Record Developments Rise As Demand Wanes Across Canadian Central Markets

Calgary

With almost 14 million square feet (msf) of new office developments rising in central Canada, this is the hottest development cycle in over 20 years. Particularly active markets include Vancouver, Calgary and Toronto, where downtown developments under construction total almost 11.6 msf. What is of concern is that this is occurring simultaneously to a pronounced downturn in demand. Net absorption across central markets has averaged negative 475,000 sf per quarter over the past year and a half. Remarkably, even in the face of weakening demand, new developments continue to be announced, as large asset owners and developers urge new product to the market.

New Construction by Year

One reason for this new development is the success of the recent developments in Toronto and Calgary. Between 2009 and 2011, 4.5 msf of new developments came online in downtown Toronto with strong preleasing activity and substantial expansionary growth. Another reason is the spike in demand between late 2009 and mid-2012 across Canadian downtown markets, driven by a wide cross section of sectors, including the banking sector in downtown Toronto. Tenants who are rethinking workplace strategies are consolidating space and relocating into new towers which offer modern amenities, tenant naming rights, and modern HVAC that can handle the higher loads imposed by higher employee density.

While it is uncertain what impact these new developments will have on individual markets, Vancouver and Calgary are expected to remain fairly balanced, with rising vacancy and tenants in a stronger negotiating position than today. One factor that will ensure balance is maintained is that a substantial amount of net new demand is built into the completed pre-leasing transactions.

Toronto and Montreal, on the other hand, are likely to have sharp increases in vacancy over the next few years, causing a pronounced shift to a tenants’ market. Class A vacancy in Montreal’s Financial Core hit a low of 6.4% in Q3 2012, but has since risen to 8.7%. This number will climb into double digits, particularly given recent lease transactions by TD and RBC which will relocate a substantial number of back office staff out of the downtown area and into the garment district between 2014 and 2017. And rumor has it that another new building will be announced to rise in Montreal’s downtown market within a few weeks.

Toronto has 5.1 msf on the rise in the downtown market and although preleasing activity is very strong, these transactions have little, if any expansionary demand built into them. This is quite a different story than prior to the development cycle of 2009 to 2011. Our projections indicate that downtown Toronto vacancy will rise to about 12% by Q3 2017 and this will mean 6 msf of premium space will be available for lease. Consequently, both Montreal and Toronto are likely to shift markedly towards a tenants’ market. With quality and location being paramount for tenants on the street, it is expected that the new developments will fare well, while the older and less functional office inventory will account for the bulk of the market’s vacancy.

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