I sure hope it is no big deal. My fear is that this market is accustomed to growth by the feds, and pretty consistent growth at that.  The last time the federal government went through an exercise to reduce the size of its workforce was the Chretien government, and they undertook that exercise in their first term in the early 1990s.   The civil service here contracted until about 1997 and has been growing ever since.  The following chart illustrates federal government employment in Greater Ottawa from1990 (column 1) through 2010 (column 21).

Federal Government Employment in Greater Ottawa

The last government rationalization program reached its goal in 1997 with a low of 97,000 employees here.  By 2010 the number had increased to 136,000.  That is growth of about 3% per annum for 12 years.  It generated a need for additional accommodations for about 3,250 people each year, and that is equivalent to demand for 650,000 sf of office space every year.

My contention is that the Ottawa office leasing market is so accustomed to this level of growth that it does not even notice this level of demand, and now feels that it is ‘natural’ or ‘unremarkable’ or ‘to be expected’ because the feds never get smaller.  My contention is that PWGSC has been taking space it might not otherwise choose because it had no options.  My contention is that Ottawa has benefitted from a combination of market forces – little new supply and consistent employment growth – for more than a decade.

My contention is that is over.  PWGSC has supply options, and its level of demand is about to decrease.

The new majority government is working to reduce the size of the federal government.  Before and during the election they suggested that attrition – retirements and people leaving – could provide the savings they want to capture.  The budget of June 2011 suggests that attrition will not get them the cuts they want, and that job losses may be more severe.

The attrition rate for the past few years has been running about 5,000 people per year.  The Conference Board of Canada recently estimated the federal government will downsize by 7,000 people over 2 years.   The Conference Board estimate is equivalent to 1.4 million sf in negative absorption over 2 years.   Attrition is equivalent to 1.0 million sf in negative absorption per year.   The majority government plans to look for savings for a year and announce them in next year’s budget.  That has implementation starting near (?) the end of 2012.

What the leasing market here is used to is growth, not contraction.  The ‘double whammy’ of new supply and a reduced need for accommodation will hit some buildings hard.  Check out the direction for their initiatives for accommodations from the 2010 Ottawa Real Estate Forum.

I think that a problem for PWGSC is just how many leases they have for at most 41 million sf.  It is hard to imagine that they find 448 leases in 235 buildings as ideal.  It is reasonable to expect them to consolidate into larger premises.  It is reasonable to expect them to reduce the number of firms they contract with for leased accommodations.

I expect that this slide will soon show a decline in the number of buildings they lease here, and a decline in the number of leases while at best maintaining the size of the portfolio.  If you have big, LEED compliant office buildings with good access to the public transit system you are good.  Renewal negotiations may be very tough, however those buildings are preferred.  Buildings offering smaller space in older physical plants will be a different matter.

At a minimum, PWGSC will be a “price maker” in all its lease negotiations.  The ownership community will be “price takers” in an environment of increased supply and decreased or negative demand.

Welcome to the new normal.

This blog deals with supply for the government.

The good news for figuring out what the government wants to do in Ottawa is that Public Works and Government Services (PWGSC) makes a presentation at the Ottawa Real Estate Forum each year and they describe their plans.

PWGSC announced that they had concluded lease-purchase deals in Gatineau for:

• 455 boulevard de la Carrière for 395,000 sf with Broccolini;
• 300 rue Victoria for 451,000 sf with Multivesco;  and,
• 22 rue Eddy for 451,000 sf with Broccolini

22 rue Eddy

300 rue Victoria

455 de la Carriere

The three new buildings in Gatineau get PWGSC to its goal of a distribution of 25%/75% occupancy by the federal government between Gatineau and Ottawa.

Since the October 2010 Forum PWGSC has completed two additional deals:

• East end build-lease for 240,000 sf with Controlex; and,
• Redevelopment of 90 Elgin Street for 516,700 sf for the Department of Finance with GWLRA and Arnon.

