Opinion: An office market in transition: Why Ottawa looks like no other city

For most of the past decade, Ottawa’s downtown office vacancy rate was among the lowest in North America. So why have rents been so flat?

By Steven LeFaivre

From 2002 to 2010, Ottawa’s downtown vacancy rate averaged 2.7 per cent, the lowest among all major North American metropolitan markets. Yet landlords neglected to hike their rates, as net effective rents – the actual rent collected by landlords after deducting leasing costs such as tenant inducements, free rent periods and commissions – was stagnant at between $20 and $22 a square foot.

The reason Ottawa landlords were unable to increase rents is because the actual vacancy rate was at or close to Ottawa’s natural vacancy rate, which is the point at which rents are stable and the market is considered balanced.

When the actual vacancy rate exceeds the NVR, the market is unbalanced and rents will fall until equilibrium is reached. Conversely, when vacancies are below the NVR, rents will rise and the supply of office space will increase.

If downtown Ottawa was like other major Canadian markets, a decade of vacancy rates hovering below three per cent would have resulted in class-A rents of $30 per square foot and a dozen new office buildings. Downtown Calgary experienced seven consecutive quarters of vacancy below two per cent and saw rents jump 40 per cent as 14 new buildings were added to the office supply. Vacancy in downtown Vancouver dropped nine percentage points between 2004-08 as rents doubled.

But Ottawa is not like other Canadian cities, since the bulk of its competitive office space is leased to one tenant: the federal government.

A homogeneous tenant market leads to highly standardized office buildings and discourages landlords from undertaking extensive searches for higher-paying tenants and gradually pushing up rents.

 

OUTLOOK

With the federal government intending to reduce its downtown real estate footprint by 10 per cent, Ottawa’s central business district is undergoing a structural shift that will likely end the days of vacancy rates below three per cent.

While Public Works wants to reduce overall occupancy costs, it is also putting a renewed emphasis on leasing high-quality office space. This means that the current period of low public-sector demand will disproportionately affect landlords on the lower end of the spectrum.

The gap between class-A and class-B is likely to widen, and owners of underperforming properties will have to make capital investments to remain competitive.

Ottawa’s downtown market is in transition.

There will continue to be downward pressure on rents – particularly for class-B and class-C downtown office space – while plans for speculative new construction will be postponed until vacancies ease back towards natural levels.

SIDEBAR: Market snapshot

Ottawa’s downtown office market was expected to finish the first quarter at with a vacancy rate of 5.9 per cent. After a decade of hovering around three per cent, the vacancy rate in the central business district has averaged 5.7 per cent since 2011. Net effective rents, meanwhile, are dropping to below $20 per square foot.

 

Steven LeFaivre is an associate director specializing in commercial real estate appraisals at the Ottawa office of CBRE Ltd.