Second quarter stats reveal a widening gap between Canada’s prospering and struggling office markets as investors continue to focus on downtown Class A properties. CBRE’s recently released overviews of supply, demand and cap rates shows Toronto and Vancouver outperforming national averages, while Calgary’s vacancy rate climbed above 25 per cent and analysts project it may reach 30 per cent as downtown tenants continue to consolidate or give up their space entirely.
CBRE’s 10 surveyed markets recorded an average vacancy rate of 13.1 per cent, with Toronto’s 8 per cent rate at the low end of the scale. However, that cloaks a downtown-suburban split, which saw the downtown Class A vacancy rate fall to 3.6 per cent despite the nearly 950,000 square feet of new office supply that came onto the market during the quarter.
Downtown Class A average net rents jumped $1.06 per square foot to hit $28.23. Suburban Class A average net rents are exactly $11 dollars lower, at $17.23 per square foot, after dropping $0.13 since March 31. This trend is also expressed in cap rates, which, while holding steady since Q1, are in the range of 4 to 4.5 per cent for downtown Class AA versus 5.5 to 6.25 per cent for suburban Class A.
Toronto office tenants absorbed more than 2.2 million square feet of space during the quarter, representing more than two-thirds of leasing activity across all 10 markets. Nearly 4.5 million square feet of new supply is now under construction, with about 3.2 million square feet of that located downtown.
“The next new development cycle kicked off this quarter with 16 York and CIBC Square,” the CBRE report observes. Together, the two projects will add about 1.5 million square feet to the downtown inventory.
Analysts also expect new construction announcements for downtown Vancouver as the vacancy rate continues to drop. Average downtown Class A net rents topped the 10 markets at $31.39 per square foot, while the vacancy rate fell 80 basis points, from 7.3 to 6.5 per cent during the quarter.
“This is the fourth consecutive quarterly decrease downtown, largely driven by technology tenants,” the report states. “As the Vancouver economy has grown since the recession, average office tenancy sizes have increased from 5,000 square feet to 7,500 square feet.”
The suburban Class A vacancy rate dropped 60 basis points, from 16.2 to 15.6 per cent, even though there was a modest 10,000 square feet of negative absorption across the entire suburban market. Average Class A net rents dipped slightly from $24 per square foot to $23.78.
Vancouver cap rates are the lowest among the 10 surveyed markets for all classes of downtown and suburban office — in the 3.75 to 4 per cent range for downtown Class A. Cap rates of 5 to 5.75 per cent for Class B suburban office properties are on par with rates for downtown Class AA in Calgary.
“GDP growth, strong leasing fundamentals, tech growth and demand, and limited new supply have contributed to a sound investment matrix in the Metro Vancouver area,” says Jim Szabo, vice chairman with CBRE’s national investment team.
Meanwhile, Calgary’s market is splitting more by class than by location. The pace of negative absorption subsided this spring, with 35,000 square feet added to the overall inventory of empty space versus the 282,000-square-foot augmentation in the winter of 2017. At the same time, construction wrapped up on the Brookfield Place, East Tower, bringing 1.4 million square feet of new downtown office space online.
“Despite being 81 per cent pre-leased, a significant amount of unoccupied space exists, driving the downtown office vacancy rate up by 270 bps to 27.7 per cent,” the CBRE report notes. “Due to lower rents and tenant inducements, a flight-to-quality within the city core has improved vacancy in AA properties, while lower class buildings suffer.”
This is reflected in an increase in average Class A net rents downtown, which have improved by $1.13 over the quarter, rising to $19.06 per square foot. Suburban Class A net rents declined by $0.32, but are still higher than downtown, at an average of $21.33 per square foot. Both have plunged from the Class A average of nearly $31 per square foot in the first quarter of 2014.
The suburban vacancy rate, at 22 per cent, is also lower than downtown. Nearly 490,000 square feet of office space is still under construction, now surpassing the supply pipeline of 430,000 square feet downtown. Cap rates are slightly lower than downtown, in the range of 6.35 to 6.75 per cent for Class A and 7.5 to 8.25 per cent for Class B. However, prospective investors aren’t tripping over vendors in either locale.
“Calgary has emerged as an alternative for buyers in Toronto and Vancouver,” suggests Garry Beres, executive vice president with CBRE’s national investment team. “Notwithstanding the state of the office leasing market, there continues to be institutional interest in well-leased core product and interest in Class B and C product on a per square foot basis. Overall, the market is active, but there is a shortage of product, especially core product.”
