Canada’s troubled office real estate sector has taken a hit from the shift to remote work, and though a rebound is expected next year, a researcher says it’s unlikely the market will ever regain its pre-COVID strength.

Keith Reading, senior director of research at Morguard, told BNNBloomberg.ca that he expects office real estate to experience “some weakness” into 2024.

While some companies will gradually return to in-office work, he expects hybrid and remote working arrangements will remain – and continue to weigh on the office real estate sector.

“I don't think it will return completely to the strength that we saw in the market prior to COVID-19,” Reading said.

“Part of that will be driven by economic growth and also the gradual return of more employees to the office.” 

In the past, Reading explained, a “down phase” for the sector with weak demand, declining rents and high vacancy rates has been followed by a “strong rebound” as the economy stabilizes.

While Reading expects an economic rebound in the second half of 2024, he’s also predicting more gradual growth in the office sector than what’s been seen in past cycles. 

SIGNIFICANT DECLINE

In a November report, Morguard noted a significant slowdown in investment sales activity in Canadian office real estate.

The real estate firm’s research highlighted just under $2.4 billion in investment sales in the first half of 2023 – marking a 57.3 per cent annual decline.

Canada’s office vacancy rate rose by 10 basis points to 18.2 per cent in the third quarter of 2023, according to research from CBRE that found downtown vacancies remained steady while suburban vacancies rose. 

‘FLIGHT TO QUALITY’

For 2024, Reading is watching two major trends in the office real estate market: demand for Class A buildings, which are typically newer and in more desirable locations, and weakened demand for older Class B and C buildings. 

Companies looking for office space next year will have many options, he said.

Morgaurd’s November report highlighted that Class A rents for office space have held up, due in part to a “flight to quality” in downtown areas across the country. 

“What we have seen recently is that a lot of companies also have taken the opportunity to move up the quality ladder,” Reading said. 

“The better buildings, the so-called Class A buildings across much of the country have fared really quite well. The real tough spot has been in Class B and C, sort of older buildings. Many of those owners are struggling with increased vacancy.”

REITS AN ‘AREA OF CONCERN’ FOR ANALYSTS

Analysts at Desjardins recently flagged Canadian office real estate as “area of concern.”

In a December report, the analysts said lower-quality assets in the sector are showing “signs of distress,” though they are not expecting a “material uptick in distressed sales in 2024.”

There is also a large degree of uncertainty about valuations in the sector, the report said, because no significant transactions took place in 2023. 

“We believe serious questions remain on the impact that both this new reality we find ourselves in and higher interest rates will have on asset values,” the analysts wrote.

“With so much uncertainty and negative sentiment surrounding the sector, we believe 2024 will likely be another difficult year for office REITs (real estate investment trusts).”

The Desjardins report followed recent turmoil for office REITS. Slate Office REIT suspended distributions in November with plans to sell its non-core assets. 

Reading said office REITs may experience a “little bit of weakness” in the year ahead, and he expects companies with assets in good locations with well-maintained buildings may fare comparatively better. 

“That's typically the case with office REITs. They tend to fare better than most other companies,” Reading said.