Edmonton Office Property Market Report, March 2022

Overview

The office has been a major topic of discussion for real estate professionals as well as global economists, second only to global supply chain disruption & perhaps inflation. The uncertainty surrounding the future of office space had many contemplating over the last two years whether the empty office towers would ever be filled again. The eerie feeling of large empty buildings and an abandoned downtown core gave a sense of a post-apocalyptic setting and the question of if or when the downtown would recover was on the forefront of the business community. Thankfully, most businesses appear to be returning to the office and the downtown may just return to life, although in a slightly different fashion than previously seen.

Market Trends

The meaning of the word “office” and what it represents has undergone a major change over the last two years. The traditional understanding of the office is a physical place of work or productivity. However, due to communication technology and the work-from-home orders this was expanded & shifted into the digital world, which revealed to many businesses, as well as employees that the physical office wasn’t essential to be productive. The virtual company also allowed for companies to expand their employment pool outside their physical location to a global talent pool. Many were predicting the end of the physical office and the collapse of the office market. This, however, was not the case, as the long-term stability of physical real estate assets kept investor confidence and no major panic selling was seen in the market. Most large property owners simply held tight and waited out the storm. What has changed, is our view of the office and the necessary innovation in attracting tenants to vacant space.

For the physical office to survive and to thrive, the definition of the office as a place to do work must expand to a place of wellness, health, social connection, collaboration, creativity, inspiration, and personal development. Because it is not a necessity, the physical office must be a destination that people are eager to go to, as opposed to a place that they are reluctant or forced to attend.

Insights

Companies located in large urban innovation centres have begun outsourcing and establishing smaller hubs in cheaper markets. These smaller cities are attracting a greater innovative talent pool with their affordability and high quality of life. Further, large companies are moving from expensive hubs to more affordable areas due to the decreased need for locational agglomeration economies. For example, Tesla has recently moved to Austin Texas from the San Francisco Bay area and many other large tech companies are following suit. Moreover, talent is opting to live in more affordable areas, causing an even greater exodus of talent out of large hubs. This trend has been seen in other expensive markets such as New York, London, and Toronto. It is unclear as to what extent this will have on office property values in those areas; however, it does seem clear that smaller up & coming cities will experience a rise in employment talent and therefore, the need for office space.

Working from home has presented significant challenges and despite the available technology, home working situations have created distrust between employees and management, have broken down the separation between work & home life, and created overall longer working hours. Additionally, lack of connection, loneliness, collaboration restrictions, and company cohesiveness has also been detrimental to company well-being, productivity, and success. Although there have been reports of anxiety toward the return to the office, most are welcoming it with enthusiasm and according to an Edmonton Downtown Business Association survey, 70% of companies have indicated that they will be returning to the office. It is likely that this number will rise as the advantages of the physical office become re-established. What a 20% - 30% reduction in occupancy will have on property values has yet to be seen. However, what is occurring, is a flight to quality product that contains extra lifestyle amenities, which is in high demand from companies looking to entice employees into the office. This will create upward pressure on higher-end rents and therefore, values of quality, high-end product, and subsequently will put downward pressure on older, lower-end product. For older, lower quality product, mass upgrading & reconfiguration will be necessary to compete in the future market. The reality is that people want to come back to the office but need extra incentive to make the commute, which has motivated many companies to focus on culture, connection, and work lifestyle.

Forecast

Although many will be returning to the office, hybrid working will become the norm as the office becomes more of a luxury than a necessity. This will likely look like three days in the office vs. the five previously required. Further, there has been a trend toward a four-day workweek with an optional day, which has been shown to increase productivity and overall well-being of employees.

Amenities, programming, design, & culture integration into the office experience will be crucial for landlords and developers in a highly competitive market. Such amenities include meditation/prayer rooms, social rooms, gyms, coffee bars, & healthy food offerings. Event programming such as yoga, workshops, lectures, therapy, as well as personal growth classes has become a major draw to current and potential tenants. People have grown accustomed to the comfort of home but are missing the social interaction & colleague comradery. Therefore, comfort, luxury, communal workspace, greenery, and outdoor natural areas will be paramount to the employee experience.

The importance of culture and cohesiveness between employees will also be crucial for businesses occupying the space. Establishing a vivid company vision, mission, and massive transformational purpose will unify & motivate the workforce.

Tenants will be looking for flexible workspace, concessions, and short-term leases, which will increase operating costs for landlords. However, owners should be able to charge higher rents to cover those increased expenses. Many companies will be outsourcing to open talent pools, opting for lean organizational structures that can adapt to changing economic conditions. Virtual components have been integrated into companies and although most companies won’t be entirely virtual that aspect of business is here to stay, which will undoubtedly reduce the number of employees in the physical office and therefore, reduce the necessary overall size of the occupied space.

Alberta is on the rise economically and many people are moving to the province from overpriced markets such as Toronto and Vancouver. International and immigrant buyers are also purchasing homes looking to take advantage of the affordable living and high quality of life. This will have a cascading effect on commercial real estate but particularly on the job market & office absorption.

