Developers remain committed, tenants take pause

Two new reports from CBRE Limited are telling in terms of where the Canadian commercial real estate market has been and how the future is shaping up. The recently released Global Prime Office Occupancy Report compared markets across the globe over the past year and found that two Canadian cities were amongst the top performers in terms of rent growth and asking rents for prime office space. The National Office and Industrial Second Quarter 2013 Statistical Summary however, points to softening demand for office space and the emergence of dynamics that may not produce the impressive office statistics that Canada has come to enjoy in recent years.

“A year ago, office landlords and tenants – who are not inclined to see eye to eye – would have agreed that downtown office vacancy rates were too low,” said John O’Bryan, chairman of CBRE Limited. “With 22 downtown office towers now under various stages of construction across the country, one has to wonder if the pendulum is beginning to swing too far in the opposite direction.”

Class A downtown office vacancy rates below 5.0 per cent had become the norm across Canada, which produced some daunting rental rates for tenants in the market. According to CBRE’s Prime Office Occupancy Report, Calgary recorded the eighth largest increase in prime office rents in the world on a year-over-year basis as of the first quarter of 2013, while Toronto was the 50th most expensive office market and the top Canadian city on the list. Landlords have responded to these conditions by launching new office projects across the country, which currently total 11.6 million square feet. Pre-leasing in the new towers continues to be healthy and has allowed construction to start on 22 downtown office towers, with additional starts expected; however, market conditions are changing.

“There was some surprise last quarter when office leasing was almost entirely confined to the new towers. We now have a second quarter of data indicating soft demand for existing office space and some significant increases in vacancy,” said Ross Moore, Director of Research for CBRE Limited. “While the Canadian office market is strong in comparison to almost any other country in the world, there are new dynamics at play which could have implications for the market once the wave of new supply comes on line in the years ahead.”

The second quarter of 2013 marks the second consecutive quarter in which more office space was returned to the market than was absorbed by tenants. There was a total 718,330 square feet of negative absorption in downtown office markets across the country, which caused the overall downtown vacancy rate to climb 30 basis points (bps) quarter-over-quarter to 6.5 per cent. Over one million square feet of downtown office space has been vacated so far 2013. Five downtown markets, including Vancouver, Calgary, Toronto, Montreal and Halifax, have sublet as a percentage of vacant space above 20 per cent. This forward looking indicator of tenant intentions is highest in Calgary at 48.5 per cent.

“The months ahead will help to confirm some of the trends that are establishing themselves and allow us to better forecast how this construction cycle plays out,” Moore suggested. “Halfway through 2013, we are seeing moderate employment growth being counterbalanced by the push for office space efficiency, and existing stock is at a significant disadvantage compared to the new builds.”

All the major markets recorded an increase in vacant downtown office space. After a relatively strong performance last quarter, Toronto joined Calgary and Montreal by posting significant negative absorption this quarter. The slowdown in the Calgary office market, which started in the back half of 2012, continues. Vacancy in downtown Calgary climbed 30 bps quarter-over-quarter to 6.0 per cent, up from 5.0 per cent a year ago. Landlords appear to have responded to the loss of momentum in the Calgary office market as the average downtown asking rent in Class A buildings fell $1.16 per square foot (psf) to $39.37 psf – a significant change for a market that had been a global leader in prime office rent growth.

There was slightly better news for the suburban office market. Over 700,000 square feet of new construction was completed in the suburbs across the country this quarter, much of it was leased. The suburban vacancy rate climbed 40 bps to 11.9 per cent; however, the overall average asking rent in Class A buildings increased $0.93 psf to $18.56 psf quarter-over-quarter. The suburban market is showing moderate strength compared to downtown office markets due in part to the decrease in construction over the last two quarters. The amount of suburban office space under construction is now 1.0 million square feet below the peak that was recorded in the fourth quarter of 2012.

National downtown office construction on the other hand, rose 290,000 square feet quarter-over-quarter to 11.6 million square feet. Toronto leads the way with 5.5 million square feet under construction, followed by both Calgary and Vancouver at 1.7 million square feet. Calgary has an another 2.7 million square feet of office space either announced but yet to start construction or likely to be announced in the next 30 to 60 days. In total, downtown office construction is very near the high-water mark that was set in the 2009 office construction cycle.

“It’s a bit like déjà vu really. There were concerns in 2009 as to how that construction cycle would play out and in the end, the new stock was pre-leased and the vacated existing stock was absorbed without any heroic effort,” said O’Bryan. “This time, however, developers look poised to get a little ahead of the market. Recent leasing activity should bring focus back to the fundamentals and the outlook for existing office stock.”


The Canadian industrial market continues to exhibit strong fundamentals overall; however, construction is putting some upward pressure on industrial availability rates in Western Canada. The pickup in the U.S. economy and signs of economic stability in China are supporting demand for industrial space in Eastern Canada.

“The industrial market continues to adjust to decreased capital spending in the resource-dependent markets in Western Canada,” said Moore. “Industrial construction activity as a percentage of existing inventory in the west is over three times that in the east and markets will likely need time to recalibrate to tempered growth in the energy sector.”

The national industrial availability rate was unchanged at 5.8 per cent this quarter, but there were some significant changes locally. Four markets had availability rates climb and five had availability fall. Increased industrial availability was limited to Western Canada, with some big moves occurring in Calgary and Edmonton where availability rates climbed 170 bps to 6.3 per cent and 110 bps to 5.2 per cent, respectively, quarter-over-quarter. Markets in Eastern Canada continue to tighten and the Greater Toronto Area (GTA) industrial market recorded impressive leasing activity in the second quarter of 2013 as the availability rate fell 30 bps to 4.5 per cent. The GTA has recorded 7.7 million square feet of positive absorption in the first two quarters of 2013, an amount that would normally require three quarters to achieve based on the quarterly historical average. Rental rates were up in both Western and Eastern Canada to an average $5.89 psf nationally, which reflects the strength of t
he industrial sector across the country despite some course correcting in resource-dependent markets.

“The second quarter office and industrial data shows markets making adjustments to economic developments and ongoing construction cycles,” said O’Bryan. “Balance is difficult to achieve and thankfully none of the Canadian markets are too far off the mark at the moment. Now is the time for the commercial real estate industry to remain vigilant in order to ensure that this equilibrium is maintained.”

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