Political unrest and rising protectionism are causing skepticism among commercial real estate owners, occupiers and investors in the current market and year ahead, according to Avison Young’s recently released, 2017 North America, U.K. and Germany commercial real estate forecast.

But despite global economic and political disruption, stability is expected to define Canada’s commercial real estate sector this year, says Bill Argeropoulos, principal, practice leader, Research (Canada) for Avison Young.

“Despite challenges in Alberta, it is business as usual in most major markets as trends prevalent in 2016 – changing demographics, workplace design and disruptive technology – continue to test the status quo,” he adds. “Successful real estate strategies will evolve to address risk and opportunity in response to these changing circumstances.”

The annual report covers the office, retail, industrial and investment sectors in 63 markets in five countries on two continents.

Office

Almost 6.5 million square feet of office space was completed in 2016, while a further 14 million square feet (61 per cent preleased) was under construction near year-end – a mere 2.6 per cent of existing inventory. Currently, Toronto and Calgary lead, with notable development also underway in Montreal, Edmonton and Vancouver. Calgary and Toronto are among the ten most active office development markets in North America, ranked sixth and eighth, respectively.

Highlights:

• Uneven demand and steady new supply lifted Canada’s overall office vacancy rate 150 basis points (bps) from year-end 2015 to close 2016 at 12.5 per cent. As expected, vacancy increased in 10 of 12 markets surveyed with Calgary posting the highest rate (22 per cent) and biggest change (+600 bps). A supply-demand imbalance will drive office vacancy higher in most markets, lifting Canada’s vacancy rate slightly above 13 per cent by the end of 2017.
• Due to weak fundamentals in Calgary and, to a lesser extent, in Edmonton, Western markets will lag Eastern markets by a wider margin. Vacancy among Western markets jumped to 15.2 per cent at year-end 2016 from 11.9 per cent at year-end 2015, and is poised to rise to 17.1 per cent by the end of 2017. Vacancy among Eastern markets has been more modest, climbing to 11.1 per cent at year-end 2016 from 10.5 per cent at year-end 2015, and is forecasted to settle at 12 per cent by the end this year.

Retail

“Retail is, perhaps, regarded as the most volatile sector as technological disruptors and rising consumer debt levels remain among the major threats,” states Argeropoulos. “As in 2016, big data, demographics and millennial behaviour will preoccupy the retail sector in 2017.”

While “hard assets will always be needed,” digital and physical retailing strategies continue to be scrutinized with an increase in online retailers’ opening physical stores. Examples include Costco’s launch of its first business centre store concept in Toronto – focusing more tightly on the office and business-supplies sector, Best Buy’s new experience stores, set to host Google’s first “shops within a shop” in four Canadian locations and Amazon’s line-free grocery store in challenge to supermarkets.

Industrial

“The industrial market has been resilient and remains the darling among Canada’s commercial property sectors, exceeding expectations in most markets in 2016, notes Argeropoulos. “Although the manufacturing sector continues to retool, e-commerce is accelerating the rapid-order-fulfillment phenomenon, fuelling both leasing and investment sales.”

Highlights

• The industrial market looks bright as higher competition prompts existing landlords and developers to offer viable, flexible and affordable product near urban centres to meet e-commerce demands. Matching the right supply with demand will be the challenge.
• Near the end of 2016, Canada’s overall industrial vacancy rate hovered at 3.1 per cent compared with 3.6 per cent at year-end 2015. Ten of the 11 markets surveyed displayed single digit vacancy in 2016, with Toronto and Vancouver posting rates below the national average. Speculative construction coming online is expected to push vacancy modestly higher, to 3.4 per cent by the end of 2017.
• Toronto is North America’s third-largest industrial market, and Canada’s largest. Canadian markets captured five of the 10 lowest vacancy rates in North America – a trend that will persist in 2017.
• More than 12 million square feet (34 per cent preleased) was under construction near the close of 2016, down from 14 million square feet at the end of 2015. While Toronto and Vancouver remain construction hubs – accounting for nearly 80 per cent of total development – Toronto was the only Canadian market to claim the ninth spot in North America’s top 10 most active development markets.
• In some markets, investment sales are the largest source of activity in this sector as users are taking advantage of available credit options to purchase, lowering their operating costs. Elsewhere, the lack of industrial properties for sale and the absence of industrial land for additional development are pushing pricing to new heights.

Higher pricing in Vancouver and Toronto led some owners to sell assets, including whole or partial interests, while joint-ventures are increasingly popular as a means of spreading risk.

“Flush with capital, investors will resume their pursuit of the best risk-adjusted returns across the risk spectrum – including core to opportunistic, debt and equity – in 2017,” concludes Argeropoulos. “Demand for high quality product will spill over from Toronto and Vancouver to Montreal – and, perhaps, Calgary, if the price of oil stabilizes.”