by Brianna Crandall — August 24, 2018 — New approaches from technology companies and coworking-space providers across North America and Europe are challenging occupiers’ and landlords’ office-space accommodation strategies, forcing players in more established sectors to adjust how they think about the size, physical form and operational function of their premises. This transformation continues to encourage new development, which is racing to keep up with demand in some markets and being bolstered by a young, educated workforce gravitating to urban centers. These are some of the key trends noted in Canada-based international commercial real estate services firm Avison Young’s just-released Mid-Year 2018 North America and Europe Office Market Report.
The report covers the office markets in 67 metropolitan regions in Canada (Calgary, Edmonton, Halifax, Lethbridge, Montreal, Ottawa, Regina, Toronto, Vancouver, Waterloo Region, Winnipeg); the United States (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, Memphis, 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 Jose/Silicon Valley, San Mateo, St. Louis, Tampa, Washington DC, West Palm Beach, Westchester County); Mexico (Mexico City); the United Kingdom (Coventry, London, Manchester); Germany (Berlin, Duesseldorf, Frankfurt, Hamburg, Munich); and Romania (Bucharest).
Mark E. Rose, chair and CEO of Avison Young, remarked:
Against a backdrop of economic, geopolitical and financial volatility, the commercial property markets, for the most part, are functioning under relatively sound fundamentals. Nowhere are we seeing more profound changes than in the office sector — especially in urban areas of major metropolitan markets across the six countries covered in our annual review. The impact can be seen on city skylines, which are changing rapidly as new construction picks up pace, driven by insatiable tenant demand from organizations adjusting their workplace strategies to a growing Millennial workforce and their adaptability to innovative technologies.
At the same time, sectors that have historically accounted for a significant amount of demand for office space are now being both augmented and squeezed by ever-expanding technology and coworking industries. This phenomenon is being seen across national boundaries, particularly in markets with dense and growing urban populations.
According to the report, of the 67 office markets tracked by Avison Young in North America and Europe, which comprise more than 6 billion square feet (bsf), market-wide vacancy rates declined in 38 markets, remained unchanged in seven, and increased in 22 markets as almost 74 million square feet (msf) was absorbed on an annualized basis.
The report goes on to say that construction cranes remained prominent fixtures across many skylines, as nearly 74 msf of office space was completed during the 12-month period, while another 138 msf was under construction at mid-year 2018 — with 50% of the space preleased.
CEO Rose continued:
It’s great to see so much confidence on the part of developers as they respond to the supply/demand imbalance in many markets. As always in this industry, the inherent risk is that circumstances could change, resulting in an oversupply of product at the time of delivery. In many cases, this scenario is the result of external economic and geopolitical factors. This time around, however, the new influences of disruptive technologies and increasing co-working space availability are also affecting how and where people work, potentially impacting the office sector from within — and challenging conventional wisdom.
Generally sound office market fundamentals are being threatened on the North American front by ongoing NAFTA talks. In Europe, the looming Brexit deadline continues to dominate the headlines in the UK, while in Germany, strong leasing activity continues to drive vacancy rates downward in all Avison Young markets. In Bucharest, Romania, development continues in response to demand.
The US office market has benefited from another strong 12-month period of positive economic indicators: further business expansion and job growth, decades-low unemployment, and rising consumer and business spending. Business spending kept its momentum in the first half of 2018, boosted by corporate tax breaks even while the federal government moved toward greater isolationism and global trade uncertainty. As of June, US unemployment averaged 4% and employment over the last 12 months grew by 2.4 million, supported by the office-occupying professional and business sector gaining 521,000 jobs.
The 5.2-bsf US office market reported net absorption of 43 msf on the strength of gains in five markets, each achieving more than 3 msf.
Earl Webb, Avison Young’s president of US Operations, noted:
In spite of this strong take-up, I’m not surprised that the overall vacancy rate remains elevated, given the volume of construction underway and the continuing trend of more efficient space design.
US office market trends mirror those in Canada, registering an increasing impact from coworking firms. Occasionally, coworking companies have occupied large blocks of space in oversupplied markets, helping to keep vacancy in check, and the concept’s popularity with tenants has forced landlords of traditional buildings to compete by adding conference rooms, tenant centers and social spaces.
Flexible occupancy is key. We also see some national corporate tenants utilizing coworking space in order to control costs and create that flexibility. One coworking operator’s recent announcement that it is moving into brokerage operations could further disrupt the office market, and we’ll be watching that situation and other coworking developments as we head into 2019.
