Office space is filling up so quickly that some Canadian cities will have some of the lowest vacancy rates in the world by 2019, says a leading commercial property firm.
Within two years, Toronto will have the fourth-tightest office market in the world and the tightest in the Americas, with a vacancy rate of just 3.9 per cent, says a report by Cushman and Wakefield, Vancouver is expected to rank ninth in the world, while Ottawa and Winnipeg are also expected to rank among the top 25 lowest vacancy cities.
The forecast underscores the improving health of the Canadian economy, which is projected to lead the Group of Seven in growth this year, and a better jobs market. But the fight for office space is also likely to drive up rental costs for some businesses and make it harder to large companies to find the space to expand.
"It's going to create some challenges for tenants in the downtown markets, particularly Toronto. Finding options for large-space users is going to be a major challenge between now and the year 2020," said Stuart Barron, director of Canadian research for Cushman and Wakefield.
The shortfall of quality supply will put "substantial pressure on rental rates," Mr. Barron said. Rental rates in Toronto are expected to rise 6.6 per cent over the next three years, while Winnipeg and Vancouver rates are projected to grow 6.4 per cent and 3.7 per cent, respectively.
On the landlord side of the equation, growth in rental rates is a boon, Mr. Barron said, particularly as rising Canadian interest rates make bank loans more expensive.
"People will be willing to pay more today for a product where they know renewals and new tenants are going to be paying higher rental rates than what the average existing rental rate is in the building," Mr. Barron said.
The picture is quite different in Alberta, where one-third of Canadian office supply is being built despite a sharp drop in demand since the oil price slump in 2014.
"I sort of see Canada as a tale of two cities," said Kevin Thorpe, Cushman and Wakefield's global chief economist. "Some of the Canadian markets are just superstars by most metrics … and on the other end of the spectrum are the energy markets, Calgary and Edmonton, which rank towards the bottom, meaning higher vacancy rates."
"It's very similar to Houston. The construction cycle took off when oil prices were over $100 per barrel, but they're delivering [new buildings] into a market where oil is at something like $47 per barrel."
Because of the disparity between cities in Alberta and cities such as Toronto and Vancouver, the overall office real estate picture in Canada is mixed.
Nationwide, vacancy rates are projected to creep upward to 11.7 per cent in 2019 from 9.9 per cent in 2016, as 8.9 million square feet of office space is completed. In this sense, Canada will mirror the global picture of oversupply, where vacancy rates are expected to rise as 700 million square feet of new office space – the equivalent of all office inventory in Washington, Dallas, London, Singapore and Shanghai combined – is completed over the next three years.
However, given the uneven distribution of supply and demand, cities will have to manage potential real estate risks in quite distinct ways.
In over-saturated markets such as Calgary and Edmonton, the main risk won't be to companies developing new office property.
"The real risk in Edmonton is for the existing product in the marketplace. It does put tremendous pressure for asset owners to actively work with their product and improve the amenities and the building technology, because there's a huge flight to quality," Mr. Barron said.
For the booming office markets the biggest risk may relate to housing prices. "Canadian markets will likely see net migration and job growth suffer if affordability continues to deteriorate," the report states.
"For the younger generation, the millennials, if the jobs just aren't paying them enough to live in the city, then they will go elsewhere," Mr. Thorpe explained. "If you lose the people, you're dead in the water form a real estate perspective."