Key service centres for the oil and gas industry are at differing junctures in Canada and the United States. JLL’s newly released overview of office and industrial space trends in North American energy hubs contrasts the shale boom bolstering U.S. economic activity with the logistical constraints squeezing Canadian producers — and also flowing through to Calgary and Edmonton’s commercial real estate markets.
“Canadian WCS oil has been stuck in transit,” JLL analysts observe. “There is a lack of capital spending and a struggle to attract foreign investors to the sector until the pipeline capacity and exporting issues are addressed.”
The report underscores Calgary’s deep exposure to the volatile sector. Even with the 25 per cent downtown vacancy rate largely attributable to persistent low oil and gas prices and massive layoffs in the sector, energy-related tenants still account for nearly 39 per cent of office occupancy. That’s about 17 million square feet in a total inventory of 43.7 million square feet.
Houston also hosts a high concentration of energy tenants, filling 60 million square feet of the total 168 million square feet of office inventory. JLL analysts lump both cities into the hard-hit category, whereas the Dallas and Denver office markets are deemed to be landlord-friendly.
Of the latter, Dallas has a relatively small contingent of large energy players, including Exxon, Pioneer and Kosmos, that comprise less than 3 per cent of the city’s more diversified tenant base. Denver has the smallest office inventory at 30.2 million square feet with 1.1 million square feet under construction. Meanwhile, about 430,000 square feet of office space is still under construction in Calgary and 3 million square feet is under construction in Houston.
Relocation and downsizing typify leasing deals
“While the macroeconomic environments in markets like Houston and Calgary have seen improvements over the last quarter, the office inventories there still struggle and occupiers will retain negotiating leverage in upcoming years,” the report projects. “Weak demand and enormous inventories of vacant space remain.”
Energy firms drove Calgary office leasing deals in the first quarter of 2019, but in a way that had few landlords celebrating. The largest transactions involved companies relocating and downsizing into smaller spaces so that 1 million square feet of leasing resulted in a more modest 381,000 square feet of net absorption.
Notably, Nexen left more than twice as much space behind when it moved into 300,000-square-foot quarters in the Bow building. TransAlta similarly filled less than half the footprint it had vacated when it moved into 124,000 square feet in the beltline’s Keynote Tower.
Energy firms have dumped 55 per cent of the approximately 2.7 million square feet of sublease space now on Calgary’s market. There has been even greater offloading in Houston, where they’ve contributed nearly three quarters of 7.7 million square feet of sublease space.
Gulf Coast drawing investment
However, turning to industrial, the dynamics are more robust in Houston. Energy-related tenants have leased 3.1 million square feet of space since the first quarter of 2018, contributing significantly to 5.4 million square feet of industrial absorption in the same period. Average asking rent in the first quarter of 2019 was USD $5.76 (CAD $7.54) per square foot. The average lease size was more than 82,000 square feet versus 20,000 square feet in Calgary or 30,000 square feet in Edmonton.
Much of the Houston activity is tied to petrochemical products rather than resource extraction. “There has been $60 billion in petrochemical investments in recent years along the Gulf Coast and many of these products are processed, refined or packaged in the Houston area. Additionally, Houston handled over 40 per cent of the nation’s resin exports in 2018 and further growth is expected in the period ahead,” the report advises.
That’s a significant part of the bigger national picture. “Since 2010, natural gas from shale formations is driving a projected $204 billion in new capital investment across 330 chemical industry projects, according to the American Chemistry Council. This processing, refining and packaging of plastics and resins is occurring largely along the Gulf Coast, though significant ethane production will also come online in Pennsylvania in 2021 with the completion of Shell’s $6 billion cracker plant,” the report explains.
Logistics and distribution emerging
Industrial also offers a more upbeat story in Calgary, but it doesn’t have an energy narrative. Over the past year, 350,000 square feet of leasing from energy tenants made a fairly modest contribution to 3.3 million square feet of net absorption. The average asking rent for Q1 2019 was CAD $9.35 (USD $7.10) per square foot.
“Growth in the industrial sector is strongly centred around it being a desired location for distribution,” JLL analysts conclude. “This can be viewed as cause-and-effect based on a tight Vancouver market, in addition to the geographical location of Calgary, making it accessible to large markets in a 24-hour drive time. Investment in Calgary remains consistent and is continuing to trend in a positive direction. Again, this investment is focused on speculative-built, institutional grade distribution facilities.”
Edmonton industrial facilities have been more conventionally tied to upstream oil and gas production, and have suffered accordingly as energy-related employment in the sector declined by more than 12 per cent since 2015. Energy-related tenants filled about 750,000 square feet of the 1.6 million square feet of industrial absorption since the first quarter of 2018.
As with Calgary, JLL points to the emergence of distribution and logistics to diversify a “highly energy concentrated” tenancy, but projects it will remain a tenants’ market until 2021. Even so, Edmonton’s 5.8 per cent industrial vacancy rate is just 20 basis points higher than Calgary’s and it commanded a higher average asking rent of CAD $9.45 (USD $7.18) per square foot in the first quarter of 2019.