Commercial vacancies soar across country

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Just two years ago, office vacancies in Calgary's downtown core were virtually non-existent as cash-rich energy companies snapped up every bit of free space.

Today, with natural gas in the dumps, the economy still flagging, and five million square feet of new office space set to swamp the city, Calgary is at the forefront of a broad surge in commercial real estate vacancies.

Across Canada, office vacancies are up nearly 50 per cent in the past year, and experts say the oversupply is likely to stay in place for several years. That's good for companies looking for new space and a deal on rent, but bad news for building owners already worried about the financial health of some tenants.

In Calgary, the situation is the most stark for owners, with the increasingly long shadows of the Bow and Eighth Avenue Place office buildings under construction downtown looming over the city's commercial real estate business.

For companies, it is a welcome change. Rents are tumbling and firms can be choosy, finding the right space.

For building owners, particularly in older towers where tenants are looking to jump to newer space, it is a tough market that will only get tougher. For investors in the sector, like Eighth Avenue Place where the backers include SITQ, the real estate arm of the Caisse de dépôt et placement du Québec and Alberta Investment Management Corp., anticipated returns could be cut with rents coming down and offices sitting empty.

"Before it was a race for space," said Rick Urbanczyk, a broker at DTZ Barnicke in Calgary who joined the business during the boom.

"Anything available was snatched up right away. Our job was to find space, at whatever cost. Today, it's a little different."

Across Canada, according to new data from real estate services firm CB Richard Ellis Group Inc., the office vacancy rate in downtowns and suburbs has jumped nearly 50 per cent in the past year and stands at 9.4 per cent, up from 6.3 per cent.

With the rate poised to pass 10 per cent across Canada, Calgary has it worst. In a city where the downtown vacancy rate was less than 1 per cent in 2006 and 2007, office space around the city is now 13.1 per cent empty - almost triple the 4.7 per cent seen a year ago.

Even as parts of the economy show some strength, and central bankers talk about economic recovery, the persistent rise in office vacancy rates shows the real estate business will stay stuck in a slump longer than other sectors.

Toronto, too, faces a similar but less serious situation as Calgary. Vacancy in the city closely mirrors the national numbers: Empty office space in the city is at 9.1 per cent, up from 6.6 per cent a year ago.

Canada's biggest city has about the same amount of office space under construction in its downtown as Calgary but the Toronto market is more than double the size of Calgary's. So even with a lot more space coming, rents have remained fairly steady around $27 a square foot for Class A space downtown, while the price for the same quality of space in Calgary has plummeted to $32 from $43 last year.

The trends are bad news for building owners but rising office vacancies aren't necessarily an ugly omen for the broader economy.

This was the situation earlier this decade. While the economy and stock markets were reeling in 2001, office vacancy in Canada was at 10.8 per cent and the figure didn't peak until two years later in 2003 as 13 per cent, when the general economy was well in to a strong recovery.

"Commercial real estate is a classic lagging indicator," said economist Douglas Porter of BMO Nesbitt Burns.

He also noted the sector is entwined with employment, which typically is among the last metrics to improve as economies move out of recession.

The jump in the national vacancy rate in office space will have ripple effects into the banking sector, increasing the exposure of Canadian lenders, said economist Todd Hirsch of ATB Financial in Calgary. However, he doesn't envisage an escalation into deep-rooted financial problems like in the United States.

For Calgary, which rides the erratic, swift and severe ups and downs in the price of natural gas and oil, the slump looks like it will last a couple years, Mr. Hirsch said.

The Bow in Calgary - at 58 storeys it will be the tallest tower west of Toronto - is fully leased to EnCana Corp., which will vacate five different spaces around the city.

Eighth Avenue Place will be 51 storeys and doesn't yet have a single tenant. It was the last, and biggest, of buildings to go up in Calgary on spec, construction started without tenants signed on to fill the space. Randy Fennessey, president of Colliers International's Calgary business, has been pitching the building to potential clients for more than a year and he said he hopes to secure a first tenant this fall. He said the weak natural gas market has hurt the market but is confident it will recover.

"We know it's coming back," Mr. Fennessey said. "It's not a question of if. It's question of when. It's not the first time we've seen things like this."

Greg Kwong, managing director of CB Richard Ellis in Alberta, said even if energy prices surge, there would be a lag of six months to one year before it translated into tenants seeking office space.

Vacancy rates in Alberta's two largest cities likely won't decline much until late 2010 or early 2011, Mr. Kwong said. With interest rates forecast to rise next year, "that will add to the stress," he said.

"The commercial market is going to get worse here before it gets better. You won't see many new construction projects on office buildings start up, and that means fewer jobs."