What’s Coming Unglued Now in Canada?
by Wolf Richter, Wolf Street
Canada lumbered through the first half of 2015 in a “technical recession,” Statistics Canada confirmed this week, as GDP shrank in both quarters. Among the culprits: the swooning energy sector and an investment slump.
Now everybody is lining up behind the hope that a sudden acceleration will put the economy back on track in the third quarter, despite oil that has re-crashed and despite the ongoing collapse – and that’s what it is – of the all-important energy sector.
To get to this acceleration, the once booming residential and commercial construction sectors have to hold up, or else Canada’s economy is in real trouble. Alas….
“Canada is also in the midst of an ill-timed supply surge that caused vacancy rates to rise even in markets with positive absorption” in the second quarter, warns a new report by commercial real estate firm Colliers International cited by the Financial Post. It paints a picture of an epic office boom turned into an even more epic office glut, particularly in Calgary and Edmonton, Alberta, the epicenter of Canada’s oil patch.
This office glut comes on top of Calgary’s housing meltdown. For the first eight months, total home sales in Calgary plunged 25%, according to the Calgary Real Estate Board. Condo sales collapsed 39% in August and 30% year-to-date. Inventory sits a lot longer on the market before it sells, if it sells. And pressures are building on prices: the average condo price was down over 10% in August from a year ago.
Commercial real estate is heading in a similar direction. Only worse. Calgary was a boom town. Office towers have been sprouting like mushrooms. In recent years, commercial real estate costs downtown were “going through the roof” and “accelerating at a pace far beyond the Canadian average,” Calgary Chamber of Commerce director of policy and research Justin Smith told the Financial Post. But it takes years to plan and build office towers, and now no one can just turn off the flow.
With 5.2 million sq. ft. of office space under construction, Calgary ranks eighth in North America and first in Canada, ahead of mega-city Toronto with 4.8 million sq. ft. Houston, the epicenter of the US energy boom and bust, crowns the list with 12.3 million sq. ft.
In downtown Calgary alone, there are 3.4 million sq. ft. of office space under construction, almost as much as in downtown Toronto (3.8 million sq. ft.) and 28% of the 12.3 million sq. ft. under construction in downtowns across Canada!
In relationship to the size of the market, Calgary ranked third in North America, with office space under construction amounting to 7.8% of existing inventory.
It’s behind only Silicon-Valley boom-and-bust-town San Jose, whose 7.8 million sq. ft. under construction amount to a breath-taking 10.1% of existing inventory, and Edmonton, the capital of Alberta, whose 2.2 million sq. ft. under construction amount to 8.3% of existing inventory.
“With seven new office towers under development and coming to the market between now and 2018, it is no surprise that Calgary is leading the way in new construction in North America,” Joe Binfet, managing director at Colliers International in Calgary, told the Calgary Herald. “The new developments will add an additional 12% of new inventory to the downtown market.”
“Add to this the new developments in the suburban, retail and industrial markets and it is clear Calgary would be among the top cities in terms of new construction,” he said. The report explained it this way: “The new construction speaks to the long-term vision developers have for the city and the confidence they have in Calgary going forward.”
That vision was perhaps a tad grandiose. Now companies are cutting back on costs and capital expenditures to preserve precious capital, they’re scaling back operations, laying off employees – ConocoPhillips, Nexen, and Talisman recently announced layoffs in Calgary – and reducing or eliminating hours for their contractors. They’re shrinking their footprint.
Companies gave up 1.7 million sq. ft. of downtown office space, the largest quantity of newly vacant office space in any downtown in North America, beating even Houston, where 1.6 million sq. ft. have become available.
So the vacancy rate in Calgary soared to 13% in the second quarter, from 10.6% in the first quarter, according to Colliers International. In Edmonton, it jumped to 11.2%.
“The number of half-empty office buildings in Alberta is projected to spike,” according to the Financial Post.
Tom Dixon, manager of real estate, transportation, and logistics with Calgary Economic Development, remains (sort of) upbeat:
“The best test is have you seen any cranes stop? Have you seen any being disassembled and projects capped? We’ve seen that in other situations. I haven’t seen any this time,” he told the Calgary Herald. “I think the commitments are strong, firm, and people are moving ahead based on the fact that once you start construction it makes sense to just complete it. Who knows? When each of those buildings is completed, maybe oil is back at $60, $80, or $100. We don’t know.”
They’re all waiting for the deus ex machina, the next oil boom.
But as terrible as these vacancy rates are – and they’re bound to get much worse – they understate the problem. As a company sheds employees and contractors, it might nevertheless hang on to the thinly staffed or vacant space. These “ghost vacancies” don’t enter into the official vacancy rates.
“The ghost space may never come to market, but those companies that currently have excess capacity of office space, as they continue to staff up, you can’t assume that they’ll be back in the market looking for more space,” Colliers executive VP and partner Jim Rea told the Financial Post. And so even when the slump ends, and employment rises again, it might not reduce the vacancy rates for years to come since companies will first fill the empty offices they already have.
This is how an epic office construction boom – not just in Alberta but in much of Canada and the US – boosts the economy for years only to run afoul of the eventual business cycle or, as is the case in the oil patch and Silicon Valley, the boom-and-bust cycle.
Businesses get “crunched” in the Canada’s oil patch, consumers lose it, and indexes hit Financial Crisis levels. Read… It Gets Even Uglier In Canada