By Stuart Barron, National Director of Research, Canadian Markets
Green Shoots Start to Appear
Once the dependable darling of the Canadian office markets, suburban markets absorbed a bullish three million square feet (msf) a year from 2000 until late 2008 when the financial crisis put the brakes on growth. Ten years later, many are still wondering when a turnaround will take place.
“Wow” Stat Tells the Story
Vancouver, Ottawa, Montreal, and Toronto drove in excess of 83% of this growth or 2.5 msf per annum before the crisis. Between Q4 2008 and Q4 2017, average absorption in these key markets plunged to 411,000 sf per year or 16.3% of pre-crisis levels.
The financial crisis had a massive impact on the mindsets of business leaders. In its aftermath, real estate was suddenly seen as a core investment strategy, a key engine of productivity and competitiveness. Accessing and keeping talent became the mantra of success and the main target was those plugged-in millennials. This young-and-restless cohort had its own live-work-play vision, which ignited a dramatic CBD development cycle that’s led to a new era of revitalization in gateway cities around the world.
As tenant migration into CBD markets proliferated and new tech entrants targeted downtown markets to locate their budding businesses, suburban markets saw growth decelerate. Interestingly, these markets also experienced more subdued cap rate compression compared to office product in the downtown markets.
Why We Expect Revitalization to Happen
Okay, that’s the backstory. The good news is that we believe suburban growth is about to turn a corner, and this trend, already underway, should become more pronounced over the next two to four years. Here’s some reasons why:
- Companies have been compressing space footprints on a per-workstation basis since the financial crisis. As the first organizations to densify face the natural expiry dates of 10-year leases, many will undoubtedly want to expand their footprints.
- The financial crisis marked an explosive increase in migration into the downtown markets, particularly in Toronto and Vancouver. Availability rates are dramatically low at 2.7% and 5.0%, respectively, with little relief on the horizon until late 2020 and beyond. With tight overall market conditions, tenants will go where options exist – and the suburbs are a likely choice.
- Super-tight downtown markets are seeing rental rate pressure intensify, and with little near-term development relief in sight, the business case for suburban growth has never been stronger, particularly for cost-conscious businesses that do not require a downtown location.
- The live-work-play environment within CBD markets is getting more expensive. The average price for a newly constructed downtown condo has increased to $656,000 in the city of Toronto. As millennials age, many are already embracing the more affordable housing opportunities offered by suburban markets.
- Rising interest rates and rising commodity pricing should bolster key sectors. Banking, financial services, engineering, and the resource sector will see some lift within this business environment. This too should buoy suburban growth.
There are always potential headwinds with the potential to disrupt the real estate markets of tomorrow. NAFTA renegotiations and the entire “Buy American” movement are huge question marks that could compress real GDP growth and slow expansionary momentum across Canadian markets. Rising interest rates are also likely to dampen consumer demand as we move towards 2019.
That said, the global economy has been gaining strength, not losing it. The U.S. economy, despite signs of rising inflation, continues to perform well. The technology super cycle, which has driven tremendous growth across Canadian urban and suburban markets is still very much in play. So, against this backdrop, stronger suburban growth is likely to occur.
Of course, real estate is very much a local story, and there will always be winning and losing office nodes. The “attract-and-retain” mantra is still huge. Suburban office nodes that have recreated the advantages of urban city life will attract the business growth of tomorrow. Winning attractions include: modern, sustainable buildings, excellent access to transportation, high parking ratios, large floor plates and lifestyle (gyms) and food (grocery & restaurant) amenities.
So, while we don’t expect to see suburban demand return to pre-financial crisis levels, stronger growth is on the horizon for Canada’s suburban office markets. Stay tuned for more on this hot topic in a special report on suburban markets to be released with “the winter thaw”.
Stuart Barron, National Director of Research, oversees the collection and dissemination of research information supporting the Canadian markets. Stuart is supported by a knowledgeable research team stretching from Vancouver on the west coast to Newfoundland & Labrador on the east coast. One of the key priorities of research is to drive out market intelligence across asset classes including office, industrial, retail, capital markets and multifamily.