An uneven recovery: economic uncertainty sees retreat in demand after two quarters of improvement

Net absorption ends the year on down note in the wake of positive mid-year improvements

The Canadian office market reported its weakest quarter of 2022 in Q4 with negative 2.1 million sq. ft. of net absorption. This should not outshine the fact however that overall annual net absorption is at its highest level since the onset of the pandemic.

Four of 10 markets reported positive net absorption this quarter and was led by Waterloo Region and Vancouver. Losses were seen elsewhere across the country, with many including Calgary and Edmonton noting occupier rightsizing coming into play.

As has been the case throughout the year, one market in particular drove the narrative nationally this quarter. Faced with tenant relocations into new builds, long known future vacancies have finally come to market and had an outsized impact on Toronto. This impact was however amplified by the curbing of growth plans by several major tech companies.

Downtown sublets on the rise, keeping most markets near their 10-year highs

Sublet listings are once again on the rise and ended 2022 higher than a year prior. Subleases currently account for 18.1% of total vacant space and are equal to 3.1% of existing inventory.

A different picture is shaping up between the suburbs and downtown, with downtown centres accounting for the bulk of the increase this quarter. Suburban sublets meanwhile experienced a decrease and are at their lowest level since Q1 2021.

Quarterly sublet increases were seen in five of 10 markets and in absolute terms was led by Toronto and Vancouver. In both markets this was focused downtown, with the suburbs by comparison seeing improvement over the quarter.

The majority of markets remain at or near their respective 10-year highs of sublease vacancy except for a few cities: Calgary, Edmonton and Halifax. These three also noted further decreases in sublet listings this quarter.

Elevated vacancy levels anticipated to persist, especially in older properties

The overall national office vacancy rate increased after holding steady at 16.4% for two consecutive quarters and ended the year at 17.1%. Few markets escaped the rising tide with seven of 10 markets experiencing growing vacancy this quarter.

Notably, Winnipeg, Waterloo Region and Halifax were the only to see improved market conditions, either holding steady or decreasing across both of their downtown and suburban submarkets. Further, Halifax is the first market to return to pre-pandemic levels of vacancy.

The delta between downtown and suburban markets continued to grow throughout the year to 130 bps, its widest point to date. It is unlikely we will see a reversal of this trend in the year ahead with markets including Vancouver noting a shift in demand to the suburbs and multiple other downtown deliveries on the horizon.

Class A or B: Evolution in tenant preferences on display

The urban/suburban divide has continued to play out between the Classes with different factors rising to the top of tenants’ decision-making process.

As has been the case, downtown tenants have sought out quality, well-amenitized spaces to keep their employee base engaged in returning to the office. The result of this comes into clear view when comparing current Class A and B vacancy to Q1 2020, with Class B rising two times as much as A over the course of eleven quarters. Downtown Class A vacancy, while elevated due to delivery of new supply, remains at healthy levels in several markets, including Ottawa (8.9%), Vancouver (10.4%) and Toronto (12.0%).

Suburban tenants meanwhile have prioritized other factors such as greater flexibility that can be afforded with shorter commute times. In fact, suburban Class B vacancy now sits slightly lower than A, further proving that while quality helps differentiate product, it isn’t the sole driving force behind space decisions for all segments of the workforce.

Construction pipeline continues to lighten

The national office pipeline has continued to lighten, now 11.0 million sq. ft., and is at its lowest level since Q3 2017. A total of eight projects completed in Vancouver, Montreal, Waterloo Region and Toronto this quarter, five of which had been under construction since before 2020.

Pre-leasing has paused given the current economic climate and the recent wave of deliveries has seen the overall pre-leasing rate fall from 54.0% to 47.6% nationally. Looking ahead, developers overall have taken a much more conservative approach to construction and now are seeking higher levels of pre-leasing before moving forward on new projects.

62.0% of the active construction pipeline is anticipated for delivery in 2023. With developers largely placing all future projects on hold, the office pipeline could slow to its lowest level in over 20 years if no significant projects commence construction next year.