The report goes on to discuss other recent and continuing trends, including the redevelopment of aging inventory and developers’ emphasis on offering transit-oriented mixed-use projects. Tenants continue to display a preference for amenity-laden buildings and geographies — an important recruiting strategy designed to appeal to the Millennial workforce in the tight US labor environment.
Notable mid-year 2018 US office market highlights:
- Five US markets each achieved more than 3 msf of net absorption. San Jose/Silicon Valley and San Francisco together represented 29% of the US total, with net absorption of 7.5 msf and 5 msf, respectively. In contrast, a handful of US markets recorded negative net absorption. Of those, Houston lost the most ground, with negative 2 msf during the last 12-month period.
- Total vacancy in the US was 12.1% as of June 30, 2018, a drop of 10 bps year-over-year. In spite of strong absorption, vacancy rates remained stubbornly high overall, with the highest levels in Memphis (20.9%), Westchester County (19.5%), and Houston (18.3%). All but 13 of the 46 US markets reported vacancy averaging more than 10%.
- Improvement was centered in the downtown inventory (1.7 bsf), with average vacancy falling to 11.2% at mid-year 2018 compared with 11.4% one year earlier, while the larger suburban market (3.5 bsf) recorded no change in vacancy year-over-year (12.6%).
- Construction volume fell year-over-year, although 96 msf remained under development across the US. In new projects overall, 53% of the space was preleased at mid-year 2018 compared with 49% one year earlier. The 379-msf Washington, DC, region led the country with 11 msf underway. Demand for new product is high in Washington, and preleasing in buildings under construction reached 69% by mid-year. This level was almost matched by New York, where 10.6 msf was under construction (47% preleased) at mid-year 2018.
- Completions in the 12-month period ending at mid-year 2018 totaled 57.8 msf, increasing slightly from the prior year’s total (55.2 msf). Dallas and Northern California’s San Jose/Silicon Valley led the country by delivering 7.5 msf each, followed by Washington’s 5.1 msf of completions.
- Eleven US markets reported asking rents that exceeded the downtown Class A average of $48.04 psf full-service gross. Not surprisingly, tight leasing market conditions in Northern California resulted in San Mateo ($84.96 psf), San Jose/Silicon Valley ($74.74 psf), San Francisco ($76.54 psf) and Oakland ($57.56 psf) having some of the highest rents in the country. In the Northeast, Boston ($66.91 psf), New York ($64.08 psf) and Fairfield County ($54.72 psf) were the leaders.
- Suburban Class A rents tell a similar story, with Northern California markets leading the country by far, while most US markets hovered near the national average of $31.32 psf.
As we forecasted at mid-year 2017, the flight to quality and tenant demand for efficient, amenity-rich options carried into 2018 — and showed no signs of abatement, while Class A rents, downtown and suburban, edged higher. High-quality development will continue to boost tenant occupancy and garner higher rents and institutional interest while outperforming the market at large through year-end.
According to the report, Canada’s office property markets remained sound through the first half of 2018, supported by stable macroeconomic indicators, including healthy employment numbers, gross domestic product (GDP) growth and a rebounding Alberta economy. However, US protectionist policies and escalating tariffs pose a risk to the Canadian economy and global trade flows, and may lead to moderating growth ahead.
Bill Argeropoulos, principal and practice leader, Research (Canada) for Avison Young, pointed out:
Intense competition for office space continues to bolster office market fundamentals across Canada — especially in downtown markets. Demand from traditional sectors is being augmented by the proliferation of domestic and global technology and coworking firms, ongoing urbanization and a burgeoning Millennial workforce — all part of Canada’s emerging innovation economy.
The report shows declining vacancy rates in more than half of the Canadian office markets, with suburban markets outpacing downtown markets in terms of absorption (led by Montreal and Vancouver) and new deliveries (led by Toronto, Vancouver and Montreal) during the past 12 months. However, the amount of downtown space under construction at mid-year (led by Toronto) outstripped the suburbs by a significant margin.
Urbanization — partly attributable to growth in the technology sector — has created a noticeable gulf between downtown and suburban vacancy rates in emerging tech hubs such as Vancouver, Toronto, Waterloo Region, Ottawa and Montreal. Given tight conditions and upward pressure on rents in some of the nation’s downtown markets, and with little or no near-term supply relief, suburban markets — particularly those offering transit connectivity and other urban amenities — may be the beneficiaries of overflowing tenant demand during the next couple of years.
For more information about the study, including specifics about Canada as well as local market highlights for each of the cities featured in it, read the complete Mid-Year 2018 Avison Young Office Market Report online.