A more promising year ahead for Canadian CRE, but patience is still required

Understanding the Canadian landscape

Interest rates and inflation news are impactful market signals, but they don’t tell the whole story regarding commercial real estate, housing, and the hurdles ahead. Recently, Altus Group hosted a webinar digging deeper into the key factors that drive the economy, and where challenges and opportunities lie. Alice Dale, Senior Director of Valuation Advisory at Altus, was joined by Peter Norman, Vice President & Chief Economist, and Ray Wong, Vice President of Client Delivery, to share their insights.

2024 was another complex year, with geopolitical uncertainty, continued housing issues, and many new policy measures making their mark. The Bank of Canada continues its methodical approach to rate reductions and inflation now appears to be in check. But what does all of this mean for the Canadian real estate market?

Population growth a key factor shaping real estate needs

Addressing the Canadian economy, Peter Norman highlighted population growth as an unusually disruptive short-term factor in Canada's macro environment. While growth slowed during the pandemic, it has surged to approximately 1.2M people annually — almost triple the pre-pandemic norm of 450,000 persons per year. This has prompted new measures targeting net-zero population growth over two years. The impact is particularly pronounced in Ontario and Quebec's housing and labour markets, with western regions less affected. This demographic shift is reshaping real estate needs: demand for starter housing is poised to decline while markets for condos and properties targeting older demographic groups should continue growing steadily.

On the inflation side, Norman noted that “inflation has been unwinding pretty significantly since its peak,” now trending to the lower end of target ranges. We may even face deflationary environments shortly. This will somewhat depend on the effects of the policy changes coming in the US post-election.

Sharp interest rate adjustments since mid-2022 have driven this reversal. Norman expects the bank rate to settle at around 2.5%, with 10-year bond rates between 3% and 4%. Mortgage rates, having peaked last October, are declining, potentially boosting demand in the latter part of 2025. Despite economic softness, employment remains strong, with unemployment increases mainly tied to population growth. Heading into 2025 Norman predicts a modest 1.8% in GDP growth — slightly below the ideal 2–2.5% — with improvement expected as interest rates decrease.

Better days ahead, but patience still required for CRE

Given the key economic drivers, Ray Wong assessed the implications for the broader real estate market, noting sluggish retail sales since mid-2022 due to inflation. While declining interest rates generate optimism, geopolitical uncertainty and the US regime change remain concerns. Office occupancy is improving through mandates, warehouse demand is rising, and retail shows increased occupancy with higher rents.

Despite interest rates and bonds normalizing, a persistent bid-ask gap suggests buyer-seller value disconnects. While some institutions are selectively divesting, Vancouver, Toronto, and Alberta markets are increasingly attracting private investors. Supply remains tight across food-anchored retail strips, as well as industrial and multi-residential sectors. Despite Toronto's lag, Q3 2024 slightly outperformed 2023, driven by capital gains changes and momentum. 

Figure 1 - Poll question: As transaction activity picks up in 2025, what is the main driver that will get you buying or selling again? 

Most poll respondents chose “further cuts to interest rates” (37%) or “Improvements in economic factors” (27%), with 19% “Already active” and 16% still not planning to transact.

 Wong was unsurprised by these results, noting that “the noise in the marketplace [is] causing some delay and some pause, waiting for a little bit more market stability.” He also highlighted the state of the housing market as a drag factor on the recovery of residential and Industrial, Commercial and Investment land (ICI), with offices still quite active and retail dependent on existing projects. Industrial remains strong, but again, product availability is a factor.

 Cap rates are expected to continue downward in other sectors until interest rates and stability are more assured. 

Risks and opportunities

Alternative investments like data centres and student/senior housing are gaining traction, driven by yield potential and lower replacement costs. Activity is expected to increase as capital seeks previously neglected assets. While controlled inflation should boost retail activity, consumer spending and political uncertainty remain concerns. 

In industrial, newer products and strategic locations are driving stability, with companies focusing on efficiency. Speculative construction is increasing availability, though rental rates have flattened. Small building owner-users (under 150,000 sq. ft.), representing 20% of the market, have driven up some sales prices. 

The office sector shows mixed signals: return-to-work policies support growth, but availability is flattening amid downsizing and vacancies. The focus has shifted from expansion to tenant retention and renewals. Class A properties currently dominate, with B and C improving. Vancouver is leading the recovery, though could potentially face space shortages in 3–5 years. Rising prices and rents reflect higher-quality spaces, with 2025 projected to outperform 2024.

The housing market

The resale market shows resilience despite interest rate cycles, maintaining stability with active buyers. This is contrary to the general feeling around this latest interest rate cycle. While Toronto's performance has pulled national metrics down, many markets remain positive. Single-family homes are strengthening nationwide, particularly in western regions, though condo sales have softened in 2024. Toronto faces unprecedented challenges, with sales at multi-decade lows and single-family homes unexpectedly outpacing condos which hasn’t happened since 2009. Supply constraints remain the critical challenge driving market compression.

Figure 2 - Poll question: High interest rates have hurt condo launches. How much do rates need to be further reduced to see activity pick up again?

Most respondents (39%) wanted a further drop of 100 basis points, while 31% wanted to see 200 or more. Interestingly, 28% of respondents felt that rates weren’t the primary issue, while only 2% were satisfied with the current environment.

Norman agreed that the interest rate cycle has been behind the dry-up in condo product launches, even with strong demand. He also noted that government-imposed fees, planning restrictions, credit issues, and other factors have a role to play.

Norman anticipates that we could have continued cuts totalling around 125 basis points by next year, followed by a period of stabilization. While demand should improve, housing supply remains constrained, particularly in Ontario, where household growth far exceeds supply. Though the population pause over the next two years may ease pressure, supply and affordability challenges persist. 

Conclusion

Looking ahead, while population shifts pose risks, lower interest rates and normalized inflation should boost consumer demand. 2025’s outlook remains relatively more positive with steady job growth despite ongoing housing supply challenges and supply-demand misalignment requiring long-term solutions.

To learn from the full conversation, please watch the webinar.

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