Canada office market: Is further turmoil ahead?

Economist warns against jumping to conclusions about future of office space

Canada office market: Is further turmoil ahead?

Plenty of ink has been spilled in recent months about the future of the office market as hybrid and remote-work arrangements continue to impact vacancy rates – but it’s important not to assume the worst about prospects for that space, according to a prominent economist.

Nick Axford (pictured), chief economist at commercial real estate services firm Avison Young, told Canadian Mortgage Professional that while the office sector continues to see significant flux in the aftermath of COVID-19 shutdowns, it will likely continue to play an important role in the future of the modern workplace as companies continue to map out precisely what that work environment will look like.

“I am a firm believer that [with] good quality city centres, amenity rich, nice places to work, easy to get to, providing great quality environments, good office buildings with sustainability credentials… over time, we are absolutely going to see a steady tick back of people coming back to the office,” he said.

“It probably won’t get quite back to the levels that it was because people are working differently, but I don’t think it’s going to be as dissimilar as people think.”

What does the future of the office look like?

Stay-at-home orders and public health restrictions since the onset of the pandemic in 2020 have heralded an enormous transformation in work arrangements for scores of Canadians, with a huge number continuing to work at least partly from home even as the crisis has eased.

Avison Young’s first-quarter office market report for the Greater Toronto Area (GTA) showed the city’s office vacancy rate sat at 11.6% in Q1, a 2.1% increase over the same time three years earlier, while Vancouver’s downtown vacancy rate jumped by more than one percentage point to 10.8%.

In their first-quarter earnings statements for the year, Canada’s five largest banks each identified commercial real estate risks as their main rationale for stashing away large provisions for credit losses (over $3 billion combined) amid less demand for office space and rising interest rates.

Many organizations will need less space in the future – but they’ll also want better space in better locations, Axford said, a trend that’s likely to accelerate the so-called bifurcation of the office market in which distress arises out of poorer-quality ends.

“It’s very difficult to call what the overall indices of values are going to do, because it’s going to depend absolutely on what’s the mix of the very best stuff that I think is actually, probably, going to hold its value very well, probably isn’t going to trade very much… and rents could well continue to appreciate,” he said.

“Anybody who is looking for space, that’s the stuff that they’re going to want to occupy. That’s the stuff that people are going to want to own and want to lend but that will hold its value – and anybody going out to build at the moment is at the higher-risk end of the market, and getting the funding and then being prepared to go and build is a risky decision.”

Supply of the best-quality space is therefore likely to be more limited, according to Axford, with fewer new buildings coming through – a situation that will support the top end of the market. The secondary and tertiary spaces, meanwhile, are “probably not really where you want to be in the market, ideally,” he said, unless investors have a great opportunity to reposition.

What are the prospects for commercial real estate as a whole?

More generally, the commercial real estate market is seeing lenders tighten their purse strings in the rising-rate environment of recent times, with investors typically best placed to handle the current climate when well capitalized and seeking to purchase prime-quality property with a relationship lender they’ve already dealt with before, Axford said.

New loans are far harder to secure for others – and while some fractures will probably emerge in the market as a result, Axford added a “degree of caution” because the anticipated wave of distressed loans and property in the market after the financial meltdown of 2008-09 never fully materialized.

Significant volumes of real estate were traded five years ago in Canada, the typical timescale for commercial loans coming up for refinancing. Those won’t necessarily all go to default – “but inevitably, there will be more distressed sales coming through in the market [and] there are going to be people who will need to liquidate. That will help price discovery, but will hit other people’s valuations,” he said.

“And I do think that we’ll expect to see some loan stress coming through. And that, frankly, is part of the process – that’s part of what we actually need to get back to a market where value is more transparent and where people can start trading again.”