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Pay InvoiceBusiness Voice September 2011
Simple Economics: The Challenge to Downtown Development
By Richard Woodbury
When Purdy’s Wharf was completed in 1990, it became an iconic part of Halifax’s waterfront. More than just a stunning piece of architecture, Purdy’s is regarded today as the marquee place to rent office space in downtown Halifax. It also has the distinction of being the last major office complex built in the downtown.
In the 21 years since Purdy’s was completed, Halifax has undergone great change. The city hosted a G7 Summit, the city became part of a regional municipality and it even flirted with the idea of hosting a Common- wealth Games.
There’s frequent talk about why no major office complex has been built in downtown Halifax in recent years and the discussion frequently involves assigning blame. Popular tar- gets include heritage groups and HRM’s regional council, but the answer is actually much simpler.
“It’s pure economics,” says Ross Cantwell, an associate with Colliers International, a commercial real estate services company. “Development isn’t as complex as people would think. It’s basic math.”
Building an office complex is just like producing any product. If it costs X to build it and one plans to sell it for Y, how much is the profit (Z) going to be? Also, what is the risk involved?
If the Z is enough to justify production and the risk isn’t too great, odds are the product will get made. But if the Z isn’t enough and the risk is too great, then production won’t move forward. Unfortunately, the latter is the case for building new office buildings in downtown Halifax.
According to statistics from Cushman & Wakefield Atlantic, the average net asking rent for class A office space in downtown Halifax was $18.08 per square foot in the second quarter of 2011. In 1989, that number was $14. This translates to a 29 per cent increase over the last 22 years.
On the Bank of Canada’s website, it has an inflation calculator that tracks data from 1914 to the present. Using 1989 as the base year and 2011 as the current one, it calculates that a $100 basket of goods in 1989 would cost $161.66 today, an increase of 61.66 per cent. Placed within the context of class A office space in downtown Halifax, it means rent has increased at only about half the rate of inflation.
“We haven’t beat inflation, not even close,” says Bill MacAvoy, the managing director of Cushman & Wakefield in Atlantic Canada. He says there are two reasons why this is the case.
The first has to do with the large amount of office space governments rent in Halifax. MacAvoy says it’s higher than in other cities across the country and other similar size cities in North America.
“Because government occupancy is done predominantly on a tender basis where the lowest price wins, it’s going to act effectively as a bit of an anchor on the market,” MacAvoy says. “You’re not going to get the natural lift you usually would.”
The second reason is that Halifax is a branch office market with few headquarter- type properties. For branch offices, MacAvoy says they set up shop because it’s economical, both from a labour and real estate perspective.
“So those two dynamics in our market are reasons why our rents don’t clip at a normal growth,” he says.
At the very least, rents should increase with the rate of inflation and even a bit more as landlords reinvest in properties and upgrade them, thus helping to justify the reason for a rate increase.
“What we still see are some competitive forces that tend to drag that down,” MacAvoy says.
For class A office space in downtown Halifax, low rent prices mean it’s tough to establish a business case for building a new office complex.
“The economic feasibility is virtually impossible to justify,” says Ben McCrea, the founder and chair of The Armour Group Limited. “You don’t have a lot of people
clamouring to build office buildings.” Experts say the magic rental number needed to justify building new class A office space in the downtown is $25 to $30 per square foot. While the economics of building an office complex don’t work in downtown Halifax, they do work in the suburban areas and there are several reasons for this. “When you’re looking at $10 to $12 a foot [for] land, easy access to the site and quick time for development permits, it’s a lot easier to do it,” MacAvoy says.
Contrast that with the downtown where it costs about 30 to 40 per cent more to build because of higher land costs, difficulty getting supplies into the urban core and the increased costs associated with closing down sidewalks and building underground parking (which costs about $45,000 per stall). Because of the lack of available land, it means developers have to build vertically, which is more expensive than building horizontally.
From the standpoint of the city, downtown development is preferable to that of suburban development for a number of reasons. One is that because land assessments are higher, resulting in more property tax for the city compared to the suburban areas. Building in the suburban areas also requires more servicing costs for the city, such as building and maintaining roads and sewer service.
