Even the experts admit it is difficult to get a handle on Canada's office market as we enter 2023. CBRE chairman Paul Morassutti is among them.

“Interpreting and understanding what's happening in the office market today is arguably as hard as it has been in the last 30 years, just because there's so much going on,” Morassutti told RENX in an interview about his company’s Q4 2022 Canadian office market report. 

“We remain fixated on remote work, but there's really a number of issues at play in the office market today.”

Nationwide there was negative 2.1 million square feet of net absorption, the report states, making Q4 the worst quarter of the year in that respect. 

The overall national office vacancy rate increased to 17.1 per cent after holding steady at 16.4 per cent the two previous quarters. Seven of the 10 markets included in CBRE’s national report experienced growing vacancy to end the year.

Big delivery of new supply boosts vacancy rate

The biggest factor contributing to this, according to Morassutti, was five million square feet of new supply being delivered in cities nationwide.

Toronto and Vancouver, in particular, have added significant amounts of new supply over the past few years. This coincided with the onset of the COVID-19 pandemic and increasing numbers of people working from home, as well as rising interest rates and the threat of a recession.

“If you go back to the early ‘90s, we can point out all kinds of examples where the introduction of new supply at the wrong time is the biggest factor in pushing vacancy up,” Morassutti said, noting historical parallels for today's phenomenon.

The prime driver of office demand in Canada over the past decade has been the technology sector and tech-related hiring by more traditional companies. However, the markets have faced a tech firm valuation meltdown and a shift away from a growth-at-any-cost mindset to a focus on profitability and cost control.

Tech companies that previously leased more space than needed in anticipation of future growth are now having difficulty raising new funds and are subsequently closely watching their expenses. They’re looking to sublet unneeded space because their expansion plans haven’t played out as expected.

Recession fears also play a role, as companies halt hiring and expansion to focus on managing their way through an economic downturn.

Morassutti believes the new office supply will be absorbed, and less new space will be built moving forward. He also thinks the tech recalibration is temporary and recession concerns will likely have waned a year from now.

The factor that’s much harder to forecast is the issue of remote work. 

Impact of remote work hard to measure

“I’ve spent a lot of time looking at studies from all over the world, and talking to landlords and occupiers, and there's very little evidence that has emerged that allows you to say conclusively that remote work is either going to be really detrimental to the office sector or have no impact on the office sector,” said Morassutti.

“Most of the changes in the amount of space that's required will happen at the end of the lease term, which means it doesn't happen all at once. It will happen slowly over the next five to seven years. 

“Some companies will decrease the amount of space they have, some will stay flat and some will increase. But the exact percentages of how all that plays out is just very difficult to forecast.”  

More new office space has been built in downtown areas than in the suburbs, leading to lower suburban office vacancy rates in several Canadian cities because there’s less availability to absorb. Suburban sublets decreased to their lowest level since Q1 of 2021.

Some companies have also adopted more of a hub-and-spoke approach, maintaining some downtown office space but creating a larger suburban presence to reduce employee commuting times.

Vancouver’s vacancy rate still under 10 per cent

Vancouver is the only Canadian office market still with single-digit vacancy, though it rose by 270 basis points to 9.8 per cent downtown as 914,000 square feet of new supply came to the market in Q4. 

Vancouver’s overall vacancy rate of 7.8 per cent would have been considered very healthy before the boom period just prior to the pandemic, and Morassutti said the city still has the tightest office market in North America.

“I would point to Vancouver as a market that's doing remarkably well. It has always been one of the most resilient markets in the world and it's proving it again.” 

A divide is shaping up between Vancouver’s downtown and suburban markets, where vacancy is 5.8 per cent and dropping as demand grows for office space outside the core. This has left downtown Vancouver to contend with several large subleases amid the delivery of two new towers, The Stack and Vancouver Centre II, which aren’t yet fully leased.

Subletting increasing in Toronto

Toronto saw its downtown vacancy rate increase to 13.6 per cent in the fourth quarter amid the delivery of 2.4 million square feet of new supply for the year. Much of the increase in vacancy is attributed to major tenant relocations to new developments, leaving behind dated product in a flight to quality.

Sublease space is also rising in Toronto. While most units are smaller than 10,000 square feet and from groups that have elected to work from home, Q4 saw an increased number of larger subleases from occupiers curbing growth plans.

Morassutti said CIBC will sublet up to 400,000 square feet as it consolidates employees in the two newly built CIBC Square towers, which encompass three million square feet in downtown Toronto.

Good news in some markets

Some Canadian office markets bucked the trend of higher Q4 vacancies. 

Calgary’s downtown office market vacancy dropped slightly to 32.6 per cent as it registered a second consecutive quarter of positive net absorption that totalled 130,000 square feet.

However, the overall vacancy rate rose 30 basis points to 30 per cent as the strongest year of downtown leasing activity since 2014 was offset by large occupiers right-sizing suburban locations.
 
Waterloo Region saw its downtown office vacancy drop to 22.8 per cent, ending the year on a high note with 289,000 square feet of absorption. The overall vacancy rate was 12.7 per cent.

Halifax remained Canada’s most stable downtown market, staying at 18.8 per cent vacancy and in line with pre-pandemic levels.

The overall market recorded a 60-basis point decrease in vacancy to 15.2 per cent, the lowest since Q1 2020. Halifax ended the year with 198,000 square feet of net absorption.

Less office space being built

The 11 million square feet of office space under construction across Canada — including 5.8 million in Toronto and 3.7 million in Vancouver — is the smallest amount since the third quarter of 2017. Sixty-two per cent of that is scheduled for delivery this year.

The overall national office pre-leasing rate fell from 54 per cent to 47.6 per cent in Q4. This is leading to developers putting future projects on hold, which should help to mitigate the pressures created by hybrid work and slowing economic growth, and could leave the office pipeline at its lowest level in more than 20 years.

“If you have an office development and you have not yet secured an anchor tenant, my guess is that development will be delayed,” said Morassutti. “I think that's a healthy thing. 

“Gradually, over time, we will build less in the office market and what we will build will be aligned with demand. Some of the more obsolete products will get converted or demolished or repurposed.”

Forecast for 2023

Morassutti anticipates a lot of the volatility experienced in 2022 diminishing in 2023. Interest rates won’t climb at the same rapid pace, nor should inflation rise as sharply, and supply chain issues are being resolved.

Sublet listings represented 18.1 per cent of vacant office space nationally, with the majority of markets remaining at or near their respective 10-year highs of sublease vacancy. Morassutti expects available sublet office space to increase this year, but isn’t convinced that it’s a long-term structural issue.

“I think the operating environment for the next 12 months is going to be challenging,” he said. “I do think you have to pay attention to what issues are short-term in nature and what issues are longer term, or structural, in nature.

“And what's really impacting the office sector right now, I would suggest, is more short-term in nature. None of this is going to get fully resolved in 2023, and in 2024 I think you could see a resurgence in office demand.”