Market Conditions

As we put the pandemic behind us and see the negative aftereffects of the global COVID-related restrictions, Alberta looks poised for another boom cycle while the world grapples with supply shortages and geopolitical conflict. Production cuts and manufacturing shutdowns throughout the global restriction policies related to COVID-19 have caused significant disruption in the global economic system and created major supply shortages in various industries. Coupled with this, the increases in money supply have caused prices of consumer goods & services to shoot upwards. Canadians are paying on average 5% more than they did last year for goods & services. Major increases in oil & gas prices have been seen in 2022 thus far, with prices reaching $80/bbl in January due to the supply shortage. These supply shortages have been exacerbated by the recent invasion of Ukraine by Russia. This destabilization of Russian oil supply has spiked oil prices to $115/bbl, which is a 55% increase year-over-year. Although this energy uncertainty has slowed global economic activity and further increased the price of consumers goods, the increase in oil price has spurred substantial economic activity within Alberta and drawn attention back to the ethical & stable reserves of the province. Natural gas prices have also been trending to record heights with a 63% increase year-over-year, which has further increased Alberta’s natural gas exploration. As the global & national economy appears to be moving into recessionary conditions, the sense in Alberta is that we are headed for a four to five-year economic run. Alberta’s economy has historically moved in contrast to the rest of Canada and the world when it comes to high oil prices and this time appears no different. Much investor attention has been given to Alberta as of late in real estate, oil & gas, and lumber projects. Many are moving to Alberta to take advantage of affordable living, high earning potential, and good quality of life. This can be seen with Calgary experiencing the busiest day of housing sales in thirteen years on March 1st, with much of the sales coming from people moving from Toronto & Vancouver. Housing shortages in the province have increased housing prices by 16% in major centres, year-over-year.

Price Trends

Long-term leases and private lease concessions have kept office property stable through the work-from-home orders and virtual working environments. Some larger central product was disposed of at lower prices; however, this was few and far between. Smaller suburban product did not see many distressed sales and prices have remained relatively stagnant over the last two years.

Transactions

YEAR AMOUNT NO.

2018 $512,564,079 34

2019 $875,663,500 24

2020 $235,338,917 31

2021 $78,062,000 22

The above chart indicates that office sale volumes in Edmonton have been relatively on par throughout COVID as 2018 & 2019. However, the total value of the transacted product is significantly lower, which indicates that the product being traded is smaller, lower-priced property. What this says about the market is that the larger investors sat out most of the pandemic due to low-risk appetites and shareholder obligations. It was the smaller players that were doing the deals throughout the pandemic, which is reflective of smaller investors being more adaptable, agile, and willing to take on greater risk to reap the benefits of slightly lower prices and distressed property owners.

Vacancy

CBRE is reporting that suburban vacancy rates dropped 20 basis points in Q4 of 2021 from the year prior. Downtown product was hit much harder by the government-imposed restrictions, increasing vacancy by 50 basis points. Overall vacancy is hovering around that 20% - 22% marker. This rate is expected to decrease significantly over 2022 as companies return to the office. These numbers represent a short-term market dip and are not considered to be stabilized or normal vacancy rates. As mentioned, the higher quality AA product is experiencing lower vacancies at 15% in Q4, 2021, whereas the B class product is clipping 40%.

Absorption

The suburban office market saw 100,000 sq.ft. of positive absorption through the second half of 2021. AA product saw a positive absorption of 29,000 sq.ft., which is an indication of the flight to quality previously mentioned. Overall, however, the office market saw 200,000 sq.ft. of negative absorption through 2021, as uncertainty about the future was at its height. Figures through 2022 will likely see significant positive absorption as most companies return to the office.

Cap Rates

Office properties have been one of the more negatively affected assets in the real estate market and are considered to have greater investment risk than other asset categories. Long-term leases that were in place prior to 2020 and lease concessions have pulled the office market through complete disaster and the office market is starting to reinvigorate itself, with the return to the office looking promising. However, there is still greater risk in the market than pre-pandemic levels, which would warrant higher capitalization rates. The risk is largely dependent on the individual attributes of the property and each property needs to be carefully analyzed and studied, as market capitalization rates have a significantly large range. However, general rates are listed below.

Edmonton proper: 6.5% - 7% Greater Area: 7% - 7.5%

Lease Rates

Lease rates have seen a significant spread between high-quality product with amenities and older lower quality product. High quality has been trending upward, while low-quality has been moving downward.

The following is a rental rate survey for various areas located on the “Edmonton Real Estate Zone Map.”

*These lease rates are an accurate representation of the general area but may not be accurate to a specific property within the area.

*Lease ranges are largely dependent upon the age, condition and amenities displayed on the property. *Lease rates are on a price per square foot & triple net basis.

Edmonton Real Estate Zone Map

DOWNTOWN CORE (Zone 12)

Low $10

Mid $16

High $35

EAST CORE (Zone 13)

$14 - $24

NORTH CENTRAL (Zone 5, 8)

$8 - $15

SOUTH CENTRAL (Zone 15)

$6 - $12

CALGARY TRAIL

$28 - $36

WHYTE AVENUE

$22 - $25

WEST CENTRAL (Zone 4, 7, 10, 11)

$8 - $13

EAST CENTRAL (Zone 17, 18, 19)

$10 - $15

SOUTHWEST (Zone 14, 16, 55, 56

$30 - $40

WEST (Zone 20, 21, 22)

$12 - $15

NORTHWEST (Zone 1, 27, 40)

$15 - $20

NORTHEAST (Zone 2, 3, 6, 9, 23, 28, 35, 43, 50, 51)

$20 - $28

SOUTHEAST (Zone 29, 30)

$18 - $20

PARSON & CALGARY TRAIL COMMERCIAL AREA (Zone 41)

$15 - $20

SUMMERSIDE/ELLERSLIE (Zone 53, 54)

$18 - $20

ST. ALBERT

$15 - $30

SHERWOOD PARK

$15 - $23

SPRUCE GROVE

$14- $26

LEDUC

$14 - $21