The office market is in turmoil. Everyone knows it. The headlines scream it. And the recent earnings calls of major office REITs, like Dream Office, reflect it. But amidst the talk of compressed NERs, tenant downsizing, and a nervous lending market, a curious thread emerged from Dream Office's Q3 2023 call: the unexpected death of two school leases at 74 Victoria Street. This seemingly minor detail might hold the key to a potential, yet overlooked, driver of value for Dream Office and the wider downtown Toronto office market: educational institutions.

Before delving into this intriguing hypothesis, let's acknowledge the current state of the office sector. It's undeniably tough. The combination of rising interest rates, economic uncertainty, and a workforce still grappling with the implications of hybrid work arrangements has created a perfect storm for office landlords. Dream Office is not immune to these pressures. While their committed occupancy is outperforming the market, NERs are compressed, and the specter of a tightening lending environment looms large.

In their recent Investor Day, Dream Office outlined a cautious five-year plan, forecasting stagnant occupancy and high leasing costs for the next three years, followed by a gradual recovery in years four and five. It's a plan rooted in pragmatism, acknowledging the challenges ahead. But what if a new, unforeseen catalyst emerges to accelerate this recovery? Enter the potential of educational institutions.

During their Q3 call, CEO Michael Cooper revealed a significant development: two school leases, in advanced stages of negotiation for 74 Victoria Street, were abruptly killed off by a sudden policy change from the Federal Government regarding student visas. This unexpected turn of events highlights a crucial factor: the potential demand from educational institutions for downtown Toronto office space.

This demand isn't baseless speculation. It stems from a fundamental shift in how education is delivered and consumed. The rise of online learning, blended programs, and a growing international student population has created a need for flexible, adaptable spaces in vibrant, accessible locations. Downtown Toronto, with its strong transit infrastructure, diverse community, and access to a vast talent pool, fits the bill perfectly.

While the loss of the two leases at 74 Victoria Street was a setback, it also underscores the potential scale of this demand. Cooper indicated that both schools were seeking substantial space, hinting at a trend towards larger, more centralized campuses within the urban core. Imagine a future where downtown Toronto buildings, currently struggling with vacancy, are transformed into vibrant hubs of learning, attracting students from across the globe and breathing new life into the city's core.

This scenario isn't just a feel-good narrative. It carries tangible financial implications for Dream Office.

Firstly, educational institutions tend to be long-term tenants, offering stability and predictability of cash flow. This is especially valuable in a market characterized by tenant churn and short-term leases. Secondly, schools often require unique space configurations, offering an opportunity for Dream Office to leverage their expertise in retrofitting and tenant customization. As Gordon Wadley, COO, emphasized, their team excels in delivering bespoke spaces that cater to specific tenant needs. Thirdly, the influx of students would create a new ecosystem of demand, benefiting Dream Office's retail portfolio. The recently completed Bay Street collection, with its focus on high-end restaurants and curated experiences, would be perfectly positioned to cater to a younger, more vibrant demographic.

Of course, this hypothesis is not without its challenges. The Federal Government's visa policy change, for example, highlights the vulnerability to unforeseen regulatory shifts. Additionally, educational institutions often operate on tighter budgets, potentially impacting achievable rents.

Downtown Toronto Office Occupancy Trends

While Dream Office REIT has outperformed the broader downtown Toronto office market in terms of occupancy, both are facing pressure. This chart, based on data from Dream Office REIT's Q3 2023 MD&A and CBRE Research, illustrates the current trends.

However, the potential rewards outweigh the risks. Dream Office, with its strategically located portfolio and proven ability to adapt to changing market dynamics, is well-positioned to capitalize on this emerging trend.

While other analysts focus on the immediate challenges facing the office sector, Dream Office's school-lease revelation offers a glimpse into a potential future where education becomes a driving force in revitalizing downtown Toronto's office market. It's a hypothesis worth exploring, a narrative worth following, and a potential catalyst for unlocking substantial value in Dream Office's portfolio.

"Fun Fact: The University of Toronto, Canada's largest university, has a significant presence in downtown Toronto, with its main campus located just north of Dream Office REIT's core holdings. This proximity could make Dream Office REIT's buildings particularly attractive to educational institutions seeking to expand their presence in the urban core."