90 Elgin Street

These five projects provide PWGSC with 2.053 million SF of new supply.  In addition to the achievements PWGSC outlined above, the federal government purchased the Nortel Campus in January 2011.  This campus adds 2.35 million SF +/- in new supply to the PWGSC.  The campus is currently partially occupied by Nortel Networks and firms that bought Nortel division – Ericsson, Avaya, GENBAND and Ciena – and these firms have leases to remain at the campus for about 2 years.

The change to the Ottawa commercial real estate market is that the federal government takes delivery of 2.053 million SF of new supply in a period of about 6-9 months in 2014.  The Nortel campus adds another 2.23 million SF, and once again for their occupancy in the 2013-2014 period.

This slide from the 2010 PWGSC presentation outlines the scale of federal government occupancy in Ottawa.  The result of the new additions to supply we identify is that the federal government is adding roughly 10% to its inventory of occupied space in Greater Ottawa in 2014.

That is a supply shock that PWGSC is incorporating into its lease negotiations now.

What helps mitigate the new supply shock is that PWGSC will have deletions from its supply inventory.  We estimate that the 39 crown-owned office buildings provide about 12 million sf of office space.  These facilities can be older and in need of significant repair.

Two examples include the Sir John Carling building, formerly occupied by Agriculture Canada, and L’Esplanade Laurier, the current home to Finance and Treasury Board.  The Sir John Carling Building has been emptied and is slated for demolition.  L’Esplanade Laurier is in need of capital repair, and the previous owner estimated these repairs at $150 million circa 2009.

It points to three distinct trends affecting Ottawa now; the massive investment by PWGSC in acquiring new buildings to occupy; the interest in securing buildings occupied by PWGSC here; the end of the Nortel era as the bastion of all things high tech in Ottawa. I expand on each of these as follows.

PWGSC was very active in securing properties for its own use in 2010 (see the following chart that the presented at the 2010 Ottawa Real Estate Forum).

(note: They do not mention the purchase of the Nortel campus in this slide because the presentation happened a month before they closed on the campus.)

In addition to buying the 2.35 million sf campus, PWGSC ran a process by which three office buildings of 400,000 – 450,000 sf are currently under construction. These are commissioned under their lease-purchase program: they enter into 25-year leases for buildings to be constructed, and they have the right to buy them on expiry.

In addition, PWGSC awarded a 15-year lease for a new building in the east end and mostly completed the process of determining whether GWLRA or Morguard would redevelop 90 Elgin Street. As well, PWGSC closed on its acquisition of L’Esplanade Laurier by exercising its right to purchase at the end of the 35-year lease.

That represents projects totalling 5.3 million square feet, and a significant investment by the federal government in the property it acquired. It is a significant investment by the private sector in providing 2.0 million sf for PWGSC occupancy (including 90 Elgin).

Noteworthy office building sales in Ottawa in 2010 include:

PWGSC is the dominant tenant in all these buildings except for 81 Metcalfe and 150 Metcalfe. Some of the sales were completed before the Nortel campus came to market, and some during its marketing. What was notable is that buyers invested in PWGSC leases with remaining lease terms that were as little as 12 months and at most 6 years.

The last longer-term trend emerging from 2010 is the dismantling of Nortel. Ottawa was its principal research and development facility world-wide representing 50% of Nortel’s R&D. At the peak, Nortel was investing $4 billion annually in R&D and half of that was in Ottawa. By contrast, RIM currently invests $1.2 billion per annum world-wide on R&D.

Nortel was a great engine training R&D talent and launching many high tech firms in Ottawa. It will be missed as an employer, a magnet for talent, and a spawning ground for high tech ventures.

As the market settled down following the initial hysteria, much of it created by the “expert” utility brokers in combination with their questionable sales tactics, utility rates fluctuated up and down and a number of customers discovered that their fixed price contracts were actually costing more than if they had simply been paying the market rate. A number of the “expert” utility brokers disappeared from the marketplace and calmness returned with only a handful of utility brokers remaining.

With the relatively recent introduction of the Ontario Government “Feed-In Tariff” Program (“FIT Program”), North America’s first comprehensive guaranteed price structure for renewable electricity production, it has been somewhat of a “déjà-vu” experience all over again. On the one hand, I shouldn’t be surprised as it is simply the evolutionary cycle whenever a new product or service is introduced into the marketplace. However, it is surprising that the lessons learned from the utility deregulation exercise are quickly forgotten; only this time, the lessons learned and the potential costs may be more prolonged and more significant.

