Commercial: Office Space – Market Outlook
The office market in Canada is experiencing significant stress, notably reflected in rising vacancy rates. Similar to the U.S., Canada’s national office vacancy has surged from around 10% pre-pandemic to 18% currently – a level reminiscent of the overbuilding-induced office correction in the early 1990s.
However, unlike the previous downturn, the current correction is characterized by a divergence in tenant demand. High-quality buildings offering desirable locations, amenities, and configurations continue to attract tenants and maintain healthy market rents. In contrast, demand for inferior, low-cost, commoditized office space has sharply declined.
Downtown high-end spaces are gaining back their allure. Since downtown towers are all relatively well-located and accessible by public transport, competition is centered around quality and luxury, rather than location.
In the suburbs, new constructions, proximity to a subway or the REM, and parking availability are heavily favored.
Vacancy Rate Downtown 14.7% | Vacancy Suburban Office 15.7%
- Throughout 2023, tenants opted to bring their operations to Montreal’s Downtown Core, as the sub-market represented 31% of all leased deals.
- The average lease transaction was 6,206 square feet, while sublets had an average deal size of 9,595 square feet.
- The suburban market ended 2023 with just under 1 million square feet leased, a 22% yearly increase.
- Leasing activity this year has been stronger on the South Shore and in the West Island, especially around the REM (Réseau Express Métropolitain) stations.
- Sublet as a percentage of all available space reached 15.7% this quarter, compared to 14.0% in Q3 2023
- Apart from prestigious towers, tenants hold the upper hand when it comes to rental negotiations. Landlords are generally willing to make concessions, but these will vary depending on the landlord’s profile. Private landlords may be willing to demonstrate more flexibility in order to avoid vacant spaces, which can quickly become a liquidity challenge. Conversely, for institutional landlords, preserving the long-term value of assets is key so they may insist on maintaining a nominal rent. In such a case, negotiations will be more focused on the lease duration, incentives, and leasehold improvements, all of which contribute to asset valuation.
- In a high vacancy environment, landlords must enhance amenity offerings to remain competitive.
Despite recent declines in the office property market, Mark Fieder, president of Avison Young Canada, suggests that now might be an opportune moment to consider investing in this asset class for the long term. Fieder notes that pricing expectations among sellers are becoming more favorable, particularly with anticipated rate cuts. With a focus on smaller business tenants, some investors are already eyeing the affordability of office assets.
While new high-end office buildings are not expected to be abandoned, lease rates are unlikely to see significant growth. However, offices specifically designed for lab space and medical offices may exhibit greater resilience against trends like remote work.
Part of Canada’s office oversupply situation, there’s a growing consensus that the issue lies more in under-demolished buildings rather than overbuilt space. Developers are expected to seize opportunities by converting obsolete structures into more viable uses, reflecting a key trend emerging from this cycle.
With a pause in new construction and absorption driven by long-term economic growth, the office market is anticipated to gradually restore balance and confidence. However, this process is expected to take at least five years before returning to pre-pandemic levels of “normalcy.”
Sources:
This article reflects our research of reports and evaluations by CBRE Canada, PWC report, Globe & Mail, Colliers Canada, Avison Young, and JLL Canada.
