Office/Occupier

The office market is exhibiting more confidence than a year ago with occupiers shifting back into a growth mindset, paving the way toward recovery. Further bifurcation of product with a focus on ‘flight-to-experience’ and a slowdown in construction activity is expected to lead to an under-supply of modern, amenitized buildings that are needed to keep pace with the newest era of occupier requirements.

Trends to Watch

1. Tenants have become more refined in what’s driving their real estate decisions, evolving existing flight-to-quality trends into one that is being characterized as a ‘flight-to-experience’.
2. A muted development pipeline is expected in the coming years. This will be a turning point for the market, helping to reduce volatility in the near-term, while also leading to an under-supply of modern buildings in the long-term.
3. Market fundamentals, past and current, are suggesting that vacancy should peak in early 2025. General sentiment is trending positively, providing green shoots of optimism in the year ahead.

Trading up in a ‘flight-to-experience’

Office space needs continue to impact the market. Increased bifurcation between trophy downtown buildings and the rest of the market is expected to persist as occupiers carry out flight-to-quality moves that focus on upgrading from their existing space. In fact, 59% of respondents to CBRE’s 2024 Americas Office Occupier Sentiment Survey noted that they were considering or executing a relocation to higher-quality space. Further, occupiers that already operate in Class A space are now upgrading to AA or AAA buildings or to improved, more central locations. This is just one facet of the story however, as this trend is evolving into what is now being characterized as a ‘flight-to-experience’.

Tenants have become more refined in what’s driving their real estate decisions. A shift to hospitality-inspired amenities and experiences have led occupiers to seek amenitized buildings that either offer or augment what they can provide within their own footprint. Again from CBRE’s 2024 Americas Office Occupier Sentiment Survey, it was noted that 57% of occupiers relocating desire improved amenities and services for their employees. Both the building and surrounding neighborhood play a crucial role in creating an exceptional employee experience that remote work cannot replicate.

High-quality offices in vibrant locations will continue to attract tenant interest and lead to tighter vacancy in the best locations. As the divide is set to widen further between these and lower-quality assets, undergoing capital improvements that add a differentiated amenity offering, along with other building upgrades, will be necessary for some product to meet the market and remain competitive.

End of construction cycle: good for now but not for long

New supply has been a contributing factor behind record high vacancy rates in cities like Toronto and Vancouver. The market has had to contend with not only backfilling associated tenant moves, but also vacant new supply as we have seen pre-leasing levels drop amongst late-wave deliveries. Properties completed in 2020 were over 75% pre-leased upon delivery versus just under 50% for projects completing next year.

When all is said and done, the current development cycle will have added 27.2 million sq. ft. or 5.8% to national office inventory since 2020. The pipeline has continued to dwindle with increasingly few projects moving forward, a trend that started to take hold in 2022 as developers grappled with elevated vacancy, interest rates and construction costs. As such, construction levels are currently at a 20-year low and are anticipated to remain muted following the last tranche of deliveries over 2025. This will be a turning point for market recovery, mitigating supply-side risks as occupiers gradually absorb new and improved existing product.

While a lack of new projects breaking ground may be a welcome reprieve and aid in reducing volatility in the short-term, a sustained period of limited construction could lead to an under-supply of buildings that meet modern needs. This might soon be the case in select markets where there has been limited construction for a number of years already. The cost of construction will pose a further challenge in this equation when considering the high rents needed to pencil out future developments. A limited pipeline of new supply could be good news for existing buildings, however. As prime spaces become scarce, demand is expected to spill over to the next tier of buildings.

Turning tide on office market cycle

Overall, the office market is exhibiting more confidence than a year ago, paving the way for recovery. Absorption is trending positive for the first time since 2019; office utilization, while still lower than pre-pandemic, has by all accounts reached a steady state; and sublease space continues to trend downward, a typical forward-looking indicator. We are also starting to see occupiers shift back into growth mindset. From CBRE’s 2024 Americas Office Occupier Sentiment Survey, 38% of respondents are anticipating their portfolio size to expand over the next three years, this is even higher in Canada at 45%, citing expected business growth and evolving workplace design standards that accommodate new work patterns behind that need for more space. This will help support office absorption moving forward.

If present indicators aren’t enough, looking at past market cycles might provide further proof that we are on the cusp of moving into the next stage of this market cycle. Current vacancy levels are on-par with market highs last seen in the 90’s recession which also came with a large influx of new supply. It took the office market roughly five years to peak, rising from Q4 1988 to Q4 1993, before starting to recover. Applying that to the current cycle which began its ascent from Q1 2020, it is expected that vacancy could peak in early 2025 and move toward recovery in 2026.

Regional differences may still crop up and result in an uneven recovery trajectory in some areas of the country. General sentiment is trending positively, however, providing green shoots of optimism in the year ahead for this challenged sector.