Industrial availability dropped to a record low in Q1 2019, while office markets across Canada had some of the best results in recent memory
Canada’s office real estate recorded the most vigorous leasing activity in years, primarily spurred by a rapidly expanding tech sector. Overall, the national office property vacancy rate decreased by 40 basis points (bps) quarter-over-quarter to 11.5% in Q1 2019, the lowest level since Q2 2015. The amount of office product under construction nationwide in the first quarter reached 16.0 million sq. ft. for the first time since Q4 2015, as Vancouver saw an additional 1.4 million sq. ft. of new office development break ground this quarter.
The rise of online retail sales, and the associated warehouse space needed to keep up with consumer demand, has pushed the Canadian industrial market into overdrive. The national industrial availability rate dropped to a new record low of 3.0% in Q1 2019. To meet user demand for taller clear heights, larger door counts, and specialized warehouse configurations, 22.6 million sq. ft. of industrial space is under construction, the bulk of which is in Toronto and Vancouver. This is the highest level of national industrial development seen since 2015.
“Canadian office markets continue to gather momentum, in large part as a result of rapidly growing tech and co-working sectors. The remarkable office market momentum continues to build, but tenants have fewer and fewer options if they don’t plan ahead,” commented CBRE Canada Vice-Chairman PaulMorassutti. “Meanwhile industrial developers are responding to chronic space shortages with new construction, while tenants are opting to secure space prior to construction completion. In Toronto, all new supply delivered in Q1 2019 was pre-leased, and 77.6% of the 9.58 million sq. ft. under construction already has tenancies in place.”
Here are some of the other commercial real estate records logged in the first quarter:
- Downtown Toronto office vacancy tightened another 10 bps, dropping the rate to a new record low of 2.6% in the first quarter.
- Montreal’s downtown office vacancy now sits at 8.6%, the lowest it has been since Q4 2013, with tech company growth playing a key role in this decline. The downtown core has had 819,500 sq. ft. of new product delivered over the past eight quarters, with 998,139 sq. ft. of additional space under construction as of Q1 2019.
- Calgary experienced 289,515 sq. ft. of positive net absorption of downtown office space in Q1 2019, the largest quarter of positive absorption since the oil downturn in 2014. Much of the activity came from tenants taking back space previously listed for sublease, spaces being converted to co-working uses, and landlords turning unoccupied supply into amenity space.
- Toronto’s industrial market, which has had 16 consecutive quarters of positive net absorption, saw its availability rate hit an all-time low of 1.5% in Q1, with 2.2 million sq. ft. of positive net absorption.
- Calgary’s industrial market, which has logged nine consecutive quarters of positive net absorption, had a further 649,080 sq. ft. of space taken up in the first quarter of 2019.
- The Halifax industrial market had 50,465 sq. ft. of positive net absorption in Q1, the ninth straight quarter of positive net absorption for that city.
“In recent years, the Canadian real estate market had been somewhat polarized between areas of pronounced strength and areas facing challenges; however, this quarter showed more momentum for cities across the country, including hard-hit Alberta,” said Morassutti. “It’s worth noting that while overall office vacancy has remained stable quarter over quarter in Edmonton and Calgary, the amount of sublet space on the market – which serves as a bellwether for the office segment – decreased by 25.1% and 8.6% respectively. This is a promising indication that Alberta’s CRE conditions look to be improving at long last.”
For further details and insights, download CBRE’s Canada Q1 2019 Quarterly Statistics report here.
A Falling Vacancy Rate
Once per year, Canada Mortgage and Housing Corporation provides a comprehensive review of rental markets across Canada. The survey occurs during the first half of October. Results for this year were released on November 28.
For October 2018, the vacancy rate was 2.4%, which was a substantial drop from the 3.0% rate recorded a year earlier. The vacancy rate for 2018 is far below the average of 3.3% for the entire period shown in this chart. The reduction in vacancies resulted in more rapid rent increases, at 3.5% this year. Over the entire period shown, the average increase was 2.6%. This data shows that the situation has become increasingly challenging for Canada’s tenants.
Vacancy rates fell in 7 of the 10 provinces. Manitoba, BC, and Ontario saw small increases in their vacancy rates. These three provinces also saw the most rapid rent increases. The lowest vacancy rate is now in PEI, followed by BC and Ontario. The highest vacancy rates are in the three provinces where economies have been hurt by the plunge in oil prices (Saskatchewan, Newfoundland and Labrador, and Alberta). These provinces saw the weakest rent increases.
Since the data is collected only once per year, it is difficult to construct any models for analysis or forecasting of rental markets. The author’s experimentation over many years, for many different communities across Canada, has resulted in statistical models that have low “reliability”. But, those low-reliability results have been surprisingly consistent, and have led to a conclusion: the two most important drivers of changes for the vacancy rate are job creation during the past year (which allows more people to buy or rent housing) and total completions of housing during the past year.It is tempting to expect that completions of new-rental apartments would be important, but the author’s analysis has found that this is rarely the case.
On reflection, this makes sense:
- The rental market is part of a complex housing system in which there are very large flows between ownership and renting, and between different forms of housing.
- Expansion of the total stock of housing offers people more choice: even when people move into new home ownership dwellings, that move sets of a chain of other moves. Much of the time, that chain of moves includes someone moving out of a rental, which creates an opportunity for a new tenant.
