Turning point – Canada’s office market nears bottom

Calling the bottom on office

The Canadian office market has been hit hard over the last few years by the shift to remote working, business downsizing and general uncertainty around future space needs. But the office sector now appears to be turning an important corner.

Office vacancies are at or very near the bottom in major markets, and best-in-class A space in particular is becoming more difficult to find. Key factors fueling the recovery are limited new construction, positive leasing momentum and emerging in-office mandates for employees. Although reaching a bottom is good news for market participants, the recovery ahead is not likely to follow a hockey-stick-like upward surge. “We're calling the bottom, but expect the vacancy rate will be relatively flat for the next while,” says Raymond Wong, Vice President, Data Solutions at Altus Group.

Companies are still reassessing their space needs and there is some hesitation in the market due to uncertainty related to interest rates and potential trade tariffs with the US. Although construction overall is limited, there is some new space coming online later this year in both Vancouver and Toronto that will cause vacancy rates to tick higher in the near term. However, there are no other major office buildings in the development pipeline in the foreseeable future. “It’s likely that we won’t see a new office tower for at least another few years in any of the major markets,” says Wong. That limited new supply will contribute to steady positive absorption and lower vacancies.

Positive leasing momentum

Data shows clear year-over-year leasing momentum with roughly 15 million square feet of leasing activity in 2024 that surpassed the 12.9 million square feet in 2023. Another positive trend is that the volume of sublet activity has declined over the past two years. “What we’re hearing from leasing representatives is that inquiries and activity have increased,” adds Wong. Some companies are taking a little bit less space, some are moving but taking the same amount of space, and others need more space to accommodate people who are coming back to the office, especially with increasing return-to-work mandates by employers.

That increased leasing activity could be due to mandates from financial and technology companies, and others requiring that their workers return to the office between two to four days a week.

According to new Flex Index research, 84% of Canadian firms offer work location flexibility, However, Canadians tend to spend more time physically in the office with an average of 2.68 days compared to 2.5 days for US workers. In addition, only 12.5% of employed Canadians surveyed indicated that they usually worked exclusively at home, according to Statistics Canada.

Figure 1 - Canada office leasing trends by deal type

Flight to best-in-class space

A common theme in the office sector has been a flight to quality with companies looking to entice employees back to the office with best-in-class “AA” space. That shift in demand is creating a bifurcated market. Class A buildings dominated leasing activity last year with the 11.6 million square feet of leased space through the end of December 2024, that far surpassed the 2.4 million square feet of leasing in Class B and roughly 540,000 square feet in Class C.

Bifurcation is also occurring within the “A” sector as companies gravitate to newer “AA” buildings that offer attractive amenities. It is also notable that the type of amenities that resonate with workers is changing. Workers who are making the extra time and effort to commute to the office want amenities that provide convenience and make their lives easier, including easy-to-access locations.

Figure 2 - Class A office space continues to dominate

Despite higher vacancies, many Class B and C buildings remain viable and continue to appeal to a certain tenant price category. “Some of these properties will be redeveloped, which is what we've seen in Calgary with office conversion activity to residential,” says Wong. The challenge with some of these buildings is that they are basically a square box with no interior windows or daylight. Another hurdle is the need to change zoning laws. “Eventually some of the B and C buildings, that may be functionally obsolete will be converted to other types of uses, but it’s not an easy solution and it will take time,” he adds.

Price is key for office buyers

Office transaction volume remains subdued, with 2024 volume ($4B) still well below the pre-pandemic high of $10.5 billion in 2019. That is partly reflective of the for-sale inventory, with owners that are choosing to hold good quality “A” buildings. “From the private investor side we’ve seen some activity and demand for assets that have potential for repositioning to higher and best use in the future,” says Wong.

Investors are still buying, but they have different strategies for repositioning, redevelopment or conversions, which is reflected in the target purchase price that they need to achieve in order to make their project work. As previously mentioned, buildings that are nearing functional obsolescence are driving aggressive investment activity in Calgary for conversion or redevelopment opportunities. “The bottom line is that even though there are still some challenges with vacancy rates, office is still viable, and investors are looking at office for potential opportunities,” says Wong.

Vancouver market outperforms

Vancouver has the lowest overall vacancy at 13.2% and also the lowest Class A vacancy at 12.7%, based on fourth quarter numbers. “If there is any market that could be poised for a new announcement for a downtown office building in the next 2-3 years, it would probably be Vancouver because of the level of demand and limited availability of AA space,” says Wong. Although construction is limited, Vancouver is also generating good pre-leasing levels on new projects that are being built.

The market has benefited from strong tech and business services, as well as its good public transit system that helps with employees who are more willing to commute to the office.

Opportunistic investors focus on Calgary

Calgary is sitting on a high vacancy rate at 21.7%. However, what is notable is that there has been steady improvement after reaching a high of 26.1% in 2021. Interprovincial migration shows strong movement to Alberta driven by its more affordable housing. The demographic growth has a positive impact on the local economy. So even though office availability is still elevated, there is good leasing momentum that is driving improvement in that market.

Calgary generated more than 2.4 million square feet of positive absorption in 2024 with no new construction. Investors also are taking advantage of office conversion subsidies at $75 per square foot, which will help to reduce some of the older obsolete inventory. “Calgary, despite its high availability rate, has good opportunity for growth down the road. Even though we have seen increases in their housing prices, it remains quite affordable when we compare it to Vancouver or Toronto,” says Wong.

Toronto vacancies are expected to stabilize

Availability rates in Toronto ticked higher in Q4 to 19.0% overall and 20.1% for Class A space. That uptick is due to some of the new supply that has come to the market, with roughly 550,000 square feet completed in 2024. Overall, leasing activity has picked up, and vacancy, excluding sublet space, is leveling off. “The availability rate will bounce around a little bit based on the new supply. But when I look at the vacancy rates leveling off from the previous quarter, that's where I see a market turn. I think we've hit the bottom with the Toronto office marketplace,” says Wong.

Montreal benefits from in-migration

The story in Montreal is similar to that of Toronto with space availability that appears to be stabilizing. The overall vacancy rate improved to 17.9% in the fourth quarter, and Class A space also declined to 17.0%. Montreal also is benefitting from some of the interprovincial migration, especially from Ontario into Quebec from people seeking greater affordability. “What we’re seeing is companies reevaluating what their needs are and perhaps leasing a bit more space,” notes Wong. Montreal will also benefit from no new construction in the market.

Pace of recovery is still in question

The leasing momentum evident in the market in 2024 is expected to continue in 2025. On the positive side, inflation seems to be tamed, and the Bank of Canada (BoC) has embarked on a rate-easing cycle. Although some companies are still focused on downsizing and relocation efforts, others are driven by the need to find space that both accommodates people returning to the office and also better fits shifting workplace preferences.

Despite being at or very near the bottom, there are still challenges ahead in the pace of office recovery. The BoC may not move as aggressively to lower rates in the coming year as people had originally thought back in November. Investors are watching long-term bond rates due to possible inflationary concerns, which moved higher in January. The possibility of US trade tariffs is also creating uncertainty in the marketplace. “There is a bit of hesitation around making decisions in the near term,” cautions Wong. “Even though we have had really good trends in office fundamentals in 2024, there could be a bit of a short-term pause due to uncertainty on possible interest rates and tariffs impacts.”

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