As with the introduction of the utility deregulation program, the introduction of the FIT Program has suddenly spawned an abundance of companies claiming to be solar “experts”. Despite a similar hysteria created by the utility brokers, the initial hysteria created by the “expert” solar companies have been successful in luring a number of companies into giving up their rooftop rights and providing them access to their rooftops for solar installations. Don’t get me wrong, the rooftop solar installations are revenue generating based on the rate premiums guaranteed by the Ontario Government, but at what cost?

At first glance, building rooftops represent unused real estate and appear to provide an untapped source of potential revenue generating opportunities for building owners. However, prior to “giving away” your rooftop to a third party solar company, and in many instances an unknown corporate entity, consideration should be given to the financial stability of the solar company, the ongoing repair, maintenance and structure of the existing roof, reinstatement provisions and associated costs, roof warranty issues, existing/future tenants’ rooftop access/rights to accommodate their expansion requirements, disruption to tenants’ quiet enjoyment and whether the Landlord may be obliged to pay a fee or fine at anytime throughout the term of the contract as a result of any changes in the environmental regulations throughout the 20-year contract term, as all environmental attributes, i.e. carbon and renewable energy credits, belong to the Ontario Power Authority (OPA) under the contract.

We stood on the sidelines throughout the utility deregulation and watched as others got sucked up by the hysteria. Despite the solar companies’ attempts at creating an urgency and the suggestion that we “must sign up within the next 30 days”, only to call us back two months later with similar insinuations, we have continued to remain on the sidelines. Perhaps once the current market uncertainty settles and we’re able to establish who the “key players” are in the solar installation market, we may take a look at entering onto the playing field. Some may argue that we may miss the opportunity and that the “game” may be over by that time; however, if it is such a viable alternative and not simply a passing subsidized government initiative, then it should continue to be a worthwhile venture 3 to 5 years from now.

A reduction in yields over the past 15 years along with the efficiency of asset managers and property managers to manage risk has reduced capitalization rates to historic lows. Tenants in turn are benefitting from lower net rental rates that have resulted from capitalization rates that have dropped faster while the cost of land and construction has increased. This has resulted in rental rates that have not kept up with inflation in many markets. That has to be good for a tenant’s bottom line.

The move of institutions into commercial real estate has certainly increased the governance requirements that asset managers and property managers have to deal with. This is positive for the sector as it helps to manage risk of the asset and therefore reduce capitalization rates. But one side effect is that some managers have focused too much on governance and have forgotten about service.

In assuming the property management for several buildings over the past few years we have witnessed some very poor practices at the site level. We have found tenants who have received very poor service from some very big names in the business. The asset became more important than the residents in the building. Unfortunately, good governance policy rarely states that the tenant must be happy.

I remember 20 years ago when virtually all of your capital appreciation came from rental increases. That has generally not been the case over the past 15 years or so. But I do believe that servicing the tenant and getting a rental increase or a low cost rollover is going to become very important again as capitalization rates reach low, stable levels over the next 10 to 15 years.

The manager that is capable of managing not only the asset but also the tenant relationship and can meet or exceed their service requirements is the one that will create maximum value for both owners and tenants alike. As we have witnessed, not all property managers are capable of delivering on both sides of this equation. In their search for space, tenants must accept that they have a responsibility to their organization to carry out proper due diligence, not only to ensure that they meet the goals of their organization when it comes to quality, location, price and amenities, but also on the level of service that they can expect from their property manager after they have signed their lease. Not all property managers are alike and the disparity can mean the difference between a good lease transaction and a poor one.

The trend toward institutional ownership, greater governance, lower risk and lower cap rates, has served to reduce rental rates, which is a significant benefit to tenants. But the tenant must also be aware that creating their win-win scenario comes from aligning themselves with a property manager that is able to consistently deliver on both great rates and great service.

