Fossil fuel fortunes continue to hold predominant sway in the Calgary office market. Reflecting on a year in which a global pandemic unsettled fundamentals to the east and to the west, Calgary-based analysts focus more on tangential circumstances than the COVID-19 outbreak itself.
During last week’s online commercial real estate review and forecast, executives with CBRE Calgary’s investment and advisory services fingered an economy tied to oil and gas for sinking the hesitant recovery that had appeared underway as 2020 began. They’re now projecting that more than a third of the downtown office inventory will be vacant by the time 2021 comes to a close.
Angus Fraser, executive vice president of office leasing, noted that few Canadian producers could viably compete as world oil prices plummeted to about $15 a barrel in sync with the early days of the COVID-19 pandemic, and weaker players have been relatively easy prey as prices recovered to the current $65/barrel range. He tallied the departure of three foreign firms — Devon Energy, Murphy Oil and Equinor — over the past 12 months and an uptick in mergers and acquisitions (M&A), such as Cenovus Energy’s recent takeover of Husky Energy. That further aggravates a five-year trend of downsizing in the sector’s office footprint.
“Our first quarter results are going to show a vacancy rate of 32.3 per cent and that’s on the back of negative absorption of 1.25 million square feet,” Fraser revealed. “Negative absorption was driven primarily by that M&A activity in the energy sector. In almost all cases, all of the office space of the acquired entity was put back on the market. The Cenovus acquisition of Husky Energy was certainly a large contributor to that number with the expected redundancy of all of Western Canadian Place.”
With downtown office space continuing to empty out in the coming months, he taps the vacancy rate to hit 34.5 per cent by end of the fourth quarter. Looking to the suburbs, Stuart Watson, a senior vice president with CBRE Calgary, outlined a similar energy-related history, albeit with the hollowing out of a slightly different tenant base.
A flourishing engineering services sector largely underpinned the construction spree that that doubled suburban inventory from 13 million to 26 million square feet in the years between 2005 and 2015. Likewise, the sector’s doldrums ripple through now.
“A lot of the space that was built over that cycle was A Class space with big expansive floorplates,” Watson advised. “The problem that we’ve faced, really from 2015 onwards, is the disappearance of big energy projects, the consolidation of that (engineering) sector and, as we come out of this pandemic, the new embracement of new workplace strategies.”
Tech sector contributes to change-related activity
Both Watson and Fraser see some promise in the tech sector, which has been a focus of the city of Calgary’s economic development strategy. There’s evidence of more local capital going into the sector as wary investors shift away from energy and — ironically — real estate; a planned downtown SAIT (Southern Alberta Institute of Technology) campus will accommodate the new school of advanced technology; and downtown tech tenants have absorbed about 500,000 square feet of space since 2016 with much of that filled during the past two years.
“Relative to the retreat of oil and gas, this is small potatoes, but, nonetheless, this is a source of growth that previously didn’t exist here,” Fraser acknowledged.
For companies favouring a return to formal office settings after the prolonged pandemic interlude, he also suggests downtown Calgary offers an attractive combination of low rents, a paucity of dense open-plan formats that would require overhauls to accommodate social distancing, and shorter commuting times than downtown workers may encounter in other large cities. Turning to the suburbs, Watson urges landlords to pivot to capture tech sector players that have been more inclined to build their own facilities.
“In the short-term, a lot of the activity in the market is going to be change-related not growth-related,” Watson hypothesized. “There’s a new challenge for the supply side of the market. Owners are going to have to find a way to innovate their properties in order to capture demand in what’s really going to be a win-lose market.”
National supply chains link industrial market to better prospects
For a contrasting supply dilemma, Iain Ferguson, CBRE’s vice chair, industrial properties, calculates that there will be no large blocks of 100,000+ square feet available for lease within 30 to 90 days. Logistics firms and national supply chain operators stymied in the tight Vancouver, Toronto and Montreal markets have been central to the past year’s activity, also priming conditions for new development.
Among factors in the Calgary market’s favour, Ferguson explains that most major consumer products companies already have a presence in the city. Meanwhile, CN and CP intermodal connections to British Columbia’s ports arguably make Calgary the best available alternative option to the lower mainland.
“We ran into a lot of circumstances in 2020 with corporate clients of ours, where they just couldn’t find the space in any of those (big three) markets and they started doing what we’re calling overweighting into Calgary,” he recounted. “Where as they might have done something smaller in Calgary or preferred to have done a deal in Toronto, they ended up doing that bigger deal in Calgary.”
Even with current supply constraints for large blocks of industrial space, Ferguson contends new product can be more quickly and cost-effectively built in Calgary.
“Due to the fact that there is a lot of vacant land available for construction, it’s a market where economics are still in line with fundamentals,” he submitted. “If you came in and said “I’d like to have a facility built in 12 or 18 months,” this is probably the only place in Canada where you could do that and where there’s a ready supply of land and a competitive field of developers and a fairly robust amount of capital to support development of these facilities.”
Private buyers more conspicuous in investment transactions
For now, capital is more circumspect about other kinds of investment property. CBRE senior vice president Duncan MacLean confirmed that 2020 was a near-low year for sales volume — “only slightly beaten to the downside by 1999” — in which private buyers accounted for 61 per cent of the deals by dollar volume as institutional investors “abstained from participating on the purchase side”. That’s a buyer profile he expects will continue in the short term, but with all investors showing more appetite in 2021.
“We’re expecting that transaction volumes for almost all asset classes will increase. It is difficult to go the other way,” MacLean said.
At least one major investment manager indicates he and his peers haven’t stepped away indefinitely. Participating in a panel discussion in conjunction with the release of the results of the Canada Annual Property Index earlier this winter, Peter Cuthbert, president and head of global real estate with Fiera Real Estate Investments, sketched out a scenario for the city and its real estate market to recapture lost standing.
“Calgary has a very innovative, very smart, very young workforce. I think they’ll re-emerge. They are going to continue to diversify their economy with a continued emphasis on energy, but it’s going to be renewable and sustainable energy,” he predicted. “If we have any leadership through our political side, maybe we start investing in clean energy because the demand for energy is not diminishing.”