Steady benchmark rate could put downward pressure on office vacancies

Although there was a collective sigh of relief when the Bank of Canada announced it’s holding the benchmark rate steady at 1.75%, those in the market for office space in Toronto and Vancouver might be feeling chary.

“It helps the bottom lines of businesses in that lower interest rates help them if they’re investing in their business, but—and the Bank of Canada just reduced the growth forecast to 1.2% for the Canadian economy—even a little expansion puts pressure on record-low vacancy rates, so you get inflation of rents,” said Keith Reading, director of research at Morguard, which just released its Q1 economic update.

“Some landlords have no vacancy, but if even a little vacancy comes up they can ask for whatever they want. We’re hearing about that in Toronto, particularly downtown, where there’s no space. The landlord is in the driver’s seat in most situations.”

Lower interest rates stimulate business growth as there are opportunities for businesses to reinvest in themselves. However, that may require considerable capital because much of the office space that’s yet to be built is already spoken for, added Reading.

“Outside of a couple of little pockets, there are virtually no new speculative developments,” he said. “Buildings without tenants signed on aren’t happening. No one looks and says, ‘Maybe I’ll wait a year, six months, or a couple of years.’ The buildings that are coming have units either spoken for, or the volume of space coming isn’t nearly enough to meet demand.”

In Toronto, there’s 11 million square feet of commercial construction, but large institutional banks are slated to eat up a substantial chunk, particularly for anti-money laundering operations that will have global reach. Vancouver has about 4 million square feet coming, but with vacancy rates in both cities hovering around 3% and demand far exceeding supply pipelines, expect the cost to billow in the short-term.

However, within half a decade, there will be relief, according to Roelof van Dijk, market economist for Canada at CoStar Group, a multinational commercial real estate research and technology firm.

“Rental rate growth has been quite high and that’s why you’re getting the construction activity, but the question, then, becomes how does it continue performing once you get further down the timeline? With all the new supply, it won’t be enough to fill everything, but you can anticipate vacancy to rise in the next three to five years as all these new builds come to fruition. In downtown Toronto, you’ll see vacancy go from just north of 3% to just south of 6% by 2022-23. As a result, you’ll see rental growth come down.”