Nearby retailers are trying to anticipate the effects on their business with Cadillac Fairview's redevelopment of a seven-story building above its Pacific Center mall. Seattle-based Nordstrom has leased 230,000 square feet (21,000 sq m) on the lower three floors, and ten to 15 new retail spaces will fill the lower concourse level. (Cadillac Fairview)

Nearby retailers are trying to anticipate the effects on their business with Cadillac Fairview’s redevelopment of a seven-story building above its Pacific Center mall. Seattle-based Nordstrom has leased 230,000 square feet (21,000 sq m) on the lower three floors, and ten to 15 new retail spaces will fill the lower concourse level. (Cadillac Fairview)

Vancouver’s geography—including the Coast Mountain Range, the Pacific Ocean, and the Fraser River—offers plenty of views for office high-rise tenants. Surrounded by those natural barriers, as well as by the U.S. border, Vancouver may seem less attractive when it comes time for office and retail tenants there to sign a lease, however. The densely populated, tightly constricted nature of the metropolitan area leads to an almost perpetual undersupply of real estate that drives up rents.

As of the end of 2013, office vacancy was 5.7 percent in the downtown area and 7.8 percent in the metro area, according to Toronto-based real estate brokerage Avison Young. Both figures came in below the overall Canadian vacancy rate of 8.3 percent and far below the U.S. rate of 13.9 percent.

Significant change is on the way, however. After years of virtually no construction downtown, seven new office and mixed-use buildings are under development, poised to add more than 2.1 million square feet (195,000 sq m) of office space—nearly 10 percent of the current supply—by the end of 2016. Add in suburban projects that are underway and the metro area will see about 3.8 million square feet (353,000 sq m) added to its current total of about 49 million square feet (4.55 million sq m) in that same period.

“It is an exciting time to see this much growth and this much new product being brought into the market,” says Tom Knoepfel, senior vice president and portfolio manager at commercial real estate investor and developer Cadillac Fairview, which is based in Toronto. “There’s some trepidation with the amount of space that’s on the market, but most of the space in the new buildings that are nearing completion has already been spoken for. It’s really just pent-up demand in the market.”

Retail Redevelopment

Cadillac Fairview is involved in one of the most visible projects downtown—the redevelopment of a seven-story building atop its Pacific Centre subterranean mall. Once a 625,000-square-foot (58,000 sq m) Eaton’s department store and later used as a Sears store, the structure—completed in 1972 and long considered an eyesore—is getting a facelift. Because of its white, porcelain-looking exterior, it has been compared to a massive toilet.

The building is now being readied for Vancouver newcomer Nordstrom, which has signed a lease for 230,000 square feet (21,000 sq m) on the lower three floors, as well as for about 290,000 square feet (27,000 sq m) of office space on the upper four floors, along with two big atriums, large windows, and a landscaped rooftop. Canadian law firm Miller Thompson signed the first office lease, for about 48,000 square feet (4,500 sq m), Knoepfel says. The redevelopment—a glassy design by Vancouver-based architect James Cheng—is scheduled for completion in 2015.

The underground mall, which already has about 366,000 square feet (34,000 sq m) of retail, is poised to get another 44,000 square feet (4,100 sq m) of small-shop space, as well as an escalator rising to a corner of the building at street level, ­Knoepfel says.

“The building was iconic in the city of Vancouver, not necessarily for the right reasons,” he says. “It was considered by many to be less than attractive. It was a solid white, precast concrete–type wall all the way around. There was very little visibility and openness. Now it’s going to be very transparent.”

Gypsum and metal from the building are being recovered and recycled, with wood chipped and used for biofuel. And those ridiculed concrete panels? They will be repurposed as 65,000 square feet (6,000 sq m) of roadway at Langley Airport, a regional facility nearby. In all, 91 percent of waste materials from the redevelopment, or 15 million pounds (6.8 million kg), is being recycled or repurposed as part of the building’s Leadership in Energy and Environmental Design (LEED) Gold certification, Knoepfel says.

