Interest rates and construction inflation have beaten down the commercial real estate industry in Canada. This phrase, “Survive ‘til 25” is heard in industry circles a lot as the general wisdom seems to be to kick the can down the road and don’t do anything unless you need to. But does this reflect reality and is it as relevant for 2024 as it was in 23? There are some trends that have emerged that can help us decide what action if any we should take this year.
Navigating Our Dynamic Terrain
The market in the Greater Toronto Area for the first quarter of 2024 is expected to see a gradual recovery, influenced by inflation and interest rates. Experts predict that the market will start to improve throughout 2024, with a notable uptick in capitalization activity (investment and lending), property trades, and leasing by 2025. (Toronto commercial real estate market update – Altus Group) The industrial sector is anticipated to remain strong, but supply and demand are beginning to balance out. In Toronto, there is a significant amount of industrial space in the new development pipeline, providing industrial tenants with more options for the future.
The office sector may experience challenges as new office supply comes on the market, potentially leading to higher vacancies. An example of a new office building in Toronto that is coming to market in the coming year(s) is the downtown Toronto office tower located at 438 University Ave. This building, owned by Dream Office Real Estate Investment Trust, has been put up for sale, indicating a thaw in the market that has been relatively stagnant. The marketing of this office tower suggests a potential shift in the market dynamics, with opportunities arising for new office spaces to enter the market and potentially impact vacancy rates. (Toronto Office Tower Goes Up for Sale in Sign of a Market Thaw – Bloomberg)
There is buoyant optimism for modern industrial spaces and cautious optimism in general among investors as we all move through the starting quarter of 2024. The Greater Toronto Area (GTA) recorded a total dollar volume of $22.8 billion in 2023, marking a decrease of approximately 25% from the previous year, primarily impacted by the escalation of interest rates. (Toronto Commercial Real Estate Market Update – Altus Group) Overall, while challenges persist in the commercial real estate market, there are positive indicators pointing towards a gradual recovery throughout 2024.
The current trends in the commercial real estate market in the Greater Toronto Area (GTA) reflect a mix of challenges and opportunities. Here are some key trends based on recent reports:
- Retail – Steady Performance for Retail Assets
In Canada there is still tremendous interest in grocery anchored retail as a capital investment and a tenant’s site selection choice, resulting from the record profits and steadfast consumer activity the sector continues to enjoy. Another factor pushing investor interest in retail properties is the housing crises and desire to buy large enough properties to support high rise and master planned developments while benefiting from holding income. Retail property trades remain at diminished levels, as the gap between buyers and sellers is still a significant one. Many buyers are looking for properties that could be distressed or coming up for a mortgage renewal that tips the balance and makes a potential sale more compelling. This sector is institutionally driven, unlikely to experience frequent instances of owner distress, and trades in 2024 will likely be at market prices and not below for properties with future potential.
Retail leasing in the suburbs continues to be strong with little vacancy in the smaller sized spaces and among REIT owned centres, vacancy has trended down to 4% in 2023 according to CBRE’s latest report. Leasing remains sluggish in urban Toronto as headwinds are the recessionary and interest rate pressures on new retail business investment. The same headwinds will create some new vacancies from retail insolvencies that are heading up but for quality locations, landlords won’t be waiting long.
- Industrial Sector Strength
The industrial sector remains robust, with rental rates for Toronto industrial real estate rising significantly. The average industrial lease rate in the GTA is $18.97, which is up 11.2% from the prior period according to CoStar. Limited available industrial space is driving pre-leasing activity, with demand outpacing supply. Many stakeholders are looking to buy versus lease but there are few sellers.
- Office Sector Challenges
While the office sector has grappled with rising vacancies from tenant relocations to newer constructions and a shift towards higher-quality spaces, there are anticipations of major banks and tech companies reentering the downtown office market. This move is likely to boost leasing demand and reduce vacancy rates.
Class A office buildings will always be in demand according to Rob Kumer, CEO of Kingsett Capital who believes that the office category is “mispriced” and presents opportunities for those who believe in the long-term viability of quality office properties.
- Hotel Sector Driven by Housing Crises and Increased Domestic Travel
Canadian hotels are experiencing improved fundamentals, on par and above 2019 levels, with average room rates outperforming pre-pandemic levels and in some cases ahead of general inflation rates. The housing crises and immigration levels are supporting occupancy rates and creating a unique situation for the industry in that the sector is recession proof. Governments and Universities are contracting with hotels for housing for students and for refugees. The head of ultra low cost carrier Flair Airlines, Stephen Jones is forecasting stronger demand for domestic trips this year as “affordable travel” becomes a more realistic option for Canadians. Stats CAN report that overseas travel remains below pre-pandemic levels as of the second quarter of 2023 while Canadians spent 29% more on domestic travel than in 2019. The hotel format with the most potential appears to be Extended-Stay, benefitting from the factors mentioned above as well as the trend to clamp down on AirBnb units by Canadian cities.
- Multi-family Cap Rates are Sticky
In the Canadian multi-family real estate landscape, recent trends indicate a modest perk-up in transaction volumes, giving us a good sign for things to come. The sector remains predominantly driven by private buyers, with institutional investors taking a more selective approach. Despite the challenge posed by higher costs of capital, cap rates have exhibited stability, remaining largely unchanged. According to CBRE, multi-family cap rates currently stand at 4.43%, representing a marginal increase of four basis points since mid-2023. Against the backdrop of an evolving economic climate, multi-family real estate emerges as a resilient investment opportunity, particularly amidst persistent supply constraints. As borrowers and developers navigate these dynamics, the sector’s enduring appeal underscores its attractiveness within the broader real estate market landscape.
- Investment Activity – The Industry is Optimistic
Commercial real estate investment activity in the GTA has slowed down, reflecting global trends of weakening investment amid high interest rates and economic uncertainty. Industrial segments have shown growth, while office and high rise land trades have decreased significantly. Large CRE firms like CBRE are issuing statements of optimism for late 2024 transaction activity and a lot of hope is pinned to interest rate decreases later in the year.
- Market Evolution
The commercial real estate market in the GTA continues to evolve post-pandemic, with a shift in asset classes. Industrial properties remain strong, with vacancy rates below 1%, while demand for office spaces lags behind other sectors like retail, multi-use residential, and land sales. The retail leasing market is stabilizing with a deceleration of rental growth. Despite economic uncertainty posing challenges for retailers, demand for retail space exceeds supply. Overall retail sales have plateaued, but certain sectors like food services, shoes, health and personal care, and sporting goods show growth. There is strong demand for new hotel development. According to H Trends, there are 66 hotel projects under construction in Canada, representing a 27% increase in projects and a 36% increase in rooms year-over-year at the close of 2023.
- Future Outlook
Despite challenges, there is cautious optimism in the industry regarding the commercial real estate market in the Greater Toronto Area. Factors such as population growth, shortage of housing, and evolving zoning and development policies are influencing market dynamics. The stabilization of markets is anticipated beyond 2024.
So, is it still survive to 25? Well, the answer lies in who you are and what sector you are focused on. Keep in mind that deals take 6 to 12 months from idea to completion and 2025 is not that far away. We have high cost of capital, higher office vacancy and lower condo prices but on the other hand we still have opportunities to solve problems such as the housing crisis, domestic travel, and the replacement of insolvent business. If you have any commercial real estate challenges or goals you want to discuss, please reach out. We love talking about the market and we help our clients get the best deal possible.
