Article
Toronto Office Market Approaches the End of Uncertainty
May 6, 2022 5 Minute Read
Much ado was made about Toronto's office vacancy rate moving up in the first quarter of 2022.
But CBRE’s Toronto Downtown leaders Jon Ramscar and Michael Case say there’s more happening in the nation’s largest office market than the headlines may suggest. While the future of the office is still in flux, they say we could at least be approaching the end of uncertainty.
Here’s what they’re seeing:
Vacancy is the Norm
The office market has changed from two years ago, from extraordinarily tight to, well, normal.
Sure, Toronto’s downtown vacancy rate rose to 11.3% in the first quarter, a big shock to those who figured the city’s 2% vacancy rates — tied with Vancouver for the lowest in North America pre-pandemic — would last forever.
The truth is, however, that a balanced office market has traditionally been in the 8% to 10% range. So Toronto is in fact a more balanced market now than it’s been for some time — since 2006 to be precise.
“The happy equilibrium has always been 8% to 10%,” says Case. “That used to be the magic number that allowed companies to grow and move, while landlords had some certainty on price and new development requirements.”
Adds Ramscar: “Any major global market tends to have office vacancy in that range. London was 10% to 12% for decades. In New York that was the norm, too. We actually don’t want Toronto to be at 2% again. That’s not a healthy market. Low vacancy can throttle an economy and make scaling businesses with top talent go elsewhere.”
Omicron Setback Hurt Momentum
Like so many aspects of life in the pandemic, office demand was really turning around in Q4 2021 before Omicron hit the pause button again at the end of 2021.
“Leasing activity accelerated before Christmas,” says Ramscar. “There was a significant pick up in demand for office space with the last quarter representing more leasing activity than the heights of 2019 and vacancy starting to trickle down. Then Omicron struck and we went back into lock down. Western Canada, however, stayed open and they carried that momentum through. We now see the pause in demand reflected in our Q1 numbers.”
Calgary, which has had the highest downtown office vacancy rate in the country, had 130,626 sq. ft. of office space absorbed in Q1—that city’s first quarter of positive net absorption of office space since the start of the pandemic. And positive net absorption was recorded in five of 10 office markets, mostly in B.C., Alberta and Manitoba, which re-opened earlier.
“So as Toronto opens up, a logical approach would dictate a reduction in the vacancy rate if nothing else were to change,” says Ramscar. “Companies are now starting to mobilize back into their Downtown offices in some form. We are at an interesting inflection point.”
Less Sublease Space = More Clarity
Big blocks of space flooded the sublease market during the pandemic. But as Case points out, “a good chunk of that wasn’t real.”
Companies working from home tested the subleasing waters, putting their space on the market to see if they could get full financial recovery if another group subleased it. If they didn’t get full recovery, most opted to hang onto their offices with plans to re-occupy them eventually.
“Now a lot of those leases are expiring, and tenants must either renew because time’s up or give the space back to the landlord,” says Case. “So we’re seeing the percentage of sublease space decreasing and as a result it’s giving us more clarity on the true state of the market."
Another sign of waning uncertainty: landlords Case is speaking with tell him they’re holding out for longer lease terms. “We had assumed many tenants would be signing 1- or 2-year extensions and not committing to longer leases,” says Case. “But term lengths are starting to creep back up. We’re not seeing the traditional 10- to 15-year deals, but we’re at 3 to 5 year and trending in that direction.”
New Supply Needed
“If you want to attract top-tier companies and talent, you need top-tier, modern office space,” Ramscar says emphatically.
The vacancy increase in Toronto reflects a tale of two markets: high quality space (i.e. new towers) and existing older buildings. According to CBRE Research, buildings built post-2010 have a 2.2 vacancy rate versus buildings built pre-2010, which have 12.9% vacancy.
Much of the new supply that is coming onto the market — 1.8 million sq. ft. in the past two quarters alone — is highly sought after, leaving older space looking for tenants. “It’s a bifurcation in the market,” says Ramscar. “There’s the high-quality modern space that everyone wants and older space that needs investment to be reimagined.”
Several sizeable deals originating from U.S.-based tech companies closed in the first quarter, cementing Toronto’s reputation as a North American tech hub. Global players are circling Toronto in search of office space, with the likes of Amazon, Nvidia and Meta looking to substantially grow their footprints in Canada’s biggest city.
“These tech giants are important for the Toronto and Canadian economy, but these groups are not going to want to be in a dated office building,” says Ramscar. “They’ll want to be in something new, current and funky for their people, like they have in London, Shanghai and New York for example. International quality buildings and space for international quality companies.”