Playing Hard to Get

When it comes to a conversation about the state of Canada’s office building and leasing activity, Toronto and Calgary are like those annoying hipsters who just want to talk about themselves. Deservedly so, one could argue: the total inventory of built space across the country, which increased by nearly two million square feet in 2012, was due in large part to new office towers in Calgary and Toronto, which have both been experiencing a development boom. In fact, nearly 80 per cent of the increase in occupied office space in downtown markets in 2012 was recorded in the first quarter when The Bow’s 1.9 million square feet was delivered in Calgary.

When taken as a whole, the numbers across Canada show that the combined Class “A” and Class “B” vacancy rate fell from 6.8 per cent to 4.7 per cent over 2012, while total vacant space in the country’s major cities fell from 11.2 million square feet to 9.8 million square feet, according to data from Newmark Knight Frank Devencore. And while the leasing activity that did occur in downtown office markets was not always widespread — thanks to Toronto and Calgary hogging the spotlight with the lion’s share of new supply — other cities would like you to know they are also doing quite well, thank you very much.

For example, in its Real Estate Market Study, Newmark Knight Frank Devencore reported that vacancy rates in downtown Montréal’s Class “A” and “B” office buildings have fallen to 5.8 per cent. Over the course of 2012, just under 585,000 square feet was absorbed, and there is approximately 2.7 million square feet currently available for lease and sublet. As has been the case for over a year, contiguous spaces greater than 25,000 square feet are increasingly difficult to find in Québec’s Metropolis.

“Over the past 24 months approximately one million square feet of Class “A” and Class “B” office space has been absorbed, so in this post-recession period there has been considerable leasing activity,” said Jean Laurin, president and CEO of Newmark Knight Frank Devencore. As a result, the dynamic of downtown Montréal’s office market is about to undergo a significant shift. Two new tower projects have secured anchor tenants: Deloitte LLP has signed on to the 514,000 square-foot Cadillac Fairview development that will be built between Windsor Station and the Bell Centre; and Aimia, which owns and operates Aeroplan, is the lead tenant in the Tour Aimia, which is part of an office tower and condominium complex under construction in the heart of the Quartier International. Other pre-development activity continues as well, with as many as three or four additional projects seeking anchor tenants before proceeding.

“The demand for top-tier space in Montréal has begun to severely limit tenant opportunities, and the two major tenancies we have seen with Aimia and Deloitte speak to the need for new LEED-certified office space,” said Laurin. “These new projects will begin to change the face of downtown Montréal and will certainly generate new leasing opportunities. However, because these projects are two-to-three years from delivery, tenants who have leases coming up for renewal over the next year or so should be strategizing now with their real estate advisors in order to take advantage of current and emerging opportunities. “

City of Glass is Getting Cramped

On the other side of the country, Jones Lang LaSalle’s second annual Blue Chip Building Index (BCBI), a barometer of the leasing environment in Vancouver’s Central Business District (CBD), reveals that the combined average vacancy rate of the city’s 20 most prestigious office towers has dropped to 1.1 per cent – an almost 50 per cent decline from the inaugural BCBI in 2011. According to the proprietary index, low vacancy combined with ongoing strong demand (1.6 million square feet of tenants currently represented in the market) may push the city’s trophy towers closer to full occupancy before new supply provides new options for tenants.

“The scarcity of space options in the city’s top 20 office buildings, and across the CBD as a whole, presents an even bigger challenge for tenants than a year ago,” said Gavin Reynolds, senior vice president in JLL’s Vancouver office. The 20 premier office buildings featured in the BCBI were selected based on criteria such as location, amenities, green standards, floor plate size, access to public transportation and building age. According to the Index, eight of the city’s BCBI buildings are currently 100 per cent occupied, compared to six fully occupied buildings a year ago. In addition, Vancouver’s BCBI vacancy level is lower than the vacancy rate of BCBI buildings in Canada’s two largest office markets: Toronto at 4.9 per cent and Montréal at 5.5 per cent (Calgary, with a BCBI vacancy rate of 0.4 per cent, is the only major city in Canada with a lower BCBI vacancy rate than Vancouver).

