Vacancy has surged in downtown office markets across the country as more new buildings are completed and companies deal with cost cuts as well as combinations of at-home and in-office work.

The real estate company said Toronto offices drove the national downtown vacancy rate to a record high of 19.4% in the fourth quarter, according to a report by CBRE. The downtown vacancy rate in Canada's largest city rose to 17.4% in the year's final quarter, up from 15.8% a quarter earlier.

Additional new supply helped to drive downtown Toronto's vacancy rate, with 624,550 square feet of new office space completed in the fourth quarter. The 1.1 million square feet of new supply in downtown Toronto's office market in 2023 led to negative absorption, or change in the amount of space occupied, of 2.7 million square feet, the worst result since 2020.

"The office market continues to face challenges, but Toronto's are particularly acute right now," said Paul Morassutti, chairman of CBRE Canada, in the report. "Based on global trends, office utilization and demand are picking up. That is helping improve office fundamentals in most Canadian cities. Toronto will also benefit from the overall trends once new construction comes to an end since it is new supply that's had the biggest impact on the city's vacancy."

Once Toronto's office market performance is factored out, Canada would have had a positive net absorption in the fourth quarter, CBRE said.

The real estate company also said office-to-residential conversion programs such as this one in Calgary have helped the office market and credited those programs with Calgary's third straight quarter of positive absorption. The oil patch still has a downtown vacancy rate of 30.2%, but that was close to 33% a year ago.

In the capital, CBRE said office-to-residential conversions have helped to reduce the vacancy rate in downtown Ottawa to 14.2%. The downtown vacancy rate peaked above 15% in the second quarter of 2023.

More than 2.5 million square feet of office space, or 0.5% of the total national inventory, was converted to primarily residential use in 2023. CBRE said the number of feasible conversions is limited because of physical requirements, zoning and financial viability.

The rising vacancy rate continues to impact Canada's office development pipeline, with only 10.9 million square feet of space under construction nationally. That is equal to 2.2% of inventory, with 54.4% of that space preleased.

Construction of new office space is now at its lowest level since the third quarter of 2017. CBRE said only 784,000 square feet of office projects started construction in 2023.

Sam Damiani, an analyst with TD Cowan, said the CBRE report points to signs of stabilization in the office market, with only Toronto's new towers masking what would have been a positive quarter for demand.

"We believe the report will likely ease some investor concerns over office fundamentals as reflected by the heavily discounted valuation of Canadian Office REITs," said Damiani in a note that suggests a capitalization rate for offices of an implied annual 8.3% yield with average prices of $305 per square foot. "We do remain cautious on the near-term outlook given the about 7.6 million square feet of deliveries slated for 2024 [versus 2.5 million square feet in 2023] along with a challenging leasing environment."