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Economy challenges Canadian office market

Lower oil prices and urban intensification are just two factors affecting various markets
Tuesday, August 25, 2015

Lower oil prices, workplace strategies and urban intensification are a few significant factors affecting various office markets across Canada.

The Avison Young Mid-Year 2015 Canada, U.S. and U.K. Office Market report examined 13 markets across the country and found performance varied based on such factors. For example, in Alberta, lower oil prices negatively impacted cities, specifically Calgary.

“No doubt the plunge in the price of oil has shocked the system, suppressing GDP growth and keeping employment growth at bay,” said Bill Argeropoulous, principal and practice leader of research (Canada) for Avison Young.

Argeropoulous adds that commodity-based and development-laden markets should experience a flight to quality. As a result, landlords may have trouble generating high rental rate growth as occupancy levels will be more difficult to maintain.

The report also found oil prices and markets tied to the energy industry are universal concerns in both Canada and the U.S.; however, Canada seems to be moving in a less positive direction with higher vacancy levels and further Bank of Canada interest rate cuts.

British Columbia

Overall, vacancy increased in 11 of 13 markets in Canada. Western markets saw vacancy hike 160 bps from the previous year to 10.3 per cent. In Vancouver, a recorded vacancy of 9.8 per cent, its highest registered since 2004, hit an 11-year high. This stemmed from about 1.5 million square feet of new product delivered over the past 12 months, as well as healthy leasing activity that resulted in more than one million square feet of regional positive absorption since mid-year 2014.

Suburban vacancy dropped 1.7 per cent from the previous year. In total, 2.5 million square feet of new space in both downtown and suburban office markets over the past two years produced a regional market in flux. Sub-lease vacancy stayed the same and is at its lowest point since mid-year 2012.

Alberta

Along with Vancouver, downtown vacancy spiked the most in Calgary at 10.7 per cent. Calgary’s market has shifted significantly over the past year with vacancy rising to 11.5 per cent from 8.3 per cent mid-2014. This is largely due to a hike in vacant sublease space. Energy companies have cancelled or deferred capital expenditures, laid off staff and placed unused space on the sublease market due to declining oil prices. Avison Young says the current market is “conducive to merger and acquisition activity,” which has been increasing in the energy industry.

There’s an expected spike coming in available sublease space due to these mergers. However, a large amount of new product—Calgary has about 6.2 million square feet of office space under construction—could pose problems if oil prices remain at current levels. For instance, five developments were delivered during the first half of 2015 with substantial vacancy. Five additional developments are poised for completion by the end of Q4.

On the other hand, Edmonton has been slightly less affected by oil prices. The city saw an office vacancy increase to 8.5 per cent from 8.1 mid-2014. With a forecasted increase in vacancy for 2017, landlords such as Dream, Morguard and Oxford are attracting tenants with higher inducement allowances so they can address property risks.

Edmonton recently shined among national headlines with news of its impending Ice District, which will house two of the three major downtown office developments. The city’s skyline continues to rise, pushing uncertainty over how vacancy rates will rise. Observers see the downtown retail and multi-family sectors benefitting from the Ice District, while office tenants should be satisfied with newer, efficient spaces.

Lethbridge recorded the highest vacancy rate in Canada for mid-2015 at 16.5 per cent. Still, while vacancy rates remain low, new downtown construction and about 20,000 square feet in the suburbs in early 2016, might push class-A vacancy. In fact, vacancy is expected with underlying market trends, such as new construction and the repurposing of retail and industrial space for office use. Lethbridge is also expected to see a high impact of suburban vacancy in 2016 as a major U.S. tenant recently announced its departure. In fact, the exit could spark a 40 per cent vacancy hike. In response, local landlords are offering new tenants incentives, such as project management, free rent and tenant improvement allowances.

Saskatchewan

Regina’s office market is now more balanced and competitive after years of being a “landlord’s market.”

Despite lower oil prices, the Saskatchewan economy has remained stable. The report says this stability can only help the office market in a city where a growing population will support incoming businesses.

In June 2015, the City of Regina determined that the downtown and central city office area should contain at least 80 per cent of the city’s medium and major office developments, and that no new offices should be approved in this area when the downtown vacancy rate is equal to or less than 6.5 per cent of available office area.

