Canada’s office markets — resilient during and since the recession — continue to sport relatively healthy market fundamentals; however, some major markets appear to be softening, turning in less-than-stellar performances in the first half of 2013. Many major U.S. markets remain oversupplied, with tenant-favoured conditions — even while tours and velocity have increased and several metro areas have moved into equilibrium. These are some of the key trends noted in Avison Young’s Mid-Year 2013 Canada, U.S. Office Market Report, which covers the office markets in 32 regions in both Canada and the U.S.
“In the United States, the lack of clarity that existed prior to the Presidential election unfortunately continues, and jurisdictions await the impact of higher taxes, sequestration, mandated spending cuts, and Obamacare. The March effective date, versus the January 1st date written into the Budget Control Act of 2011, also means that the impact horizon will stretch into 2014, and most likely beyond,” said Mark Rose, Chair and CEO of Avison Young.
“The lingering storm clouds continue to impact the American, more than the Canadian, commercial real estate markets. Even though an oversupply of office space continues to weigh heavily on many U.S. markets, we are reporting an uptick in tours and deal velocity. This will help move more metro areas into equilibrium, if they have not already. In contrast, despite moderating demand levels and modest shifts in vacancy, most Canadian markets are undersupplied – particularly in urban areas, thus escalating construction levels. Keep in mind, the Canadian market has been on quite a run, and it would not be entirely surprising to see it lose some momentum. In short, the U.S. markets have a ways to go before reaching the level of success that Canadian markets have enjoyed since coming out of the recession.”
Rose adds: “Consistent on both sides of the border is that tenants are looking at LEED-certified buildings and environments that embrace sustainability. They are also looking to control occupancy costs in their current premises and as they move, by employing collaborative work environments and reducing the overall-square-foot-to-employee ratio. With the ongoing tenant flight to quality, look for older vacant office properties to be converted to other uses, or razed, or substantially upgraded. Once again, our brokers have been active in guiding tenants through the myriad of choices that the markets have to offer.”
In the 32 Canadian and U.S. markets that Avison Young surveyed, comprising nearly 1.4 billion square feet, market-wide office vacancy remained in double digits and unchanged in the past 12 months, finishing the first half of 2013 at 13.8 per cent. The downtown markets on both sides of the border combined for a modest 20-basis-point (bps) increase in vacancy to settle at 11.3 per cent during the same period, while the collective suburban rate ended 30 bps lower at 15.4 per cent.
“While many major U.S. markets remain oversupplied with conditions favouring the tenant, the same cannot be said about Canada, especially in the country’s major downtown markets, where conditions tend to favour the landlord – for now,” points out Bill Argeropoulos, vice president and Director of Research (Canada) for Avison Young. “Limited and diminishing space options have not only created a very competitive environment for premises, and elevated rents for select properties and quality of space, but have also muted the demand levels that we have all been accustomed to during the past couple of years. Most of the markets’ transactions have been renewals and/or expansions as landlords try to lock down tenants rather than lose them to the wave of new development starting later this year and into next.”
Argeropoulos adds: “The new supply will be a welcome respite for tenants of all sizes, whether they choose to go into space that will open up as a result of tenants relocating into the new towers (as in the previous development cycle) or take advantage of the latest features offered by the new office buildings. Either way, this will be good for the markets, elevating the anemic leasing activity seen of late and, hopefully, translating into meaningful demand.”
According to the report, through the first six months of 2013, Canada’s office vacancy rate was 7.9 per cent. By comparison, it stood at 7.1 per cent at mid-year 2012, 7.8 per cent at mid-year 2011 and 9.9 per cent at mid-year 2010 – the height of the recession.
Ten of the 12 Canadian markets posted single-digit vacancy and half were below the national average. An East-West divide remains, although the gap has narrowed somewhat compared with the previous 12-month period. The Eastern markets concluded the first half of 2013 with a collective vacancy rate of 8.4 per cent (+70 bps), with Ottawa the lowest at 6 per cent. The remaining Eastern markets and ranging from lowest to highest vacancy were: Quebec City (6.7 per cent, -10 bps), Toronto (8.6 per cent, +50 bps), Halifax (9.1 per cent, +90 bps) and Montréal (9.3 per cent, +160 bps).
