Canada’s Commercial Real Estate Outlook: Key Trends and Emerging Niches in 2025

By: Allwyn Dsouza, Senior Analyst, Research and Insights, REIC/ICI?

The Canadian commercial real estate (CRE) market is undergoing a profound transformation, shaped by macroeconomic shifts, evolving investor sentiment, and changes in key market fundamentals. Investor sentiment in the CRE market has notably improved in Q3 2024, driven by declining interest rates and growing optimism about capital deployment. Following a period of economic uncertainty and high borrowing costs, the Bank of Canada’s decision to cut rates by 75 basis points (with further cuts expected) has reinvigorated the market. As a result, more deals are expected, particularly in resilient asset classes like multifamily and industrial, while distressed sectors like office and retail may present unique opportunities for investors. In this report, we examine trends and insights derived from Altus Group's recent CRE Sentiment Surveys for Q3 2024, diving deep into capital deployment, sectoral performance, and the outlook for the Canadian CRE.??

Capital Deployment: Investor Optimism Grows Amid Declining Interest Rates

As of Q3 2024, there has been a shift in investor sentiment toward increased capital deployment, with more investors actively looking to invest compared to previous quarters, increasing successively over the past three quarters. This marks a notable departure from the cautious capital-raising environment seen during 2022-2023, where rising interest rates and economic uncertainty dominated.?

Figure 1.0??

The Bank of Canada (BoC) raised its benchmark interest rate to 5.0% by early 2023 but began cutting rates in mid-2024, reducing the benchmark rate by a 75 basis point reduction. Analysts expect further cuts of up to 150 basis points by the end of next year. These declining interest rates have boosted investor confidence, spurring greater capital deployment. High borrowing costs were a key factor in the previous slowdown in investment activity. However, despite the recent rate cuts, debt remains expensive, with 10-year fixed rates averaging 5.5%—100 basis points above the 10-year historical average. The office sector has been particularly affected, facing debt costs nearly 200 basis points above average due to lingering uncertainty about post-pandemic demand recovery, contributing to a higher risk premium.

Figure 2.0?

10-Year Fixed rate (%)?

Sectoral Impact: Multifamily and Industrial Sectors Outperform While Office and Retail Sectors Create Opportunities for Distressed Asset Players

The relatively lower cost of capital has allowed multifamily and industrial assets to continue attracting substantial investment despite 55% of investors viewing multifamily properties as overpriced. Persistent housing shortages, rising rental demand, and increasing rents have sustained investor interest in multifamily properties. Even with increased rental unit supply in 2023, demand has outpaced it for the second consecutive year. Canada saw record-low vacancy rates of 1.5% and average rent growth of 8.0% in 2023, creating competitive conditions in major markets [1]. Similarly, the industrial sector has remained resilient, buoyed by e-commerce growth. However, in 2024, market conditions have slightly softened due to a surge in supply, leading to lower absorption rates and a slight uptick in vacancies.?

Conversely, sectors such as office, retail, and hospitality are facing headwinds due to changing demand dynamics and higher capital costs despite a greater proportion of players perceiving these assets to be fairly priced. The fallout from these higher funding costs, along with unfavourable demand dynamics, is contributing to growing distress among commercial real estate (CRE) players, particularly in the office and retail sectors.?

The shift toward remote and hybrid work has left the office sector vulnerable. By Q3 2024, national office vacancy rates increased by 50 basis points to a record 18.2%. Calgary and Edmonton saw office vacancy rates surpass 27%, coupled with rising cap rates. This has exacerbated distress among property owners struggling to refinance at higher costs. The weak demand for traditional office space has led to significant cap rate expansion, particularly for Class B and C office buildings, where vacancies are higher, and demand is weaker, translating into increased risk and lower investor appetite. With many companies downsizing office space, especially in central business districts, the future of the office sector remains uncertain. Rising unemployment has further dampened the prospects for office space expansion.?

E-commerce growth and declining foot traffic are pressuring the retail sector, with suburban malls and retail centres seeing rising vacancies. Many investors expect retail properties to underperform.?

While this environment presents opportunities for debt funds and private equity investors to acquire distressed assets at discounted rates, it comes with significant risks. Sectors like office, where structural changes may permanently reduce demand, could see long-term declines despite potential short-term gains from distressed asset acquisitions.?

Figure 3.0?

Figure 4.0?

Expectations of Improvement in the Overall Performance of the Market and Shift in Performance Trend for Different Asset Segments

Cap rates have remained highly sensitive to interest rate fluctuations, trending upward throughout Q2 2024. Despite strong demand for multifamily and industrial properties, these sectors experienced modest cap rate increases, primarily due to an expanding supply. However, they have largely sustained internal rates of return (IRRs) between 10% and 14%. In contrast, the office and retail sectors have seen declining cap rates in recent quarters, signalling an improving outlook, particularly for AA-rated assets. With the Bank of Canada cutting rates, deal activity is increasing, and cap rates are expected to decline, as evidenced by a sharp drop in the proportion of respondents anticipating higher cap rates—36% in Q3 2024, down from 54% in Q1 2023.