- Moreover, the tenure on a new dwelling is not fixed for all time. In particular, it is well known that many new condominium apartments are occupied as rentals. In addition, some low-rise dwellings (single-detached, semi-detached, and town homes) are ostensibly built for ownership but are made available as rentals.
It is also tempting to expect that changes in resale market activity will affect the rental market. But, once again while the statistical analysis produces unreliable results, over many repetitions it has been found that resale activity has little effect on vacancy rates. This also makes sense on reflection. Most of the time a resale transaction does not add to total demand for housing (the buyer usually moves out of a different dwelling) and it usually does not alter the total supply of housing (unless the new buyer adds or removes a basement apartment).
Our impressions about the employment situation are largely based on data from Statistics Canada’s Labour Force Survey (“LFS”). This data indicates that during the year up to this September, employment in Canada expanded by 1.2%. This is slower than the rate of population growth (1.3%), and this therefore should be considered a mediocre result. Based on this data, we would expect that housing demand would be weak, and the drop in the vacancy rate this year would be a surprise.
However, the data from the LFS is derived from a sample survey and like all such surveys, it can produce errors. Statistics Canada has a second survey (Survey of Employment, Payrolls and Hours, or “SEPH”), which is based on data from employers, and is therefore likely to produce more-accurate data. This data receives much less attention because it is published almost two months after the LFS (the most recent data is for August). The two datasets usually tell similar stories. At present, however, SEPH shows growth of 1.8% (as of August) versus the 1.2% shown by the LFS (as of September).
Over the entire period shown in this chart, job growth averaged 1.5% per year. Strong job growth in both 2017 and 2018 helps to explain the drops in the vacancy rates that were seen in both years. Housing completions were at above average levels during 2017 and 2018 (the chart shows the figures for 12 month periods ending in September). These elevated volumes of new housing supply provided some relief for rental markets. Without this additional housing supply, the drops in the vacancy rates in 2017 and 2018 would have been even larger than they were.
The mortgage stress tests have resulted in reduced buying of new and existing homes. It takes some time for changes in purchases of new homes to translate in reduced housing starts (and even longer for housing completions to be affected). Increasingly, it appears that housing starts have peaked, and may have started to fall. The next chart illustrates that total housing starts were very strong during 2016 and 2017, but the trend has started to fall during 2018. A more detailed examination would show that housing starts have turned sharply for low-rise dwellings (single-detached, semi-detached, and town homes) but remain very strong for apartments. During 2019, starts for apartments will gradually reflect the reductions in sales that have occurred this year. This is explored in more detailed within the Housing Market Digest reports (for Canada and the regions) that can be found here: https://goo.gl/kJ6mcC
Following from these trends for housing starts, housing completions are expected to fall only slightly during the coming year, meaning that new housing supply will continue to provide some relief for the rental sector. However, housing completions are expected to fall considerably during 2020. As for employment, higher interest rates can be expected to gradually weigh on job creation during 2019 and 2020.
For 2019, a combination of continued high levels of housing completions and a slowdown of job creation should mean that there will be little change in the apartment vacancy rate (perhaps a drop to 2.3% from the 2.4% seen in 2018). The low vacancy rate can be expected to result in continued rapid rent increases, at a rate of at least 3%.
During 2020, the reduction of housing completions that will result from the mortgage stress tests will add to pressures in the rental sector. For 2020, the vacancy rate is expected to drop further (approaching 2.0%) and rent increases will quicken.
Government Policies at Cross Purposes
The federal government has announced plans to make major expenditures in support of affordable housing ($40 billion over 10 years). The federally-mandated mortgage stress tests, by reducing movements out of renting, will add to pressures within rental housing markets, and are operating at cross-purposes to the National Housing Strategy.
Disclaimer of Liability
This report has been compiled using data and sources that are believed to be reliable. Mortgage Professionals Canada Inc.
accepts no responsibility for any data or conclusions contained herein. Completed by Will Dunning, November 28, 2018.
Copyright: Mortgage Professionals Canada 2018
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Investment activity in commercial real estate in British Columbia has continued its bull run in the first half of 2018.
A new report from Avison Young says there were 102 deals with a total value of $3.04 billion, the second highest on record for both deal count and total dollar volume.
However, a more cautious approach is being shown by investors in residential land amid rising political uncertainty, rising construction costs, and affordability issues.
Investors are questioning the high land values, especially in Vancouver. But for other CRE sectors, demand remains strong.
“Rising land values had the effect of increasing the cost of not only land, but any and all commercial real estate assets that included a land play,” comments Avison Young Principal Bal Atwal. “This has been one of the contributing factors of cap rate compression for a large majority of investment sale transactions over the last few years. As the land market now starts to take a slight breath, it remains to be seen over the next few months if the market will maintain its recent upward trajectory, stabilize at current levels or begin to falter.”
How the sectors are performing
Office investment sales activity in BC generated more than $1 billion in the first half of 2018 with 23 transactions valued at $1.04 billion.
The sale of BC retail assets remained exceptionally strong in the first half of 2018 with 43 transactions valued at $1.55 billion following the record-smashing retail investment sales performance of 2017.
Industrial investment activity still remained strong in the first six months of 2018 with 36 industrial transactions valued at $449 million – a slight decline from the first half of 2017 when 37 deals valued at $456 million were completed.
Sales activity of BC multi-family assets remained at historic heights with 42 transactions valued at $674 million in the first half of 2018 with the number of deals falling just short of the first half of 2017 (46) but with greater dollar volume ($652 million) than what was recorded a year ago.
by Steve Randall Ι 24 Sep 2018