Office Vacancy Rises Further in First Quarter as Canada’s Office Space Evolution Continues

Much like retail has undergone a significant retooling and revitalization, office space is being reimagined

Office vacancy continued to rise in Canada’s major markets in the first quarter as the sector undergoes a once-in-a-generation evolution, with tenants seeking to adjust to hybrid work and office landlords striving to maintain their appeal. The result is a sector in flux and greater separation forming between uninspired older offices and well-amenitized modern spaces.

Canada’s overall national office vacancy rate increased to an all-time high of 17.7%, according to CBRE’s just-released Q1 2023 Canada Office Figures report. Ten of the last twelve quarters produced negative net absorption, with more office space put back on the market than was leased by tenants.

Toronto’s downtown office vacancy rate hit 15.3%, the highest vacancy Canada’s largest office market has seen since 1995. Vancouver’s downtown office vacancy rate rose to 10.4%, the highest it’s been since 2004, while Ottawa (13.2%) and Montreal (16.5%) both recorded their all-time highest downtown office vacancy rates.

Three cities saw their overall office vacancy decrease in the quarter: London (-60 bps), Montreal (-20 bps), and Calgary (-10 bps), where office conversion programs continue to make inroads. Removal of these properties from inventory is helping lower Calgary’s downtown vacancy, which has declined for three consecutive quarters.

The new year has also brought more sublet opportunities to market as some businesses change course mid-lease term. Now equal to 3.4% of existing inventory, sublet space has risen nationally for three consecutive quarters, though not at nearly the same pace as seen at the pandemic’s onset. Toronto and Ottawa had the largest increases in sublet space in the first quarter.

There are pockets of strength and stability, especially newer and highly amenitized buildings, while older downtown product with outdated amenities struggles to attract and retain tenants. Vacancy in the downtown Class B segment has fully decoupled from not only Class A, but also all classes of office space in the suburbs, where demand is stronger thanks to shorter commute times.

Amid higher office vacancies, fewer projects have commenced construction. The active development pipeline is currently 11.2 million sq. ft. – its lowest point since 2017 and equal to 2.3% of Canada’s total office inventory. The bulk of projects underway are in Toronto, Vancouver and Montreal, most of these having broken ground before the pandemic.

As far as new office construction starts go, the majority have been in the suburbs. In fact, over the last four quarters suburban office projects accounted for 80.0% of the new starts, whereas in 2018 they only accounted for 17.4% of total office starts on a square footage basis.

“The office market is in the midst of an evolution that is analogous to what the retail sector experienced over the past decade,” says CBRE Canada Chairman Paul Morassutti. “Demand for cheap commodity space has evaporated and been replaced with the desire for spaces that act as conductors for business productivity and development. There is a greater focus on higher-quality and highly amenitized office assets as companies learn that remote and in real life are not binary choices, but in fact each reinforces the other.”

Download the Q1 Office Figures report here.

Industrial market moves toward balance

The national industrial availability rate rose a modest 30 bps to 1.9%, according to CBRE’s Q1 2023 Canada Industrial Figures report. The absorption of industrial real estate slowed to its lowest level in 11 quarters in Q1, totalling 896,000 sq. ft. of positive net leasing activity.

Vancouver led net leasing activity in the quarter, with 661,000 sq. ft. of positive net absorption. This was more than double the next highest market of Ottawa, which recorded 298,000 sq. ft. of net leasing activity over the quarter. Toronto, Montreal, and Winnipeg were the only markets to record negative net absorption in Q1.

The Canadian industrial construction pipeline continues to grow, with 7.4 million sq. ft. of new developments kicking off in Q1. But new supply deliveries fell to 5.7 million sq. ft. in the quarter as construction delays pushed project completion dates into next quarter.
Over two-thirds of the new developments that broke ground in Q1 were in either Toronto (3.6 million sq. ft.) or Montreal (1.4 million sq. ft.). Overall construction activity remains at conservative levels, with all markets except for Halifax building at 4.0% or less of their respective current inventories.

Net industrial rental rates continued to rise across Canada in the first quarter. Vancouver has the highest industrial rents in Canada, averaging $21.33 per sq. ft. and is followed by Toronto and Montreal with average rents of $17.77 and $16.65 per sq. ft., respectively. But rental rates rose in the first quarter at a slower pace than seen in previous quarters. The national average rent rose 28.1% year-over-year to $15.99 per sq. ft.

“It was inevitable that in an industrial sector that has been red hot for so long, people would begin to ask if the party is over,” Morassutti says. “Well, after 11 years of consecutive rental growth and an off-the-charts 2022, it’s fair to say that the pace of that rental growth is over.

“But a deceleration in rental growth is not the same as declining rental growth,” he adds. “The market is still strong, especially third-party logistics leasing activity, and there remains runway for further rental growth, albeit not at last year’s pace.”

Download the Q1 Industrial Figures report here.