Five-Star Office Space Outperforms Other Classes in Downtown Toronto
Five-Star Office Space Outperforms Other Classes in Downtown Toronto
Office vacancy rates in Toronto’s downtown show that all office has been affected by the rise in hybrid-work policies.
However, five-star office buildings, with the amenities and accoutrements that make their spaces stand out, are faring significantly better than somewhat older, but still high-quality four-star buildings. The divergence in performance has accelerated since the start of the year. This suggests that some occupiers are choosing to take new space in the highest quality of buildings while reducing or exiting their footprint in older, or lower-quality space. In short, occupiers are increasingly “fleeing to quality.”
Downtown Toronto is Canada’s most important office market, accounting for nearly 100 million square feet or roughly 10% of the nation’s office space. Nearly two-thirds of office space in downtown Toronto submarkets is four- or five-star quality and represents some of the best quality space in North America. Yet, downtown Toronto, like other important office nodes, has been affected by the rise of hybrid work since the pandemic, which have caused many occupiers to rethink their space needs.
In fact, at the beginning of the pandemic, five-star office space was affected more than other classes. Vacancy jumped from 0.7% in the first quarter of 2020 to 4.5% a year later. This increase of 380 basis points in vacancy compares to an increase of 320 basis points for the market overall. The relative underperformance of five-star space was likely affected by the addition of over 2.5 million square feet of new five-star office space in 2020, which proved difficult to lease up during the public health crisis. Yet still, the overall vacancy rate in five-star space remained less than other classes.
Between 2021 and early 2023, the vacancy rate continued to rise across all classes of downtown Toronto office. However, in 2023 a new trend emerged: Vacancy started to decline in five-star offices while continuing to increase across other classes. This likely had something to do with the fact that 2023 — and to a lesser extent 2024 — are years in which a large wave of office lease expiries transpire. This has provided more opportunities for owners of five-star offices to find potential occupiers who may be looking to upgrade their space.
The picture is bleaker for four-star space. Occupiers of this quality Class A space often have the financial means, if desired, to upgrade to five-star space even in the context of a cooling economy. Yet three-star occupiers, who might aspire to four-star space, are more likely to be financially constrained given the slowing economy. In other words, four-star offices risk losing more occupiers to five-star offices than they are likely to gain from three-star offices.
Because of this, at least in the short term, four-star office space is likely to underperform relative to the other categories, especially versus five-star. This suggests that Toronto’s downtown office sector is likely to see a bifurcation in leasing performance in the future, with the best-in-class buildings outperforming the rest.
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