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Tuesday, August 9, 2011

Wide gulf remains between Canadian and U.S. office leasing fundamentals

By Mark Rose (Toronto)

In Canada, the propsects of a stable economy and improving leasing market fundamentals continues, as we look forward to the second half of 2011 – this, despite the lagging performance in the U.S., strange behaviour by the U.S. government, and a debt crisis that has consumed the Euro-zone, in particular Greece.

Two key metrics among others that influence the overall health of the market are business confidence and job growth. Business confidence remains positive, now close to 70% – up from around 58% one year ago and 35% at the height of the recession.

Canada's unemployment rate was unchanged in June at 7.4% as the number of people participating in the labour market increased. Employment rose for the third consecutive month, up 28,000 in June, surprising many analysts. Over the past year, employment has grown by 238,000 (+1.4%).

Despite the summer season, leasing markets remain active across the country. A recent survey of Avison Young’s markets across Canada revealed a national office vacancy rate of 7.8% – down 210 basis points from the same period one year ago. Conditions are especially tight in the country’s downtown markets – collectively showing a vacancy rate of 6.2% at the midway point of 2011.

Read the press release and full report here:

Avison Young releases Mid-Year 2011 Canada US Office Market Report: Decreasing vacancy and rising rental rates evident in many markets as business confidence grows; Canada continues to lead US in recovery

Avison Young Canada US Office Market Report (Mid-Year 2011)

On the development front, there is more than 8 million square feet of office space under construction in Canada – with more than 70% of the office space already preleased. And on the investment front, $8.5 billion worth of commercial real estate changed hands in the first half of 2011 – a marginal increase over the first six months in 2010. Toronto is the hottest market… and retail the most sought after investment, capturing more than 50% and 28% of the investment volume, respectively. Of course trophy assets are highly contested and confirmed by very low cap rates.

Year-to-date 2011 capital raisings (Canadian REITs and corporations) equate to $2.8 billion, in line with the 10-year historical average aggregate of $2.75 billion/year. In all, $5.6 billion was raised in 2010. And 2011 looks to at least match that. REITs remain the biggest buyers. The big news since our last update? Dundee REIT will soon close the largest office portfolio (24 assets in 2.7 msf) ever acquired by a Canadian REIT for $690 million from Blackstone Real Estate Advisors and Slate Properties.

The momentum established over the past 12 months, and particularly through the first six months of 2011, is expected to keep building for the remainder of the year.

And now we turn to the U.S…..

Two years into what has been an uneven recovery, a wide gulf remains between Canadian and U.S. office leasing fundamentals. Canada continues to lead the U.S. in this recovery, having weathered the storm of the recession more robustly. Employment, a leading indicator, has propelled Canada’s office markets forward, while in the U.S., employment gains have largely been lagging and inconsistent.

There are serious issues and risks facing the U.S. economy. As of June 2011, the Federal Reserve of the United States has pulled back on quantitative easing; employment growth and GDP are anemic or trending negatively; and the politically-embarrassing debate over the U.S. debt ceiling has potentially undermined the economic recovery.

This month, the Bureau of Labor Statistics reported a national unemployment rate of 9.1% for July -- essentially unchanged from June and May – and although it represents the highest level since year-end 2010, it remains lower than averages reported during most of 2010.

Sectors adding jobs included the professional and technical services sector, which added 24,000 in June and has added 245,000 jobs since its recent low in March 2010. Government jobs continued to trend down over the month, losing 39,000 jobs in June -- 14,000 of which were federal.

State and local employment has been falling since the second half of 2008. And as state and local governments struggle with operating deficits, these employment losses could serve to dampen the effect of any private-sector employment growth, and remain a threat to a broader economic recovery.

The U.S. office market saw its vacancy dip to 12.6% in the second quarter from 12.7% in the first quarter. The 10-billion-square-foot U.S. office market recorded positive net absorption of 12 million square feet in the second quarter – most of which was in class A space, as tenants continue to take advantage of oversupply and “trade-up”. As well, sublease space continues to decrease (it has fallen each quarter for the last four) and points to trending market improvement.

One area of optimism is the recovery of the sales market. Core assets, with stable cash flows, will remain the most desired investment class, especially in the biggest markets. There is a healthy sales and financing environment right now, albeit with minimal improvement in real estate market fundamentals.

According to Real Capital Analytics, June is on track to record the highest volume of sales thus far in 2011, and more than double the volume during the same month last year. The major markets of Manhattan, Washington, DC and San Francisco account for nearly half of the volume as of May.

Job growth is key to improved fundamentals, and those numbers have been bumping along. Watch what happens to the public sector employment numbers in the coming months as election campaigning season ramps up.

You can also listen to this Q3 2011 update on our Avison Young Audiocast tab:

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