Given these numbers, an oft-asked question is “When will market conditions begin shifting in tenants’ favour?” With Vancouver is in the midst of the largest downtown office-building construction cycle it has ever experienced, the Index suggests that the leasing environment will improve leading up to 2015, when several companies with leases of 50,000 square feet and higher will move into newly completed towers such as TELUS Garden, MNP Tower and 745 Thurlow. The confirmed projects are approximately 43 per cent pre-leased, and large users are already beginning to take advantage of the opportunity to lease space that will be vacated by tenants scheduled to move into the new crop of buildings.

“In addition to the availability of space in the city’s new developments, backfill opportunities will open up for tenants seeking space downtown,” said Reynolds. “With the strong pre-leasing activity at downtown projects currently under construction, we expect space in the newly-opened towers to be absorbed in a timely manner. With this activity, we are already seeing a movement away from the current landlord-favourable environment as options begin to expand for tenants.”

Signs of Life in Canada’s Suburban Office Market

Canada’s major downtown office markets have attracted a lot of attention in recent months, which has eclipsed yet another solid year for the suburban office market. Hard hit during the recession, the suburbs have recorded steady demand for office space and fundamentals have improved consistently over the past two years according to CBRE Limited’s National Office and Industrial Fourth Quarter 2012 Statistical Summary. Urbanization will continue to drive office demand in downtown cores; however, a large suburban population still needs to be serviced, and the 43.7 per cent of existing office stock which is located in the suburbs will prove to be more than viable.

“While frequently overshadowed by our thriving downtown markets, the suburban office market should not be written off,” said John O’Bryan, chairman of CBRE Limited. “Vacancy remains higher in the suburbs, but demand has been consistent and the suburban market has been resilient despite two challenging years for the economy.”

In the fourth quarter, the suburbs recorded 200,284 square feet of positive absorption nationally compared to 221,680 square feet of positive absorption in downtown markets. In relative terms, activity in the suburbs actually outpaced leasing activity downtown when one considers the fact that the downtown inventory is 53.9 million square feet larger than the suburban universe. The resilience of the suburban office market in 2012 was not all that surprising. Suburban demand has been consistent for the past two years with total annual absorption reaching 2.2 million square feet in 2011 and 1.9 million square feet in 2012. In comparison, downtown office absorption was cut
in half from 5.7 million square feet in 2011 to 2.4 million square feet in 2012. The smaller 312,000 square feet decrease in suburban office absorption between 2011 and 2012 is quite impressive given that the economy was growing more slowly in 2012.

“In many markets, the suburbs present the only options for tenants looking to expand or sign new leases in the near-term,” noted Ross Moore, Director of Research for CBRE Limited. For example, the lack of vacant downtown large-block options in Calgary forced Imperial Oil to make an unprecedented decision to move to Quarry Park in the suburban south.

“With a construction cycle underway and additional towers likely to be announced, downtown markets will stay in the spotlight. But make no mistake, suburban office space remains desirable and has a viable future – especially where public transportation is available,” says O’Bryan. Interestingly, Edmonton, London, Ont. and Ottawa were the only markets to record a drop in office vacancy both downtown and in the suburbs compared to 2011, according to CBRE.

Tenants Should Consider Their Options

This plethora of figures proves what we already know: that demand is not abating in the Canadian office market. As such, rents have and will move up year-over-year in every city as downtown markets are settling into a holding pattern that is expected to continue until new supply is delivered over the next three to four years across the country. And while global economic volatility and the increasing number of mergers and acquisitions have led to an growth of grey market opportunities for downtown A class tenants, current conditions are also triggering early renewals and amplifying pressure for companies to do more with less square feet. “Due to tight supply in office buildings, the larger tenants need to begin evaluating their options several years in advance of their lease expirations,” said Reynolds. “With the shortage of available space downtown, renewing current leases or relocating outside the CBD is among the most viable, although not necessarily ideal options for tenants.”

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