“Basically, anything you build in the down- town core is pure tax profit for the city,” says Paul MacKinnon, the executive director of the Downtown Halifax Business Commission.
While there’s demand for office space, the demand is in the suburban areas. Over the last few years, vacancy rates for class A office space in downtown Halifax have risen while the suburban rates have fallen. The vacancy rate for class A office space in downtown Halifax briefly fell to 2.2 per cent in the second quarter of 2008, but has inched upwards and is now in the double digits. For the second quarter of 2011, that statistic was at 10.5 per cent.
With the numbers being difficult to justify building a new office complex in downtown Halifax, MacAvoy says there is a concept called “a flight to quality,” which might justify a new building. This involves building a cutting-edge facility that because of the prestige, a certain cohort of tenants will be attracted to set up shop there, despite the increased rental costs.
“If you put a really jazzy, all glass building [with] great underground parking, restaurants on site, [a] fitness centre, some other major fun stuff, maybe some exterior branding possibilities, the major Canadian chartered banks, large law firms and others will not worry about the $5 delta,” MacAvoy says, adding that he questions just how much space these businesses could soak up.
“In our current fleet of tenants, there’s a discrete amount of tenancy that would have the ability to put that grade of rent into their business model. It’s not to say there aren’t more tenants like that, they just don’t happen to be resident in our market today. Does it mean those firms could expand? Maybe. Does it mean Nova Scotia Business Inc. (NSBI) could attract somebody in the financial services sector in another jurisdiction to come here to expand their service offerings? It’s totally possible.”
In any case, there are many reasons for the shift in demand to the suburbs.
“If you provide subsidized land outside of the downtown where it’s cheaper to build anyway and you provide the road [and] communications [infrastructure], people will build there,” says Mike Turner, the president of Turner Drake & Partners Ltd., a real estate services firm. “Why wouldn’t they?”
Much attention is often heaped on developments in the downtown, with opposing sides waging very public (and often heated) debates.
“It’s easier [to develop in the suburbs],” notes Fred Morley, the executive vice president and chief economist of the Greater Halifax Partner- ship. “There’s less regulation, less public attention, less scrutiny, all that kind of stuff.”
In a way, public attention is a synonym for controversy, which is something that usually leads to change (sometimes positive and sometimes negative).
“In Halifax, the impulse on the part of the community to preserve the heritage qualities of the downtown is very strong and it resulted in some significant policies of protection, going back to the view planes 30 or more years ago...” says Andy Fillmore, the manager of urban design for HRM. “Over time amendments, additions and changes to the municipal plan resulted in a very complex input/output regime, some would say almost to the point of dysfunction.”
When office development started happening in the suburban areas, it required new regulations (which were done quickly) and were far simpler in nature. But another factor is a particularly tough
one to change: the cultural shift of where workplaces are located. In a report called Vanishing Halifax, Turner wrote: “We believe the trend for office tenants to relocate to the suburbs was triggered by the 1990 recession, which produced a sea change in the way business operated. The latter was given impetus by the improvement in communications (cell phones, world wide web, virtual private networks, webinars, etc.), and their falling cost, coupled with outsourcing and a more Calvinistic attitude to office accommodation (flash was out, function was in). Accessibility, free parking and larger floor plates in the suburbs have robbed downtown office space of much of the rental premium it used to command over locations elsewhere.”
While employers may have had efficiency on their minds when making their relocation decisions, for today’s employees, location is a priority when deciding who to work for. MacAvoy says that friends of his in the head hunting and human resource industries have told him about how an employee’s primary concerns used to be who the employer was and what the level of compensation was.
“The question they get now usually at the top of the pile is, ‘Where is the office located?’” he says.
While the downtown has been immune to office development, that hasn’t been the case for residential development as the economics can still be justified. And with the introduction of HRMbyDesign, it’s now providing some clarity to the often confusing development process.
Prior to HRMbyDesign, development was guided by the previous municipal planning strategy and land-use bylaws, some of which were up to 60-years-old. Written in vague language, some policies contradicted each other and these factors led to appeals, regard- less of whether a project was approved.
