Wednesday, July 31, 2013
by Mark Rose (Toronto, ON)
In both the U.S. and Canada, the recovery is progressing, but headwinds from fiscal constraint, tax increases and reduced spending at the federal and local levels are restraining growth to below normal levels. In the U.S., the combined uncertainty contributed by discussion of “tapering” by the Federal Reserve and delay in the implementation of Obamacare are adding to the uncertainty facing employers, and show up in disappointing job growth levels even as the stock market continues to push to new highs.
Employment stagnant, but with bright spots
The Bureau of Labor Statistics released its regional and state unemployment summary last week and reported a national unemployment rate for May of 7.6% – virtually unchanged from what we reported last quarter.
That said, several states demonstrated significant year–over-year improvement (from June 2012 to June 2013) and are worth noting:
· California’s unemployment rate dropped to 8.6% from 10.6%, the largest U.S. decrease;
· Nevada dropped from an 11.6% unemployment rate to single digits at 9.6%, although the rate remains the highest among the United States;
· Florida improved to 7.1% from 8.8%; and,
· In New York, the unemployment rate fell to 7.5% from 8.7%.
Tenants remain in charge, even as vacancy improves
As of the second quarter, many major U.S. office markets remain over-supplied with tenant-favorable conditions, even while tours and deal velocity have increased and several metro areas have moved into equilibrium.
Tenants are looking to control occupancy costs as they move, by employing collaborative work environments and reducing the overall-square-foot-to-employee ratio. With the ongoing tenant “flight to quality,” look for older vacant office properties to be converted to other uses, razed or substantially upgraded.
On the office side, vacancy for the 10.3-billion-square-foot U.S. market decreased to 11.7% at the end of second quarter – representing another quarter of ongoing improvement from levels just above 12% for most of 2012. Avison Young anticipates that vacancy will continue on its downward trajectory through year-end 2013.
Meanwhile, the 20.8-billion-square-foot U.S. industrial market ended the second quarter with vacancy decreasing to 8.5% from 9% in the third quarter of 2012, with construction and deliveries below historical levels. In fact, in the first two quarters of 2013 alone, net absorption was more than double the amount of product delivered. The warehouse sector, comprising 18.6 billion square feet, stood at 8.1% vacant at the end of the second quarter.
Investment sales continue steady improvement, and Canadian investor appetite in U.S. grows
The U.S. investment market continues to improve this year, with sales volume through May of nearly $115 billion for all property types. This compares favorably to sales of $91 billion for the same period in 2012, and has increased each year since 2009 when January-May sales volume only reached $20.4 billion.
According to Real Capital Analytics, Canadian investors purchased $5.4 billion of U.S. assets year to date and are on pace to eclipse 2012’s transaction volume of $8.8 billion. Manhattan (with Canadian transaction volume of $988 million) and Los Angeles (at $897 million), have garnered the most Canadian capital thus far this year. Seattle, Raleigh-Durham and Atlanta round out the top five capital destination markets.
Now a look at Canada…
As we enter the “dog days of summer,” market fundamentals across most Canadian markets remain relatively stable. However, tight market conditions in major downtown office markets (Vancouver, Calgary and Toronto) are challenging for tenants as they are faced with limited space options and rising rental rates, even while favourable space and rental-rate alternatives are commonplace in select suburban markets (such as suburban Toronto), where demand has not kept pace with new supply.
Additional supply beginning to impact vacancy in some market, but landlords still rule
We are currently finalizing our figures for Avison Young’s upcoming Mid-Year 2013 Canada, U.S. Office Market Report. Canada’s office vacancy rate finished the first half of 2013 just shy of 8% – a rise of almost 80 basis points (bps) from one year ago.
Canada’s downtown office markets collectively posted 5.6% vacancy compared with 5.2% last year. (In contrast, the U.S. downtown vacancy is coming in at 12.5%.) Given the current low vacancy rates in Canada, and with new supply in most markets 18 to 24 months away, especially in downtown core locations, landlords are constantly pushing rents higher.
Turning to Canada’s suburban markets, vacancy has jumped an estimated 130 bps to 10.6%. This is despite positive performance in Regina, Quebec City and Ottawa, which are posting vacancy well below the national average.
Developers are very active, with more than 21 million square feet (msf) under construction across the country – 4 msf more than last year, with Toronto and Calgary accounting for more than half of the total office space construction underway. Through the first six months of 2013, downtown is outpacing suburban office construction with each market segment having an additional 2 msf under development compared to one year ago.
The heightened downtown construction levels in such markets as Toronto and Calgary are raising concerns over the markets’ ability to absorb not only the remaining new supply, but also the residual vacancy left behind by relocating tenants.
Employment bumpy but trend is positive
Switching to the labour front, despite May’s surprising and massive 95,000 job surge, (which was the biggest gain in 11 years and just shy of the record of 95,100 set in Aug 2002), in June, employment was virtually unchanged with the unemployment rate remaining at 7.1%. In the first half of 2013, employment growth averaged 14,000 per month, slower than the average of 27,000 in the last six months of 2012. Over this 12-month period, employment grew by 1.4% (+242,000).
Investment volumes continue to increase
We haven’t finalized overall sales figures for the first half of the year yet, but the investment market in Canada remains busy. We can report first-half investment volumes for Toronto, a barometer for the rest of the country, with $6.5 billion worth of commercial real estate changing hands, up 15% over the same period one year ago. In the most recent quarter, sales volumes doubled for office, industrial and retail investments compared to the first quarter.
While Canadian REITs and Pension Funds continue to bid up assets north of the border, they also continue to deploy their growth strategies south of the border in markets such as Houston, Dallas, Atlanta, Phoenix, Seattle and Portland, to name a few.
The recent rise in interest rates (and bond yields) may curb capital flows and halt any further cap rate compression. This will certainly have an impact on the REIT sector where unit prices have come under pressure of late. We will be monitoring this situation closely as we move into the second half of the year.
We hope you enjoy the rest of your summer, and we look forward to helping you meet your real estate goals as we enter the second half of the year.
Posted by Mark E. Rose, AY Toronto at 2:12 PM