A successful theme and vision for a property is achieved when an owner, asset manager, and property manager can all agree on what the property will become and they each commit the time, staff and resources required to get there. We have found that the most successful engagements have occurred when all parties are working toward a common result that is well articulated and documented.

It is not unusual for us to bring a multi-disciplinary team (leasing, property management, development, architectural, mechanical, electrical and others where necessary) to a meeting with an asset manager and owner in order to get all of the issues covered in a single meeting. It also serves to ensure that the entire team has a clear understanding of how you came to the final vision for the property and cements everyone’s commitment level to the desired result.
Coordinating the effort between leasing, property management, development, architecture, engineering, and contracting is made much simpler with a common vision and goals. Clear instruction and well defined outcomes are critical in complex leasing, construction or redevelopment projects in order to achieve what was originally envisioned.

So don’t just get caught up in the minutia of the property management function, get involved in the big picture and enjoy the process of achieving your common vision.

We have spent the last 2 years changing the way we deal with information flow.  The basis of our philosophy is that documents should not move through cyber space for anyone to see.  We now require users to come to the document in a secure environment.  This simple change in philosophy required a huge mental and physical change in the way we dealt with information flow in the past.  We have centralized all documents that pertain to the properties we manage, we track the people that have accessed the documents and we are in the process of having all users go to a document rather having the document move to the user.  This is a bit more complex than it seems.  We create millions of pages of information per year and they have to be categorised, secured and tracked and then be viewed by different users that have unique needs and security accesses.

Why be concerned?

1. I think that IT policy should extend to all areas of your business in which your information resides.  Most companies probably have a fairly rigid set of internal controls on how information is managed.  But as soon as the information goes outside their firewall there appears to be little or no concern as to the security and integrity of the information.  So, the fact that property managers are the temporary custodians of an owner’s information should not limit the owner’s ability to ensure that it is handled in a manner that is consistent with their internal policies.
2. Under this philosophy there is only one document generated and stored.  A link is then sent that invites someone to visit a secure area in which the document is stored.  This allows us to track who has seen the document, who has changed it and who has uploaded it.
3. By having only one document we significantly reduce our e-storage requirement which is the fastest growing area of IT.

So, take the time to understand what it means to you to never again send or receive an unsecure email with confidential content and still make the timely decisions that are required to manage a building.  I believe that we have overcome this hurdle and we now better align with the governance policies of institutional owners today.

Managing a real estate company through choppy economic times requires us to broaden our sensitivity analysis and consider shocks as routine. In fact, many players have cashed up in the hopes that more shocks to the system will occur that will allow them to pick up bargains and deploy funds. If these shocks take a long time to occur you have to wonder what an asset manager will do with committed cash and no revenue being generated. They will probably relent at some point and have to invest in something or risk losing their investors. This might lead to short term strength in the market.

The distressed debt seminar in particular was indicative of this theme of uncertainty. When the conference was set up, the organizers obviously thought that this would be a timely and relevant topic of discussion. As it turns out, very little time was spent on distressed debt as very few transactions had occurred at the date of the forum. Obviously, many more transitions and opportunities were anticipated and I was certainly in the camp that thought there would be many more distressed properties by now.

The only predictable part of the conference was how effective the conversations are outside the conference doors. That is where you find out where the average real estate person is focused and the direction they are taking their companies. Many are nervous and remain very cautious in their outlook. That is when I knew I was not alone.

We decided to expand our operation outside Ottawa for several reasons:

1. Our size, currently managing over 3.5 million square feet in Ottawa, means we are getting to the point where expansion of our leasing operations will start to run into conflicts if we take on more real estate in certain markets with new owners.  Our property management operations don’t have to worry about these conflicts so much.
2. We developed a communications tool we call Colonnade Central that will allow us to move information across a national platform far more efficiently then we had been able to do before.
3. We have an aggressive style of management that builds value in the real estate of our clients and appears to be different enough that we are garnering interest from other markets.

The key to our success and that of our clients is our ability to communicate and move information internally and externally in a very efficient, accurate, and secure manner.  We also have the people, platform and commitment to accomplish this and we look forward to getting others excited about our expansion.