Why Toronto's Office Sector May Be Less at Risk Than New York City's
Why Toronto’s Office Sector May Be Less at Risk Than New York City’s
Hybrid work has negatively affected the office leasing business across North America, including in Toronto and New York, the largest office markets in both Canada and the U.S., respectively.
However, Toronto is dominated by well-capitalized institutional owners who are better able to withstand market corrections relative to other property owner types, such as developers, who are prominent in New York. This difference in ownership composition is one reason why capitalization rate movements tend to be less pronounced in Toronto. While certainly not immune from the effects of hybrid work, Toronto’s institutionalized office market is better able to withstand the current market turbulence, making it a less risky market than New York.
The North American office market has been affected by the adoption of hybrid work policies as well as slowing office-using employment growth. In both Toronto and New York, the average office vacancy has climbed by roughly 500 basis points compared to pre-pandemic levels. Moreover, major Class A office nodes, such as Downtown New York City and the Financial Core in Toronto, have witnessed weaker leasing fundamentals relative to their respective markets.
Despite these similar trajectories in leasing fundamentals, the ownership composition in both markets for large office assets differs in a meaningful way. In Toronto, a quarter of all downtown office assets that are three-star-rated or higher and with a rentable building area of greater than 200,000 square feet, are partially or fully owned by institutional entities, such as insurance companies, pension funds or sovereign wealth funds. This contrasts with downtown and midtown New York, where partial or full institutional ownership is less than 5%. Also, while developer-owners are important in both cities, they are more prominent in New York.
Institutional owners tend to be well-capitalized and better able to weather risks related to rising interest rates. Developers tend to be more exposed to risks related to leverage and debt. Although Toronto is not immune from development or construction loan risks, the office sector is less exposed than New York. In downtown Toronto, developer-owners account for one in three partial or full owners of large mid-to-high-quality office assets, as opposed to over 50% in downtown and midtown New York. Given the current macroeconomic environment, this suggests that the Toronto office market is less exposed to risks associated with higher interest rates.
This difference in ownership types helps explain why, despite similar fundamentals, office cap rate movements in Toronto are less volatile compared to New York. In fact, despite witnessing a similar increase in vacancy levels since early 2020, office market cap rates in Toronto currently are 50 basis points less than in New York.
The higher number of developer-owners in New York and the low number of institutional owners suggest that the New York office market is at greater risk of seeing more assets repriced in the event of a significant downturn. The Toronto office market, with fewer developer-owners and more institutional owners, is likely better positioned to ride out any future market turbulence. The prominence of developers as owners in New York suggests that this city could offer more future distressed office opportunities than Toronto if market conditions in both cities continue to deteriorate.
Source Renx.ca Click here to read a full story
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