A new report from CBRE is underlining major demand for new office space in Downtown Toronto. The new 2016 Q4 commercial market report signals a growing disparity between the demand for commercial space and the supply of new-build space as the current 2014-2017 development cycle comes to a close. During the fourth quarter of 2016, office market conditions in Downtown Toronto tightened significantly, bringing the downtown commercial vacancy rate in this submarket to 4.2%. This matches the market's lowest-ever recorded vacancy rate, and is currently the lowest Downtown vacancy rate in North America.

EY Tower in Toronto's Financial District, image by Forum contributor ADRM

The Downtown submarket's decline in vacancies is being attributed to tight market conditions caused by the lack of new supply. Vacancy rates as low as these haven't been witnessed in this submarket since Q2 2008 (4.2%) and in Q1 2013 (4.4%). A positive net absorption of 2.65 million ft² was recorded in the Downtown Toronto office market, fueled by major building completions such as the east tower of the Bay Adelaide Centre, the Globe and Mail Centre, and One York. Even with these new injections of commercial space, larger tenants currently in the market for office space are being forced to lease space in a competitive environment.

New, under-construction, and proposed office buildings in Downtown Toronto, image courtesy of CBRE

In contrast, the overall Toronto office vacancy rate sat at 9.2% at the close of Q4 2016, driven by weakening market conditions in the Midtown and Suburban submarkets. Despite these submarkets recording negative quarterly net absorption rates of 77,152 ft² and 152,070 ft² respectively, the two areas ended 2016 with positive net absorptions and lower year-over-year vacancy rates.

Once the current 2014-2017 development cycle wraps following the April opening of the EY Tower, over 5,500,000 ft² of office space will have been added to the core of the city. While a number of major office developments are in the pipeline for Downtown Toronto, no significant projects are currently under construction, meaning that Downtown office market conditions are expected to remain tight for the next few years. Strong tenant demand and constrained supply are expected to help spur the next development cycle, which CBRE expects to be led by leasings in the finance, insurance and real estate (‘FIRE’) industries.

A comparison of under-construction office space and vacancies, image via CBRE

The office investment market in 2016 followed a similar path as leasing market conditions, with the Downtown Toronto submarket accounting for a 63% of the total $3.3 billion in office transactions recorded in the GTA. In line with vacancy trends, year-over-year cap rate declines were recorded across the board in all office categories, with a market-low of 4.38% for Downtown Toronto A-class assets, and cap rates of 5.25% in Downtown-B assets. With institutions, pension funds, and foreign investors competing for the very limited assets on the market, these market trends are expected to continue well into the future.