Looking ahead, Agriculture Place, the city’s newest 10-storey office tower, will eventually bring 160,000 square feet of office and retail space to the market upon completion. Downtown vacancy and rental rates remained the same, while demand in the suburbs caused an absorption uptick.

Manitoba

The office market in Winnipeg is slowly growing, with transactions stemming from relocations, expansions or space consolidation. Lease renewals remain an affordable option.

Avison Young found that the city has not seen a decline in lease rates for the last ten years, and this stability is keeping investors satisfied and tenants happy upon lease renewal.

Existing buildings are turning more creative as construction costs remain expensive. In June 2015, True North Sports and Entertainment and CentreVenture announced a $400-million mixed-use redevelopment in the heart of downtown.

Ontario

As Canada delivered 8.5 million square feet of new office space during the past year, 42 per cent of this is in Toronto. About 3.5 million square feet was completed across the Greater Toronto Area by mid-2015.

Meanwhile, 5.7 million square feet is under construction. This represents 57 per cent of more than 20 million square feet now under construction across Canada. Along with Calgary, Toronto’s development represents 60 per cent of the pipeline.

The suburban market posted strong year-over-year absorption numbers in Toronto at 13 per cent. As previously reported, the suburbs outperformed the downtown market. Suburban vacancy is improving and tenants are committing to these spaces despite burgeoning developments. Meanwhile, the downtown market remains resilient.

Vacancy rates in the Toronto West market reached 15 per cent; however, the report suggests much of this space is part of completed deals with wavering terms, as absorption is at its highest. A recent trend towards flex space, as seen in Oakville, might see single-storey buildings competing with multi-storey buildings currently under development in the area.

Large-block deals are almost complete, and momentum in key nodes is expected to spark further leasing velocity in Toronto West until the end of 2015.

Vacancy rates increased in downtown Ottawa to 8.8 per cent, and the market is having “a rougher ride than what is considered normal in the nation’s capital.” Rental rates have increased as more technology companies move in to take advantage of the local talent pool. Meanwhile, with the upcoming federal election, the office market is expected to face big expansion plans with a “wait-and-see attitude,” as companies earn income from providing goods and services to government. The first phase of Ottawa’s LRT system is continuing to prompt more retail and hotel developments in the core, as greater access is expected.

In the Southwest Ontario market—Kitchener, Waterloo, Guelph and Cambridge—70 per cent of total office space remains focused in Kitchener and Waterloo. A depressed economy has driven high vacancy (11 per cent) in this technology-driven sector. Yet, demand for space is on the rise as a local economy stabilizes. Large tenants have relocated to suburban areas, into new class-A buildings. Downtown areas are struggling as a result, prompting more aggressive landlords. Waterloo Region’s LRT system, still under construction, is pushing more office developments on new commercial lands along the planned route. Overall, this market is ripe with opportunities for short-term rental value.

Quebec

Quebec City posted the lowest vacancy rates at 8.6 per cent. Over the past 12 months, several projects were announced, including the Phare de Quebec, a 65-storey skyscraper that will be the tallest east of Toronto. By the end of Q2 2015, six suburban projects totalling 950,000 square feet were in the preleasing phase. Overall, with the announcement of 60 mixed-use projects, leasing and development are expected to rise in the next few years, prompting a potential rise in downtown office vacancy.

In what the report calls a “real estate transformation,” 41 new projects were announced in the Greater Montreal Area as of mid-2015. Half of this preleased space is located downtown. More supply than demand is expected and vacancy rates should remain high. As of mid-2015, these rates reached 9.4 per cent from 8.6 per cent last year during the end of Q2. Suburban vacancy is also rising, and developers are active there with nine projects in the works that will eventually add 1.3 million square feet of space.

Maritimes

Halifax has seen more office space rise along its skyline, causing a slow increase in vacancy. Still, this market is expected to outperform the suburbs, even as suburban landlords lure tenants with flexible lease term, attractive rates, free parking and green space.

New developments like the Nova Centre will bring one million square feet of mixed-use development to the market. This will include two office towers, expected for completion in September 2016. While vacancy is expected to increase through 2015 as two new buildings near completion, there is no forecasted change in net or additional rental rates. Meanwhile, developers are finding spots outside the city as highway access is a major tenant amenity.

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