by Brianna Crandall — August 29, 2016 — The North American, U.K. and German office sectors reported overall healthy leasing fundamentals at the mid-point of 2016. Despite positive absorption on both sides of the Canada-U.S. border, the office vacancy rate in Canada has risen, while the U.S. rate decreased year-over-year, bringing vacancy in the two countries into closer alignment than at any time since the Great Recession. The effects of depressed oil prices continue to be felt in certain U.S. and Canadian markets — a situation that may result in further volatility affecting local leasing metrics.
These are some of the key trends noted in commercial real estate services firm Avison Young’s recently released Mid-Year 2016 North America, U.K. and Germany Office Market Report.
The expanded report now covers the office markets in 61 (up from 50 in 2015) Canadian, U.S., Mexican, U.K. and German metropolitan regions: Calgary, Edmonton, Halifax, Lethbridge, Montreal, Ottawa, Quebec City, Regina, Toronto, Vancouver, Waterloo Region and Winnipeg; Atlanta, Austin, Boston, Charleston, Charlotte, Chicago, Cleveland, Columbus, Dallas, Denver, Detroit, Fairfield County, Fort Lauderdale, Greenville, Hartford, Houston, Indianapolis, Jacksonville, Las Vegas, Long Island, Los Angeles, Miami, Minneapolis, Nashville, New Jersey, New York, Oakland, Orange County, Orlando, Philadelphia, Phoenix, Pittsburgh, Raleigh-Durham, Reno, Sacramento, San Antonio, San Diego County, San Francisco, San Mateo, Tampa, Washington, DC and West Palm Beach; Mexico City; Coventry and London; and Duesseldorf, Frankfurt, Hamburg and Munich.
Mark E. Rose, chair and CEO of Avison Young, stated:
The divergence in economic performance between Canada and the U.S. that we reported in 2015 has continued during the intervening 12 months. As a result, office market fundamentals in the two countries have also posted differing results. While the U.S. shows continued signs of improvement, Canada has seen varied performance from its office markets. Rounding out North America, the Mexico City office market is performing well with a healthy vacancy rate — though vacancy is at its highest point since the end of 2013.
Meanwhile, in Europe, the Brexit vote in June marked the start of a period of uncertainty for the U.K. economy and property market. Despite this uncertainty, and a reported low level of leasing activity, U.K. vacancy rates remain at historically low levels. And in Germany, the top office leasing markets recorded solid take-up levels on the back of a stable and growing economy with leasing activity above the long-term average across all markets.
The U.S. office market demonstrated further strengthening during the last four quarters. November’s presidential election should have little impact on commercial real estate after a year of generally positive economic growth reports — increased consumer spending and real gains in employment resulting in sub-5% unemployment levels. In addition, the Federal Reserve is unlikely to raise interest rates until late in the year.
In Canada, softer economic results were reflected in the office market’s performance. Not surprisingly, this situation was mostly attributed to weak market fundamentals in Alberta, while Toronto, Montreal and Vancouver saw an uptick in demand. Nevertheless, we expect continued deal velocity for the remainder of the year in Canada, while vacancy could face upward pressure and rents could experience downward pressure due to new supply and moderate demand.
According to the report, of the 61 office markets tracked by Avison Young in North America, the U.K. and Germany, market-wide vacancy rates decreased by varying degrees in 34 of the markets on an annualized basis. Given that all five countries reported positive net absorption over the 12-month period, the fact that only 56% of markets saw a decreasing office vacancy rate demonstrates the importance of understanding individual markets’ demand drivers, construction pipelines and local economic conditions, notes the company.
With the exception of Canada, the amount of space under construction ticked upward in most markets year-over-year, and preleasing levels are significant. Nonetheless, stakeholders will need to monitor vacancy levels on a market-specific basis for signs of oversupply.
United States
In contrast to office market conditions in Canada, according to the report, the office sector in the United States experienced broad-based improvement. The office vacancy rate in the 4.6-billion-square-foot (bsf) U.S. office market tracked by Avison Young tightened at mid-year 2016 when compared with the vacancy recorded a year earlier. For the office markets, common themes persisted during the 12-month period ending at mid-year 2016 as occupiers again focused on space efficiencies and a preference for locations served by public transit and walkable conveniences.
Earl Webb, Avison Young’s president, U.S. Operations, noted:
Absorption in the U.S. office sector was a notable indicator of the markets’ increasing health as the country posted 43 msf of net absorption between mid-year 2015 and mid-year 2016. During the same period, Class A rental rates in downtown markets spiked, moving almost 8% higher. With another year of sustained job growth, the overall U.S. unemployment rate fell below 5% in 2016. We anticipate that favorable leasing fundamentals for the office sector will be ongoing through year-end 2016, and although select markets may experience some delay in office lease executions until after the election is decided, this situation should have minimal impact on market conditions into 2017.
Development is on the rise in answer to demand for new buildings, while the growing presence of amenity-rich, co-working options may spur owners of older properties to add social gathering places and tenant-recreation areas to compete for occupiers in this environment.
Notable mid-year 2016 U.S. office market highlights:
- National office vacancy dipped to an average of 12.7% at mid-year 2016 — a 40-bps improvement compared with the same period one year prior. Downtown markets experienced less change (down 20 bps from mid-year 2015), but have tighter conditions overall, with 10.8% vacancy inclusive of sublet space and 15 markets reporting vacancy in the single digits.
- The cluster of Northern California downtown markets — San Francisco, Oakland and San Mateo — reported extremely low vacancies of 5.5%, 3.9% and 1.7%, respectively. In New York, the nation’s largest downtown market with 443 msf, vacancy improved by 40 bps falling to single digits (9.6% vacant).
- Twelve-month net absorption in the USA was 43 msf for the period ending June 30, 2016, representing nearly a 16% decline year-over-year and only 0.9% of existing inventory. Suburban markets captured the bulk of net absorption achieved between mid-year 2015 and mid-year 2016.
- The USA had 90 msf of office space under construction at mid-year 2016, up from 82 msf one year earlier. Projects under construction are 50% preleased, pointing to the demand for new buildings.
- Three U.S. markets have significant volumes of construction activity. New York has the greatest amount by far (15.1 msf, 46% preleased), followed by Washington, DC (11.1 msf, 31% preleased), and Dallas (10.2 msf, 67% preleased). These three markets alone accounted for 40.3% of all U.S. development underway at mid-year 2016.
- Houston delivered 7.9 msf between mid-year 2015 and mid-year 2016 and has another 3.8 msf under construction; however, 3.8 msf is a modest volume, as Houston reported an average of 11.7 msf under construction at mid-year 2013, 2014 and 2015.
- Pricing again trended upward, and average asking Class A rental rates grew in both downtown and suburban markets, with downtown rents increasing significantly by $3.69 psf, or 7.7%, year-over-year to $51.80 psf. Notably, of the 39 downtown markets tracked, all but five reported increases in their rental rates.
Webb added:
In 2015 we reported a return to more balanced leasing conditions with lower vacancy after several years of absorption and job growth, and the office market remains the strongest we’ve seen since the Great Recession. Companies have demonstrated a distinct preference for work-live-play environments with a mature infrastructure of tenant services to aid their recruiting efforts. For the remainder of 2016, tenants’ need for space efficiencies and flexibility will endure. Nevertheless, we expect this year’s office leasing levels to be in line with historical averages and, in spite of elevated volumes of construction, no real threat of oversupply.
For more details on the office vacancy rate of the specific U.S. markets and coverage of the Canadian, Mexican, U.K. and German markets, access Avison Young’s Mid-Year 2016 North America, U.K. and Germany Office Market Report online.