Figure 5.0?

Overall Cap Rate Trend?

Figure 6.0?

Expectations for Going-In/Current Cap Rates?

This optimistic trend is further underscored by growing competition, with a 6% year-over-year rise in respondents reporting intense market competition. While industrial and multifamily assets remain the top performers, increasing supply and heightened competition could moderate returns, as reflected in the decline in net performance expectations for these segments.?

Figure 7.0?

As returns in traditional asset classes stabilize, niche sectors like student housing and timberland are emerging. In particular, student housing is gaining attention due to record international student enrollment. Vacancy rates have dropped below 1% in key markets like Toronto, Calgary, and Montreal.

According to Bonard, Canada's off-campus student housing provision rate is 15.7%, significantly lower than the U.K.’s 60.6% [2]. In major cities, these figures are even lower—Toronto at 8.8% and Montreal at 5.2%—highlighting strong investment potential in this underserved market.?

Further, the optimism surrounding the revival of the office market is evident, with 85% of respondents in Q3 2024 viewing it as the worst-performing segment, down from 100% in Q3 2023. This shift indicates growing confidence in a potential turnaround.?

Figure 8.0?

Optimistic Economic Outlook and Tempering Recession Expectations?

With low inflation and declining interest rates, recession concerns in the CRE market are easing. Altus Group’s survey revealed that expectations for both the likelihood and severity of a recession are diminishing. The percentage of respondents who believe a near-term recession is 'very unlikely' rose by 8 percentage points quarter-over-quarter to 17% in Q3 2024, compared to just 1% in Q4 2023. Additionally, while most respondents expect any potential recession to be shallow, there is less consensus on its duration.?

Figure 9.0?

This improved sentiment is mirrored in transaction activity, which saw a notable increase in Q3 2024. A majority (75%) of respondents indicated plans to buy or sell within the next six months, marking a 10-percentage point rise from the previous quarter and the highest level in the past year.?

Figure 10.0?

Raymond Wong, Vice President of Data Solutions Delivery at Altus Group, shared his outlook for 2025, stating, “Looking into 2025, we anticipate investor sentiment to improve as the interest rate environment begins to ease, leading to more deal activity across segments. Industrial and multi-family properties will continue to outperform, fuelled by good demand and solid fundamentals, while the office market could see some stability in mid-2025 as lower rates take effect and the increased return back-to-office mandates gains further traction among businesses. However, some risks remain, particularly reflected in high debt costs, which could weigh on the office segment."?

Adaptability is Key to Success in Canadian CRE?

The Canadian CRE market is at a crossroads, with both opportunities and risks on the horizon. Multifamily and industrial sectors will continue to be the pillars of the market, driven by robust demand, tight supply, and stable returns. Niche sectors like student housing offer compelling investment opportunities for those willing to venture beyond traditional asset classes.?

However, the office and retail sectors face ongoing structural challenges, with rising vacancies, weakening demand, and expanding cap rates. Investors with a higher risk tolerance may find opportunities in distressed office and retail assets, but these sectors require careful strategic planning and long-term repositioning to succeed.?

As the market evolves, adaptability and strategic capital allocation will be critical for investors seeking to navigate the complexities of the Canadian CRE market. Whether through investing in distressed assets, exploring niche markets, or capitalizing on sectoral outperformance, the key to success lies in staying ahead of market trends and adapting to shifting economic realities.?

The Real Estate Institute of Canada (REIC) is committed to advancing professionalism and ethical standards in the evolving commercial real estate (CRE) market. As the Canadian CRE landscape undergoes significant shifts, creating opportunities in niche asset classes, REIC equips its members with the tools and knowledge to excel. Our educational programs focus on strategic capital allocation, sectoral performance, and navigating risks in distress situations. REIC members are empowered to adapt and lead confidently in a transforming market.?

References

[1] CMHC Rental Market Report

[2] Canada's student housing market in 'early stages': Bonard

Founded in 1955, the Real Estate Institute of Canada (REIC) is a distinguished organization committed to advancing professionalism and ethical standards in the real estate industry. REIC empowers individuals through a robust educational framework, offering courses and esteemed designations such as the prestigious Fellow of the Real Estate Institute (FRI) , Certified Property Manager? (CPM?) , and Accredited Residential Manager? (ARM?) , which recognizes exceptional achievement in the profession. We elevate the calibre and integrity of real estate professionals by providing unparalleled learning opportunities, fostering a culture of excellence, and promoting ethical business practices. Through targeted programs, networking events, and advocacy, REIC plays a pivotal role in shaping skilled, ethical, and successful real estate practitioners, enhancing the industry's overall reputation and effectiveness.?

Allwyn Dsouza is REIC’s Senior Analyst, Market Research and Insights. He can be reached at [email protected] . Media enquiries can be directed to [email protected] .