“It bred uncertainty,” Fillmore says. With HRMbyDesign in place, this has cleared up much of the confusion. “We put very clear envelopes on every site, so now people know exactly the square footage they can build on any site,” Fillmore says.
The city also established strict protocol on approving development applications. From the time of receiving them, HRM must make a decision within 60 days and is bound by provincial legislation to do this, but most people Business Voice spoke with said while that might be the intention, it isn’t the reality.
MacKinnon is a fan of HRMbyDesign for this reason and others. “I think the clarity is so important,” he says. “To me, it always seemed so crazy that you’d expect a developer to buy a piece of land and not have any idea what they could build on it.”
However, he admits that while HRMbyDesign has improved the development process, it doesn’t fix the market conditions.
Getting the land-use policy right is one of the things that will help the downtown, Fillmore says. The second thing is getting the economic environment right.
“That’s the thing we still have a lot of work to do on,” he says.
In the city’s latest economic development strategy, it discusses measures that can be undertaken to improve the city’s business climate, such as creating incentives and reviewing tax and development fees and processes to make development more attractive. Cantwell says measures like this are needed to tip the economic scales.
“That is absolutely what they have to be doing,” he says. “It’s the only thing they can do. You can’t force a developer to go build.”
But not everybody is a fan of subsidies. Turner has harsh words for HRM on this matter.
“How stupid can you get?” he asks. “What are you going to do? Subsidize everything?”
Turner says subsidies don’t work for two reasons: first, they’re unaffordable and second, they distort the free market because people who have already built buildings are competing against people that have received subsidies to build buildings.
Developer Wadih Fares makes a strong argument as to the rationale of offering subsidies. “The city’s not going to lose anything because if the building doesn’t get built, they’re not going to get any taxes anyway,” he says. Fillmore believes that mixed-use developments may hold the key to revitalizing the downtown. “If you don’t quite have the business case on a solid office building, you can start to get the business case if you bring in those other uses there’s a demand for,” he says. “I think mixed use is the way out of this.”
In a mixed-use development, there would probably be some retail or commercial activity on the ground floor, with residential and or office space above.
With more people living in the downtown, Fillmore says this would kick-start a chain of events.
“As soon as you start to feed in a lot more people, that activates the retail, then that creates tax wealth for the municipality to invest in the streetscapes, which makes the city a place where offices want to come,” he says. “It’s all inter-related.”
While the economics can be justified for residential developments, there’s going to have to be a profound mindset change in how HRM employees view development. Cantwell is also involved with a non-profit organization called the Housing Trust of Nova Scotia (HTNS), which is devoted to developing affordable housing. Besides being the co- founder, he currently serves as its president. The organization bought two buildings on Gottingen Street and is looking to build 250 units (128 would be rented at market rate, while 122 would be affordable and reserved for the working poor). The problem being en- countered is that there is a 50 foot height limit at the site.
“We went to HRM and we said, ‘Look, your plan only allows 50 feet, that’s like five to six floors. We need to go eight to nine floors in order to make these projects economically viable,’” Cantwell recalls. “And they’re freaking out. They’re like, ‘Well, that’s just too high.’”
He says that HRM couldn’t explain why this height matter was an issue. Cantwell further explained the economics of development to the staffer to explain why an exception was needed, but it didn’t matter.
As an alternative, Cantwell proposed that HRM reduce the permit fees to help make the project more economical. Given about 50 per cent of the housing would be classified as affordable, he proposed HRM waive half of the permit fees. HRM didn’t bite.
One other option Cantwell suggested was deferring the payment for the permit until the final inspection of the building, right before the occupancy permit was granted.
“It would cost them nothing to defer the fee and they still said no,” Cantwell says. “And the staff person wasn’t even willing to run it up the flag. Staff do not understand the economics of development and until they understand the economics of development, they can’t write policy to make it work.”
Developer Peter Polley is also extremely frustrated with his dealings with HRM. At the moment, he is engaged in two legal proceedings over the right to build a condominium complex adjacent to the existing Ocean Towers development between Barrington Street and Brunswick Street (see sidebar The curious case of Polycorp for details.)
