Commercial Real Estate Swings into 2011

Retail, downtown and suburban office, industrial – all play by different rules

By Derek Sankey

If you’re affected in any way by the commercial real estate sector in Calgary, it probably depends largely on the type and location of space as to whether you can expect to upgrade into higher quality at a bargain, renegotiate your lease, even find space in some areas of the market or take your pick.
In downtown Calgary, it’s been a busy few months as tenants look to upgrade into a growing abundance of office space. “A lot of companies are using this environment as an opportunity to upgrade their space – whether that means quality or moving from small floor-plate space to large floor-plate space – those are the kinds of things driving a lot of business decisions today,” says Todd Throndson, managing director of Avison Young.
“There have been a lot of big deals done in the marketplace,” he says. That trend isn’t expected to last into the latter part of the year – most big deals have already been done – but tenants can expect a surge of new space from projects such as Eighth Avenue Place and The Bow to add new options into 2011 and beyond. “I think it’s going to stagnate a little going into the last half of this year, but what has really been interesting has been to watch the level of high-quality tenants go after high-quality space,” says Throndson.
Rents downtown have dropped 50 per cent from their peak during the boom, so a lot of businesses are locking in now with the anticipation that after the market absorbs the new space expected to come available over the next two years, rents will creep back up.
“A tenant can get into a much better building, get an allowance that pays for all or most of their costs for improving their space and they’re set for the next 10 or 15 years,” says Throndson, adding landlords are now offering $60-80 per square foot for things like renovations in many buildings.
“There will be a lot of pressure on markets going down next year, but right now it’s flat and next year it will probably be a lot more aggressive,” he says. Once the two major projects hit the market – Eight Avenue Place in 2011 and then Encana’s The Bow office tower – places will get backfilled and there is already a lot of sub-lease space available. Current vacancy rates hover around 15 per cent in the downtown core, depending on the type and location of space, and that number could swell close to 20 per cent within a few years.
Greg Kwong, regional managing director for CB Richard Ellis (CBRE) in Calgary, believes some developers may be wishing they had crystal balls just a couple of years ago.
“When (the developers of Eighth Avenue Place) made the decision to actually go ahead with it and start developing it, the market was actually quite robust, but by the time they said OK and committed the money, six months into it the market crashed,” says Kwong. “I’ll bet you if they could have shut it off, they would have.”
It’s quite a different story in the suburban office market.
“Suburban (office space) has been a lot quieter than downtown,” explains Throndson. “A lot of the vacancies that are out there have stayed vacant.”
There are mostly smaller pockets available, since large engineering companies have already largely locked into suburban office space commitments – the real drivers of the suburban market. Rental rates in this sector have gone down and incentives have gone up, but there’s still not a lot of big deals being done in the suburbs.
The vacancy rate in the suburbs is around 15 per cent, according to CBRE’s recent analysis, and lease rates have decreased to an average of $16.72 per square foot.
“While vacancy is forecast to decline, rental rates are projected to remain relatively static until the market approaches more balanced levels. It remains to be seen what impact the delivery of new space downtown will have on the suburban office market,” states CBRE’s forecast. “While the beltline sub-market will be affected, there has not been a significant migration back into the core from other suburban sub-markets so far in this cycle. Should that hold true, improvement in the engineering sector and limited new inventory should allow the suburban office market to continue on the road to recovery.”
The industrial real estate sector is yet another wrinkle in the broader commercial sector.
“The market activity has definitely picked up 100 per cent over six months ago (in industrial real estate),” says Kwong. It’s mainly due to an influx of oilpatch activity – the energy sector accounts for about 40-50 per cent of industrial real estate activity in Calgary, with the remainder comprised of distribution and warehousing and other heavy manufacturing.
Northeast Calgary has had the highest vacancy rate in the third quarter, but that dropped slightly as most of the new construction has taken place in northeast and southeast Calgary.
“The good thing about the industrial market is that developers are able to react quicker by stopping projects or choosing not to build projects,” Kwong says. “There’s only a six- to 18-month time-frame to actually build a larger industrial facility, whereas a downtown office building is three to four years out – you’re committed.”
While vacancy in the industrial sector reached about five per cent in the second quarter of the year, no new projects are going to immediately hit the market, causing further constraint. But by the end of 2010 and into 2011, more projects will become available as developers react to the demand amid a recovering economy.
“Land prices were getting up to a point where they were getting almost to be uneconomical a year and a half to two years ago, but those have now dropped quite dramatically and more importantly availability (has increased),” says Kwong.
Supply remains strong heading into 2011. “There is a short-term supply that should satisfy any growth at this point,” he says.
Commercial retail space in Calgary is something of an anomaly compared to other major centres. There simply isn’t much of it and never has been.
“Calgary is extremely under-retailed per capita compared to other regions in Canada,” explains Krystyn Gatto, retail leasing associate with Colliers Calgary. “You can even see it if you go up to Edmonton and there’s a shopping mall on every corner, where in Calgary you don’t see them on many corners.”
Even the expansion and renovations taking place at destinations such as Chinook Centre, The Core and various suburban shopping malls still leaves the retail vacancy rate at about 1.5 per cent, says Gatto. Still, that’s an improvement from rates below one per cent two years ago.
“There’s been more of a (levelling) of the playing field,” she says. “In the last couple years, it was really a landlord’s game in which they could demand the rates that they wanted. Now, the tenants have a little bit more of an advantage.”
Every quadrant and sector is unique, but in retail the city is moving to the “town centre” format of developments such as Seton in the city’s southeast and Sage Hill Crossing in the northwest community of Symons Valley.
Wherever you look in commercial real estate, it could be a game changer in 2011. It all just depends where you look, so keep your eyes open.