, businesses are overwhelmingly choosing the suburban market over the downtown area for a variety of reasons including shorter commute times, amenities, free parking and newer buildings that can offer superior work environments."

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