The growing Western markets combined for a vacancy rate of 7.1 per cent (+100 bps), with Regina reporting a national-low vacancy of 5.2 per cent. The next closest market was Calgary (6.2 per cent, +160 bps), followed by Winnipeg (7.1 per cent, +80 bps) and Vancouver (7.6 per cent, +90 bps). At 8.7 per cent, Edmonton remained unchanged, while Lethbridge was the highest at 13.1 per cent – up 170 bps over 2012.
Competition for office space is intensifying across the nation’s major downtown markets and, despite a modest increase of 40 bps compared with 2012, Canada’s downtown vacancy rate is a tight 5.6 per cent. However, corporate restructuring, downsizing and consolidations have raised sublease vacancy in some markets. Downtown vacancy is lowest in Calgary (4 per cent, +80 bps), followed closely by Ottawa (4.4 per cent, -140 bps) and Vancouver (4.6 per cent, +130 bps). The highest was Lethbridge (13.5 per cent, +100 bps) while Regina (5.5 per cent) saw the greatest jump, up 370 bps. Unsurprisingly, Calgary, at $57 per square foot (psf), an increase of $5.66 psf over 2012, Vancouver ($52 psf, -$2 psf) and Ottawa ($47.95 psf, -$0.53 psf) registered the highest average gross rents for class A space during the first half of the year.
Canada’s suburban markets saw their collective vacancy rise 130 bps since mid-year 2012 to finish mid-year 2013 at 10.6 per cent. Except for Lethbridge (11.6 per cent, +350 bps) and Vancouver (10.1 per cent, +50 bps), single-digit vacancy persists in the same markets as one year ago, with seven of the 12 markets surveyed coming in with rates below the average. Once again, Regina (3.1 per cent, +170 bps) has the lowest suburban vacancy and Mississauga (Toronto West) (13.7 per cent, +130 bps) the highest. Vacancy in Toronto, the country’s largest suburban market (37 per cent of total), increased to 11.8 per cent this year from 10.5 per cent in 2012. With the exception of Winnipeg (7.9 per cent) which saw vacancy fall 130 bps, the remaining suburban markets experienced increases of between 30 to 350 bps compared with 2012. Calgary and Regina are the most expensive suburban markets with average gross rent for class A premises of $37 psf, followed closely by Vancouver ($36 psf). The most affordable is Lethbridge at $26 psf.
The development pipeline continues unabated. During the past 12 months, office space under construction has increased by 4.5 million square feet (msf) to bring the Canadian total through the first half of 2013
to almost 22 msf (53 per cent preleased) – equating to 4.4 per cent of the existing inventory. Toronto is the biggest development market in the country with 7.1 msf (49 per cent preleased) – one-third of the national total – and also leads with 5.3 msf (47 per cent preleased, 41 per cent of national downtown total) underway downtown. However, Calgary is narrowly outpacing Toronto on the suburban front with almost 2 msf (78 per cent preleased) under development – accounting for 23 per cent of the national suburban total.
One of the larger developments is Oxford Properties’ Ernst & Young Tower: a 900,000-sf, 40-storey, class AAA, LEED Platinum tower in Toronto’s financial core, to be completed in 2017. The tower is 45 per cent preleased to Ernst & Young and TMX Group. Montréal is having a development renaissance as Cadillac Fairview has broken ground on the Deloitte Tower, to be completed in 2015. The tower will comprise 514,000 sf over 26 storeys and is the city’s first LEED Platinum (Core and Shell) office building and first privately owned and financed office tower to be constructed in more than 20 years. Deloitte and Rio Tinto have leased 160,000 sf and 190,000 sf, respectively.
Argeropoulos adds: “A month or so into the third quarter (not reflected in mid-year tally), the construction announcements continue to flow across the news wire with Manulife Financial’s real estate arm launching a tower in downtown Vancouver (980 Howe Street) and in Calgary (707 5th Street SW), while Brookfield Office Properties is proceeding with Brookfield Place Calgary.”
“Though the level of development across the country is impressive, it’s also worrisome, especially in places like downtown Calgary and Toronto where office space under construction as a percentage of the existing inventory sits at 6.6 per cent and 7.6 per cent, respectively. While the new towers will eventually lease up, it’s the back-fill space that tends to linger and ends up being a drag on the market.”