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Tenants gain more power as office vacancy rate grows

Tenants are gaining power in negotiations for existing buildings, but landlords remain in a position of strength for new builds, according to CBRE’s first quarter 2014 Statistical Summary.


The recent trend toward sluggish demand for office space in Canada is likely the new normal, CBRE Ltd. predicts.

More office space was vacated than leased across the country during the first quarter of this year, to the tune of 1.5 million square feet, CBRE says. That's the fifth quarter in a row that the demand for space in existing buildings has been weak.

"The trends are now well established and it appears that the rebound in economic growth and leasing activity that followed the recession were outliers," says Ross Moore, director of research at CBRE. "The current pace is likely much closer to the new norm."

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The national office vacancy rate now stands above 10 per cent for the first time since the second quarter of 2010, and has reached its highest level since the third quarter of 2005. It increased by 60 basis points in the latest quarter to 10.3 per cent. Office vacancy rates in Calgary, Edmonton, Winnipeg, London, Montreal and Halifax all top 10 per cent, and other cities are catching up.

"With solid GDP numbers, an uptick in the RealPac sentiment index and improving hiring intentions, one might have expected more office leasing this quarter," says CBRE chairman John O'Bryan. "It's normal for there to be a lag between good news and business investment, but job growth is the basis for real estate demand and until the economy is creating more jobs on a consistent basis, the current pace of office leasing is unlikely to change."

Since the middle of last year the average number of jobs created each month has been about 5,000, compared with about 15,000 historically, CBRE says.

The softer demand for office space will give tenants more leverage over landlords.

The national suburban vacancy rate rose 90 basis points during the first quarter, to 13 per cent, while the vacancy rate for Class A space has risen from its recent low point of 4.7 per cent in the third quarter of 2012 to 7 per cent.

CBRE suggested that the more modest leasing environment in Canada is still strong relative to a number of other countries, and that this pullback is bringing it into balance.

A large number of new office towers are under construction across the country, which is feeding into the slower environment. At the same time, corporations are finding ways to put more employees into less space.

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These are some of the reasons why some market-watchers have been warning owners of office space to be careful. Richard Johnson, a Zurich-based managing director of UBS Global Asset Management, held a meeting with pension funds in Toronto last month and told them that UBS is concerned about their level of exposure to Canadian commercial real estate.

In contrast to the more worrisome picture for the office market, CBRE also notes that the industrial leasing market is actually getting stronger, with the national availability rate in that asset class falling 20 basis points from the prior quarter to 5.6 per cent.

"The strength of the overall market is reflected by the fact that the average industrial availability rate is almost identical in Western and Eastern Canada despite their different economic characteristics," CBRE states. "Across the country, industrial markets continue to benefit from retailers setting up new distribution centres."

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