Economic headwinds challenge Canadian office market fundamentals, U.S. sector shows resilience

The Canadian and U.S. office sectors appear to be moving in opposite directions. Stymied by less-than-stellar economic results, Canadian markets are seeing mixed performance, while U.S. indicators have been largely positive. Despite the differences, there are similarities – mounting concern surrounding depressed oil prices and the burden placed on markets tied to the energy industry (such as Calgary and Houston) on both sides of the border.

These are some of the key trends noted in Avison Young’s Mid-Year 2015 Canada, U.S. and U.K. Office Market Report, released today and covering the office markets in 50 Canadian, U.S. and U.K. metropolitan regions.

“The economic well-being of both Canada and the U.S. impacts directly on property market fundamentals, and there appears to be a widening divergence in economic performance between the two countries, resulting in a corresponding shift in their respective office market indicators,” comments Mark E. Rose, Chair and CEO of Avison Young.

“In the U.S., the Federal Reserve continues to signal it will raise interest rates later this year, though slowly. And in July, the Bureau of Labor Statistics reported the unemployment rate continued to fall in June. Amidst these signs of recovery, the U.S. office market continued to strengthen in the 12-month period ending June 30. Meanwhile, Canada is seeing what has been described as a mild contraction, as the Bank of Canada made a further cut to interest rates and revised down its annual growth forecast. Employment levels have stalled through the first half of the year. The price of oil also has certainly affected some markets more than others – but overall, while vacancy is retreating in the U.S., it is starting to creep up in Canada,” says Rose.

According to the report, of the 50 office markets tracked by Avison Young in Canada, the U.S. and U.K., market-wide vacancy rates decreased by varying degrees in 34 (or more than two-thirds) of the markets, on an annualized basis.

Development activity has surged, with almost 43 million square feet (msf) of office space completed across the 50 markets, up from 38 msf in the previous one-year period, while the under-construction tally is approaching the 100-msf mark – roughly 4 msf ahead of the 2014 pace.

CANADA Already contending with a burgeoning development pipeline, Canadian office market fundamentals faced additional headwinds from weaker-than-expected economic indicators through the first half of 2015. While performance was mixed among the 13 markets surveyed, depressed oil prices are taking a toll in Alberta – particularly Calgary. Meanwhile, workplace strategies and urban intensification continue, and as purely office development sites become increasingly scarce, urban renewal and mixed-use development – combining office, retail and residential – are found across many of Canada’s downtown markets.

“Improving market fundamentals in the U.S. office sector are a welcome relief, and though Canada’s sound property fundamentals are being tested as indicated by the latest results, it’s difficult not to take a glass-half-empty point of view,” states Bill Argeropoulos, Principal and Practice Leader, Research (Canada) for Avison Young. “No doubt, the plunge in the price of oil has shocked the system, suppressing GDP growth and keeping employment growth at bay. Commodity-based and development-laden markets will likely experience a flight to quality, making it difficult for landlords to maintain occupancy levels and generate any notable rental rate growth, thus shifting the tenant-landlord balance that some markets have enjoyed.”

Argeropoulos adds: “Notwithstanding some softening in the Canadian office sector, we expect the marketplace to stay active in coming quarters, supported by diverse local office market drivers. If we take the glass-half-full perspective, the markets have yet to realize the full benefits of the recent interest-rate cut and a low dollar. The wild card is that U.S.-based tenants continue to show considerable interest in expanding or establishing a foothold in major Canadian centres, a trend that has the potential to offset some of the negatives.”

Notable First-Half 2015 Canadian Office Market Highlights:

  • Varying and sporadic absorption levels, coupled with new office completions, lifted Canada’s overall vacancy rate 110 basis points (bps) from one year earlier to 10.3 per cent at the midway point of 2015. Vacancy climbed in 11 of 13 markets.
  • Quebec City (8.6 per cent) and Lethbridge (16.5 per cent) posted the lowest and highest vacancy rates, respectively; the greatest swing occurred in Calgary (11.5 per cent, +320 bps).
  • Weighed down by Calgary’s woes, Canada’s Western markets collectively saw vacancy spike 160 bps over the previous year to 10.3 per cent at mid-year 2015. Eastern markets witnessed a modest 30-bps bump to 10 per cent.
  • Downtown markets as a whole expanded, posting 8.8 per cent vacancy at mid-year 2015, up 160 bps year-over-year – more than half of the markets remained in single-digit territory. Downtown vacancy jumped significantly in Calgary (10.7 per cent, +450 bps) and Vancouver (9.8 per cent, +340 bps).
  • Suburban markets recorded positive growth as vacancy retreated marginally (12.1 per cent, -20 bps), led by strong year-over-year absorption numbers from Toronto (13 per cent, -120 bps). Unlike downtown, less than half of the suburban markets displayed single-digit vacancy.
  • Canada delivered 8.5 msf annualized of new office space (42 per cent in Toronto), with developers slightly favouring completions in the country’s downtown markets. This trend reversed the previous 12-month tally, when suburban outpaced downtown completions by more than two to one.
  • Despite a decline from 2014, more than 20 msf is under construction across Canada (52 per cent preleased and representing 3.9 per cent of existing inventory). Calgary (6.2 msf / 51 per cent / 8.9 per cent) and Toronto (5.7 msf / 57 per cent / 3.2 per cent) are the most active and together account for almost 60 per cent of the development pipeline.
  • In the past year, the average asking gross rent for class A downtown office space in Canada fell to $43.47 per square foot (psf) (-$0.52 psf), while rising modestly for suburban class A product ($41.34 psf, +$0.83 psf).

 

The Canadian and U.S. office sectors appear to be moving in opposite directions.
The Canadian and U.S. office sectors appear to be moving in opposite directions.
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