“There needs to be a culture in HRM senior staff that says urban development is a good thing,” Polley says.
He’s been very vocal about his frustrations with the city, something that can’t be said for most developers.
“Most of them (the developers) say, ‘Peter, you’re nuts. You can’t say that in public. The next time you go to get a project approved, you’ll be dead in the water.’ I don’t care,” Pol- ley says. He points out that he hasn’t heard of any instance where a development has been turned down because of public comments made by a developer.
With roots in the community, Polley doesn’t want to have to move away to run his business. At the moment, Polycorp is working on a project in Wolfville and just bought 140 acres of land on the Herring Cove Road.
“We’ll develop land where we can find land that’s developable and makes economic sense,” he says.
HRM takes a lot of heat on the development front from all sides. Whether it’s being blasted by heritage groups for not doing enough to protect the city’s heritage or for not being pro-development enough, HRM is often cast as the villain.
“It’s a true statement we’re often cast as the scapegoat,” Fillmore concedes. “HRM can either choose to take a defensive posture or we can engage and change. The challenge that any city faces is that it’s incumbent on the city to manage development through land-use bylaws,” he says. “Land-use bylaws by their nature are inflexible, so if you have a bylaw, you have to enforce it. Otherwise, you’re breaking the law essentially. Where we can improve is to have the right kind of bylaws.”
Fillmore understands the importance of the downtown to the city and is committed to making it successful.
“Without a course correction, we’re heading towards being another North American city with a hollowed out core,” he says. “And we don’t want to be that city.” After a long period of neglect, the downtown is starting to get the attention it deserves. Fillmore’s vision is that of a pro- development environment that allows the regional centre to compete with the suburban areas and the development process is simplified and expedited. Inside the corridors of HRM, there’s even a buzz slogan circulating: Red carpet, not red tape. Buzz slogans are one thing, a genuine mindset shift is another.
Part of what makes the lack of development problem so vexing is that so much of the situation involves factors that can’t be controlled. While HRM can do some things to improve the business climate and speed up approvals, the reality is that – in the case of office buildings –the market rent in the down- town is insufficient to justify building new buildings. With a vacancy rate of slightly more than 10 per cent for class A office space, the downtown isn’t exactly screaming for office space. That’s a bitter pill to swallow.
“The way the market has been set, either intentionally or not, is that development is simply not viable for downtown, at least not commercial development,” MacKinnon says.
The Curious Case of Polycorp
Still winding its way through the courts, Peter Polley worries the legal battle over a disputed development still has a long way to go before a resolution is reached.
“We’re close to $200,000 at this point [in legal costs] and my fear is we are maybe a third of the way through,” says the president of Polycorp Properties Inc.
The legal battle concerns the right to build a 62-unit condominium complex adjacent to the existing Ocean Towers development be- tween Barrington Street and Brunswick Street.
In a nutshell, HRM has argued it will not issue a permit for the development on the grounds the property in question must remain open/recreational space, as per a late 1960s initiative called the Barrington Street Housing project.
“The bizarre thing is this is the city fighting against something that everybody including themselves say should be able to happen,” Polley says. “Downtown development is good. Building buildings within walking distance of downtown is good. Building buildings next to major traffic corridors and bus routes is good.”
Currently, there are two legal proceedings working their way through the courts. The first involves Polycorp’s efforts to force the city to issue a development permit for the project. On June 20, the Supreme Court of Nova Scotia ruled in Polycorp’s favour.
“[T]he court declares that the Applicant’s development rights with respect to the Property are not affected by any purported development agreements, site plans or authorizations made by HRM pursuant to s. 538 of the former Halifax City Charter,” wrote Judge Gregory M. Warner in his June 20 decision. “Any decision respecting a development permit application in respect of the Property shall be solely governed by the terms of the Land Use Bylaw.”
However, as of press time, the matter wasn’t over as an appeal from the city was still a possibility. The second proceeding is related to the first one and involves a claim for damages.
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