How The Oil Bust Is Crushing The Office Real Estate Market
Commercial real estate, particularly office space, in Calgary, Alberta, the epicenter of the Canadian oil bust with 1.2 million people, is collapsing at a breath-taking rate. As companies in the oil & gas sector have downsized or gone out of business, 25,000 people who used to work downtown have lost their jobs.
Office vacancy rates have soared to 22%, the highest on record, according to the second quarter report by commercial real estate services firm CBRE.
Vacancy for Class AA office space reached 17.6%, and for Class A space 18.9%. Older buildings are getting clocked: Vacancy rates for Class B buildings soared to 32% and for Class C buildings to 28%.
It’s going to get worse: three towers with 2.3 million sq. ft. of office space are under construction in downtown and will be completed by 2018. Of this space, about 1 million sq. ft. is not leased. And even some of the pre-leased space may end up on the sublease market.
Colliers International in Calgary estimates that the overall downtown vacancy rate will approach 26% by year-end 2018. How optimistic is this estimate? A year ago, we reported that Colliers had estimated that the vacancy rate would hit 17.5% by year-end 2018, with the warning that “this may even be an optimistic forecast.” It sure was.
The sublease market is the crux. Sublease space can appear out of nowhere overnight. During the good years, amid a perceived shortage of office space associated with a notion that rental rates will only increase, companies leased more space than they needed and warehoused that space. But now, the hard times, they dump this space on the sublease market, which now accounts for 42% of total vacancies.
The Financial Post adds some details:
This week, TransCanada Corp. put 11 floors of office space back on the market in an attempt to find a tenant to sublease their office space in a 25-floor building. As TransCanada moves out and consolidates its staff at or closer to its headquarters, the older building’s vacancy rate will rise to over 50%, with more floors available in 2017.
A few blocks south, Brion Energy Corp. is poised to move out of Encana Place and into a new tower, which would leave its current address more than 90% empty and only the building’s landlord, Aspen Properties Ltd., in the 30-story tower.
Many other towers are over half empty, and energy producer’s efforts to control real-estate costs is putting pressure on landlords at both old and new buildings.
Only one tenant, for example, has moved into Eau Claire Tower, a 25-floor building completed in 2015. Peyto Exploration and Development Corp. occupies two floors in the glass tower, which is fully leased but currently sits 90% empty.
Rental rates have collapsed. Landlords are desperately trying to fill some of this space by slashing rental rates. Quoted Class A rental rates have plunged 56% from $40 per sq. ft. in 2012 to $17.50 now, lower even during the brief oil bust and the Financial Crisis when rates bottomed out at $20 in 2009.
And it’s even worse:
“Not only are the rental rates lower, but the inducements to individual tenants for improvements and/or free rent are all going up,” Randy Fennessey, president of Colliers International in Calgary, told the Financial Post.
Fennessey said that landlords would rather sign a lease with higher contractual rental rates and then give tenants the option of moving in a year early free of charge rather than drop their prices. Tenants in the energy sector currently looking for space, he said, have been taking those deals with the expectation that the worst of the downturn is over.
“That’s a common negotiating tool today because a lot of tenants, particularly in the energy sector, are trying to control their general and administrative costs,” Fennessey said.
So how long might it take before vacancy rates fall back to 10%? Colliers Q2 report, cited by the Financial Post, offers a glimpse: “at historical absorption rates, it could take five to 10 years….”
Now there are discussions that the solution might be to tear down some of the older towers, a number of which have vacancy rates over 50%, or convert them into condos in the hope that by then there will be buyers. Calgary Economic Development CEO Mary Moran put it this way: “There are a lot of people in Calgary that would say, ‘We’re not overbuilt, we’re under-demolished.’ So there are some products that probably could go.”
Of the big cities impacted by the Great North American Oil Bust, Calgary is ahead of the curve, being so heavily focused on oil, particularly on tar sands production, the global high-cost producer. Houston, the epicenter of the oil bust in the US, is more diversified. But it too can no longer shrug off the impact. The oil bust in the 1980s made its way into the broader regional economies via real estate, banks, and unemployment. And Calgary shows that this oil bust is sending out similar ripple effects that will take years to overcome.
The financial bloodletting is far from over in the US and Canadian oil patch.
Note: The author of this article is Wolf Richter. He is a contributor to EconMatters.com.
Category: Commodities