Large windows will be a hallmark of the redesigned Pacific Center.

Large windows will be a hallmark of the redesigned Pacific Center.

European Investment

In another repurposing effort, the circa 1929 Stock Exchange building will be restored as part of Swiss financial services firm Credit Suisse’s first ground-up development in North America. The exchange, a 31-story office tower, will be constructed alongside and cantilevered over the existing building, which contains 80,000 square feet (7,400 sq m). The combined new property will have 369,000 square feet (34,000 sq m) of office space, says Franz Gehriger, chief executive officer of Vancouver-based SwissReal Group, the local development partner and minority investor in the C$200 million project.

“It’s exciting to see a European investor come to Vancouver to make a substantial investment,” Gehriger says. The project will be completed in late 2016, he says.

Credit Suisse’s willingness to back an office tower on speculation—without any preleasing—could be seen as a definitive response to the widely held view that not enough new, high-quality space has come on line in Vancouver in recent years. But it also demonstrates the difficulty of investing in existing downtown office towers.

Office brokers Glenn Gardner and Bill Elliott, principals at Avison Young, point out that most downtown towers are owned by institutional investors such as pension funds and insurance companies, which value the consistent annual cash flow produced by well-leased office and mixed-use properties.

“Part of the reason Credit Suisse is going to build in the market is [that] it’s very difficult to buy an office building in downtown Vancouver,” Elliott says. “They can’t buy an asset, so they’re going to build an asset.”

On the rare occasions that trophy towers are offered for sale, they tend to sell for cap rates, or first-year returns, of as low as less than 5 percent, Elliott says. “If you are from outside Vancouver, it is very difficult to buy an office building,” Gehriger concedes. “It’s very difficult to break into the market.”

Building on spec also may be a necessary evil for Credit Suisse, which doesn’t have a track record locally, Gardner says. “They’ll be the first LEED Platinum heritage conversion done in Canada,” he says. “They decided they were going to build it on spec and let the market come to them. They’re new to the market. This is their only development in Vancouver. People want to be able to see it and touch it.”

Credit Suisse plans to construct a 31-story office tower atop the 1920s-era Stock Exchange building in Vancouver, shown at the bottom right corner of the rendering. (Swissreal Group)

Credit Suisse plans to construct a 31-story office tower atop the 1920s-era Stock Exchange building in Vancouver, shown at the bottom right corner of the rendering. (Swissreal Group)

Rent Effects

The wave of downtown projects is likely to lead to a “tapering of rents” as well as a gradual increase in vacancy as four towers are completed this year, Gardner says. Downtown vacancy at the end of 2013 was up from just 3.9 percent a year earlier, and further increases in vacancy appear likely this year and beyond as towers are completed, he says. “It’s a beautiful city from a landscape perspective,” Gardner says. As new supply comes online, existing space in the lower and middle floors of existing buildings could see some drops in rents, while upper floors in all buildings will continue to fetch high rates because of the views, he adds.

Even so, the new towers are relatively small compared with those in larger cities, where the square footage of just one skyscraper can eclipse the total square footage currently under development in downtown Vancouver. The modest sizes reflect the makeup of tenants in Vancouver, where the average tenant takes up just 3,000 to 5,000 square feet (279 to 474 sq m), making it “a nickel-and-dime kind of market,” Elliott says. British Columbia attracts few major corporate headquarters and traditionally fills offices with a range of industries including mining, shipping, lumber, fishing, engineering, technology, accounting, and law, he says.

Developers say the current office development wave is a natural progression to meet a long-building need, spurred by recent changes in land use regulations. Vancouver’s government has made it more difficult to change zoning from office to residential, and has also relaxed height restrictions on some office projects, they say. “City Hall, about four years ago, prepared a study that forecast a substantial shortage of office space in the future,” Gehriger says. “Many office buildings were being converted to condos. An office building doesn’t bring quite the same return as condos. It’s a longer-term investment. In the last ten years, there was very little [office space] built. Talented, high-tech people want to live and work downtown.”

