The Canadian economy and real estate markets shifted significantly over the course of 2024, driven by the Bank of Canada (BoC) charting the most aggressive course of rate cutting among major central banks.

In December, a 50-basis point (bps) reduction capped a cumulative 175 bps reduction in 2024, bringing the policy rate to 3.25% at year-end. This sharp reduction promises to improve the outlook for 2025 as consumers and businesses take advantage of lower financing costs. 

As we enter 2025, the Canadian and United States (U.S.) economies will navigate uncertainty related to new political leadership and policy changes. With respect to immigration policy, Canada placed restrictions on temporary workers and reduced permanent immigration levels, while the incoming U.S. administration has threatened tariffs on imported goods from Canada and Mexico.

In addition to these policies’ potential direct impact on consumption and growth, higher import prices, reduced labour supply, and higher wages may slow progress in reducing inflation. As a result, the U.S. Federal Reserve (Fed) and the BoC could move more cautiously with future rate cuts in 2025. Higher U.S. rates could also constrain the BoC’s policy flexibility, as a widening gap between U.S. and Canadian rates could place additional downward pressure on the Canadian dollar.

CRE capital markets outlook 

After reaching a low for the year in 2024, commercial property sales in Canada are expected to rebound in 2025 due to an improving financing environment, a significant amount of capital on the sidelines, and a likely return of institutional investors. The lower mortgage rates will support higher transaction activity. However a period of price discovery will likely continue across several asset classes, with class-B/C offices facing the greatest challenges in securing financing.

Debt availability is likely to increase as lender optimism improves through this year. However, traditional lenders will likely remain selective by incorporating more conservative market trends into underwriting for those market segments showing weaker rents and higher vacancies. This caution could lead to lower net operating income projections and valuations, affecting the total loan proceeds available. In addition, certain properties needing refinance may continue to face shortfalls in loan proceeds due to higher mortgage rates at refinance. Consistent with trends over the past year, alternative lenders will continue to fill an important role in commercial real estate (CRE) capital markets by providing higher loan proceeds and “gap” financing to quality sponsors. 

The Canadian real estate market has shown remarkable resilience despite varying performances and valuations across asset classes. According to CBRE Research, the overall opportunity for investors in CRE remains compelling, offering one of the best entry points in the past fifteen years. After almost two years of increases, overall capitalization (cap) rates have stabilized, and indications point to a decline in 2025. 

Property type fundamentals influence investor preferences

Through 2024, Canadian investor sentiment was mixed across property type and geography. Although bid-ask spreads appeared to narrow, shifting property type fundamentals and the persistence of higher-than-expected financing costs weighed negatively on transaction activity. Market sentiment also reflects the uneven performance of property values over the past year. While overall Canadian commercial property prices declined 1.3% for the year ending in Q3 2024, according to MSCI/Real Capital Analytics, office performance was substantially weaker, reducing the overall average, while the apartment sector achieved positive price appreciation.

Office

A wide delta in performance between high-amenity trophy assets and lower-quality class-B/C space will remain a key feature of the office market in 2025 as occupiers pursue “flight to quality” moves to upgrade their existing spaces and incentivize their workforce to return to the office. According to CBRE Research, 59% of respondents in a 2024 occupier survey considered relocating to a higher-quality space. 

Such dynamics may create more distress in class-B/C offices, where downtown vacancies have surpassed 25%. However, there is optimism that office fundamentals will shift from headwinds to tailwinds in 2025. Physical office occupancy in Toronto has been higher than in most other North American cities as Canadian employers have been less amenable to remote work policies. Net absorption of space turned positive across several office segments in the first half of 2024 as leasing activity improved. 

Industrial

The industrial sector is in the process of a “healthy reset” of supply and demand after a period of record-low availabilities and rapid market rent growth.  Following record demand in 2021, third-party logistics (3PL) providers and retailers slowed leasing activity.  In response to strong demand and higher rents, construction activity peaked in 2023, and remained elevated in 2024.  As a result, the availability rate moved up to 4.5% in 2024, according to CBRE - improving options for occupiers in search of space.  

An increase in new supply is expected to put pressure on the industrial sector in 2025. Although completions are expected to fall further from their 2023 peak, the remaining supply is heavily concentrated in projects that started on a speculative basis, which account for 70% of projects in the active development pipeline. National availability rates are forecast to increase an additional 50 bps in 2025, along with modest increases in net rents, according to CBRE-Econometric Advisors.

Retail

High immigration levels over the past few years have been a positive force in driving strong retail demand, especially for non-discretionary and discount retail. This surge in demand has led to steady declines in retail vacancies and rising rents across key space categories. However, with the curtailment of immigration targets, inflation’s effects, and potentially slower growth, consumers’ spending may become somewhat more cautious. Despite a boost from the planned GST holiday, Oxford Economics predicts slower growth in consumption activity in 2025.

Housing

Despite shifting immigration patterns and large unsold inventory in some condominium markets, the lack of affordable housing supply will continue to shape the housing landscape, providing strong investment opportunities. In addition to easing mortgage rates, new mortgage regulations aimed at improving affordability brought additional buyers into the market. Robust population growth over the last few years has also increased the pool of potential homebuyers. Canada’s housing market revived in the second half of 2024, with home sales rising over 18% between May and November. Home prices increased in November but remained 1.2% lower year-over-year. 

With national rent growth expected to be flat to slightly positive in 2025, sustained high home prices will fuel continued demand for rental housing. While rental market conditions remain tight across most major markets, Canada’s supply of purpose-built rental apartments grew by 4.1% according to the Canadian Mortgage and Housing Corporation (CMHC) – the highest increase in over thirty years – increasing the national vacancy rate from 1.5% in 2023 to 2.2% in 2024. 

While modest improvements were made in 2024, housing affordability will remain a key issue in 2025, paving the way for new CRE investment opportunities, particularly in rental.