Vacancy inches higher with anticipated new supply to largely deplete construction pipeline by year-end
Tenant preferences are becoming increasingly clear and having an impact. Suburban Class A product has seen the strongest rental performance, increasing 7.8% since Q1 2020, meanwhile, Downtown Class B has seen declining rates, reflecting the priority for high-quality, well-amenitized office buildings that minimize commute times.
Q2 was a quarter for moderation with most markets reporting softening conditions, but not to the same degree as seen at the start of the year. National quarterly net absorption for example recorded half of the total seen in Q1, however, remained in negative territory. Only two markets meanwhile posted contracting vacancy: Calgary and Halifax.
Sublet vacancy marginally increased this quarter and managed to maintain being equal to 3.4% of inventory. Eight of 10 markets have sublease levels less than 3.0% of inventory.
Construction has been steadily declining since Q2 2022 as projects are completing with very few kicking-off. Should this continue, anticipated Q3 and Q4 deliveries will lower the 11.5 million sq. ft. pipeline to 4.2 million sq. ft., the lowest level since 2005.
Suburban Class A sees rent growth as new supply propels downtown vacancy to climb
Downtown Class A remains the tightest segment, albeit marginally. Its vacancy has climbed in recent quarters as new supply deliveries have hit amidst dampened demand. Net asking rents currently average $29.44 per sq. ft., up 4.6% compared to Q1 2020.
Downtown Class B has the highest vacancy at 23.3% and saw its vacancy increase 250 basis points (bps) year-over-year, the most of any segment. It is also the only area where average net asking rates are down since the start of the pandemic.
While vacancy within the Suburban Class A segment is creeping up, it has nonetheless seen the strongest rental profile. Rents in this sector are up year-over-year in most markets and continue to slowly and steadily increase, now up 7.8% since Q1 2020.
These differing performances reflect the priorities of tenants for high-quality, well-amenitized office buildings situated in office nodes that minimize commute times for their employee base.
Vacancy inches higher as delta between downtown and suburban areas widens
Overall national office vacancy rate has increased to 18.1%. Downtown was responsible for the majority of this increase however both areas experienced market softening. The gap between the two segments continues to widen, with the suburban rate currently 180 bps lower than downtown.
Calgary and Halifax were the only markets to report decreased vacancy this quarter. In Calgary, this was driven by a variety of expanding industry groups including engineering, construction, and education. In addition to the several office building conversions underway, landlords are also getting creative by retaining previously vacant space and transforming it into additional building amenities.
When looking at downtown vs. suburbs, three markets saw their suburban areas improve over the quarter (Calgary, London, and Halifax), relative to just two downtown (Calgary, and Waterloo Region).
Continued softening with only three markets posting positive net absorption
National quarterly net absorption remained in negative territory in Q2, however it also moderated from the start of the year and recorded about half of the total seen in Q1.
Of those that posted negative net absorption this quarter, the magnitude of that decline lessened relative to the first quarter in three markets: Waterloo, Toronto and Ottawa. In Toronto, this was the lightest quarter of negative net absorption since Q2 2022.
Calgary, Vancouver and Halifax were the only markets to report positive absorption this quarter. Vancouver was aided by the delivery of two fully pre-leased properties.
Sublet offerings continue to creep up, increasing for a fourth consecutive quarter
Sublet vacancy grew nationally this quarter, albeit more marginally than in Q1, but managed to maintain being equal to 3.4% of inventory. Eight of 10 markets have sublease levels that total for less than 3.0% of inventory.
The current quarter is now nearly 1.0 million sq. ft. or 5.9% higher than the previous peak seen in Q2 2021. The increase is attributable to downtown centres, as suburban areas have largely held level.
On year-over-year basis, four markets have seen sublet space as a % of inventory increase, most notably in Ottawa (+130 bps) and Toronto (+110 bps), a result of rightsizing primarily within the tech sector. Five markets meanwhile saw sublease levels decrease over the same time period, as Montreal held flat.
Calgary, meanwhile, has posted the greatest improvement having declined by 100 bps year-over-year and is no longer the market with the highest sublet vacancy rate.
Construction pipeline on track to lower to a level last seen in 2005
11.5 million sq. ft. of office product remains under construction nationally, equal to 2.4% of existing inventory, of which 50.7% is pre-leased.
Construction has been steadily declining since Q2 2022 as more projects are completing than kicking-off. Should this continue, anticipated deliveries for Q3 and Q4 will lower the pipeline to a level last seen in 2005. For additional context, the national vacancy rate was around 11.0% at the time.
As has been the case, the bulk of the product being built nationally is in Toronto, Vancouver and Montreal with pre-leasing highest in Montreal thanks to the new 1.0 million sq. ft. National Bank tower.
Construction activity in Canada’s remaining markets are either limited, negligible or non-existent.
Tail-end of projects that started during 2018-2019 wave to deliver by year-end
Increasingly few construction projects have moved forward over the last year with just 81,000 sq. ft. commencing this quarter in Halifax.
4.3 million sq. ft. or 37.7% of active projects under construction have been underway since before 2020. This product tends to have higher pre-leasing than those that started in 2020 or later.
Vancouver was the only market to deliver new supply this quarter, including the South Tower at The Post which was a part of the wave of projects that kicked off in 2019.
In total, 7.3 million sq. ft. is anticipated for delivery in the second half of the year and will see the last remaining projects that started in 2018-2019 completed. This includes the North Tower at the Post in Vancouver as well as 160 Front Street in Toronto. The delivery of these and other buildings will bring 2023’s annual new supply total to 8.5 million sq. ft., a high not matched since 2016.