A recent report from commercial real estate services firm CBRE shows the national office vacancy rate reached a 30-year high of 18.5% in the second quarter of 2024, up 40 basis points from this time last year. And in downtown areas, that number has sat at 19.4% for the last three quarters.
To make matters worse, projections show that new office buildings anticipated to enter the supply in the second half of 2024 will only be 39.5% pre-leased, meaning that the current vacancy rate will raise 20 basis points (bps) if projections remain unchanged. According to the report, the majority of these vacancies would be in downtown Toronto.
On the bright side, seven cities in the 10 markets highlighted in the report revealed stable or declining vacancy rates this quarter.
The obvious culprit behind the increasing number of overall 'ghost' office spaces is the phenomenon of remote work and its stratospheric rise following the onset of the pandemic, but other factors like "muted GDP growth, new supply, and a big slow down in leasing by US-based tech companies" are also driving office vacancies, according to Marc Meehan, Managing Director at CBRE.
There's no doubt that vacancies are increasing, but the data shows that not all office spaces are being abandoned equally.
According to the report, Class A product (newer, shinier office buildings with more amenities) has now posted two quarters of improvement, dropping 30 bps this quarter, with six of 10 markets experiencing declining downtown Class A vacancy in Q2. The gap between these new builds and Class B and C product (older office buildings, with no foosball tables or swanky lounges) continues to widen, reaching a difference of 850 bps this quarter.
But not only are Class A buildings more likely to have their leases filled, tenants are actually leaving class B and C offices in search of more modern workplaces. This trend, dubbed “flight-to-quality moves”, has forced owners of older buildings to undertake “significant capital improvements and retrofits to help remain competitive and support the long-term appeal of their assets,” says the report.
Marc Meehan, Managing Director at CBRE
Among the upgrades that landlords can use to entice potential tenants, are office gyms, tenant lounges, improved lobbies, and even golf simulators, says Meehan. "Anything to improve the environment to which employees show up on a day to day basis."
But despite the flood of tenants to Class A offices, the trend likely won't be enough to offset the national vacancy rate. "Difficulties within that Class B and C segment are going to have a greater impact than gains or improvements we're expecting to see within Class A," says Meehan.
An alternative solution could reside in office conversions, which can provide tenants for office landlords facing high vacancy rates, while also creating more housing and bringing people to the downtown core, though CBRE’s report shows this movement hasn’t picked up steam like many had hoped. According to the report, only “6.0 million sq. ft. of former office product has begun conversion since 2021, equal to 1.3% of inventory." Meehan explains that this is largely due to high conversion costs, but "every conversion does help," he says.
Of course, if more employers initiated a return to work, older office spaces would likely fill up alongside the swankier builds. It's for that reason, and to revitalize the city that Toronto Mayor Olivia Chow has been in return-to-work talks with Toronto banks who, according to CBRE, occupy 7M sq. ft of the city’s existing 34M sq. ft of office space.
But Meehan sees the commercial market, and our office culture along with it, as a dynamic beast. "Downtown cores that are not populated with office workers is concerning," he says. "But I think we're moving through an evolution in the office space that good things are coming out of, like improving office space conditions for employees. That's a great thing."