While technology tenants flock to the city center in many markets, in Vancouver they generally wind up in older, loft-style buildings on the fringe of the central business district in Gastown and Yaletown, or farther out in new suburban structures with wide floor plates that are difficult to find in space-constrained downtown. “If you’re in the Yaletown marketplace or the Gastown marketplace, there’s a lot of funky brick-and-beam office space,” Gardner says. “Downtown typically has very traditional office space, aside from the Cadillac Fairview development.”

The tech push into suburban campuses, resulting from geographic constraints in the city’s core, makes Vancouver a smaller-scale version of western U.S. markets such as San Francisco and Seattle, commercial brokers say. “Our geography doesn’t allow us to have sprawl, even if we wanted to,” says James Shandro, an Avison Young retail broker.

Suburban development tends to take the form of large, mixed-use projects offering office, retail, and residential space close to public transportation. Because of the lack of space, many residents do not own cars. “The geography is great, but it’s also a nightmare to get around in,” Elliott says.

Some new projects with wider floors, such as the aforementioned Pacific Centre, could lure tech tenants to the central business district. One big-name tenant, Amazon, has already claimed 151,000 square feet (14,000 sq m)—a huge total by Vancouver standards—in Telus Garden. Codeveloped by Canadian telecommunications giant Telus and developer Westbank, the huge, suburban-style mixed-use project will include a 22-story tower with 465,000 square feet (43,000 sq m) of offices, as well as retail space and residences. The office space is almost fully leased ahead of its mid-2014 opening, including 250,000 square feet (23,000 sq m) for the headquarters of Telus, which will relocate from suburban Burnaby.

Other downtown office towers in the works, according to Avison Young, include the following: the 35-story, 275,000-square-foot (25,500 sq m) MNP Tower, developed by Oxford Properties; the 12-story, 110,000-square-foot (10,000 sq m) West Tower at 800 Griffiths Way, by Aquilini Development and Construction; 23-story, 340,000-square-foot (32,000 sq m) 745 Thurlow, from Bentall Kennedy and British Columbia Investment Management; and 16-story, 250,000-square-foot (23,000 sq m) 980 Howe, from Manulife Financial.

Rents have dipped slightly in most areas of Vancouver, according to a fourth-quarter 2013 report from real estate brokerage Cushman & Wakefield. Yet there has been a resurgence of top-quality tenants willing to pay C$200 or more per square foot in the prime stretch of Robson Street, according to the report.

Newcomers to the Vancouver area include well-known U.S. brands such as Victoria’s Secret, Saks Fifth Avenue, Tesla, Target, Bass Pro Shops, and De Beers. “We project more and more retailers coming from south of the border,” Shandro says.

While Robson Street clearly remains the city’s top retail strip, with rents ranging from C$150 to C$250 per square foot, Gastown continues to gain popularity among younger professionals and tourists, Shandro says. Rents there range from C$35 to C$60 per square foot, he says. “It really is the Mecca for any boutique shopping or high-end dining or nightlife,” he says. “That’s where all the young people hang out and spend their money.”

Knoepfel says the new Pacific Centre space should be fully leased by the time it is completed in the spring of 2015. “The conversion of the building was really precipitated by Nordstrom wanting to have a flagship store in downtown Vancouver,” he says. “We quickly came to realize it made sense to continue the mall on the lower level. It’s one of the most successful malls in Canada, so we knew we could attract more retailers.”

Nordstrom’s pending arrival leaves nearby retailers plotting their future, Shandro says. “That is causing a lot of unknowns,” he says. “No one is really sure of the ripple effect that will have. Streetfront retailers in proximity to that are trying to lock into long-term leases at favorable rents.”

On the flip side, some smaller shops worry that Nordstrom won’t create enough new business to offset the anticipated leap in rents, Shandro says. “No one has any doubt that Nordstrom will be successful,” he says. “It’s a matter of how much trickle-down there will be for surrounding businesses.”

Ryan Ori covers commercial real estate for Crain’s Chicago Business.