Office Market Positioned to Survive a Bruising Recession

As a deep recession looms around the world, there is a country where a conservative investment community has resisted speculative office construction, enabling vacancy rates to fall to historically low levels and rents to continue rising through the third quarter of 2008. Where is this magical land? Canada. According to an analysis of the office markets in six major Canadian cities by Toronto-based Colliers International in Canada, the Canadian office market will finish 2008 well positioned to withstand the recession. The Colliers study looked at Montreal, Ottawa, Toronto, Calgary, Edmonton and Vancouver. “Generally, Canada’s credit markets have tightened and are probably similar to those in the U.S.” Ian MacCulloch, vice president, research, with Colliers International in Canada, told CPN. “But cap rates are lagging those in the U.S. and have only just begun to move up–maybe 50 to 100 basis points.” Meanwhile, loan to value ratios have spiked. In 2007, lenders were underwriting debt of 75 percent. That has gone to 60 percent and even 65 percent in primary markets and 50 percent in secondary markets, said MacCulloch. “Lenders have also changed their underwriting assumptions,” MacCulloch said. “Instead of indicating an upside potential, vacancies mean zero income. Instead of indicating an opportunity for rental growth, rollovers are taken to mean a probable decline in rent.” Nevertheless, the Colliers study shows that Canada’s major urban office markets have performed well through the third quarter of 2008 and seem by and large to be prepared to weather problems that may arise over the next year or two. In Vancouver, vacancy rates have fallen throughout the year, from 4.7 percent in the fourth quarter of 2007 to 4 percent at the end of the third quarter of 2008. Over the same period, rents have risen from $24 to $24.50 per square foot. MacCulloch said that a sublet market has begun to emerge, but no significant projects will get underway until 2012. The 2010 Olympic games are also shoring up the market. In Edmonton, rents are expected to plateau at the current $32 per square foot, as a low 3.8 percent vacancy rate as of September of 2008 appears to have stabilized rents. The office market in Ottawa has fared less well. Vacancy rates over the past 12 months have risen from 5.6 percent to 6.3 percent. Still, rents have remained stable at $17.23 per square foot. With new space coming to market in 2009, vacancy rates will probably rise more. Still, the Colliers study suggests that the federal government’s need for Ottawa office space will likely prevent any strong move up in vacancies. Montreal’s office market had a solid 2008 as the vacancy rate topped from 9.1 percent at the end of 2007 to 6.60 percent at the end of the third quarter. Tight credit has delayed new projects and is helping to keep rents stable in the low $20 range. Calgary and Toronto will feel the fallout of the global economic slowdown, according to the Colliers report. Both markets share short-term oversupplies, with several million square feet of new office space scheduled to come on line in 2009 and 2010. In Calgary, vacancy rates rose from 3.2 percent to 3.5 percent from the third quarter of 2007 through the third quarter of 2008. Even so, rents spiked from $40 to $48 per square foot over the period and may pad the impact of the oversupply on the market. The Toronto office market saw vacancy rates decline from 5.6 percent to 4.5 percent from the third quarter of 2007 through the third quarter of this year. Rents rose from $21.36 to $22.90. Demand will soften, however, as new space comes to market over the next two years.