2023 Year in Review and Outlook for 2024

As we approach the conclusion of 2023, the real estate landscape is grappling with the dual pressures of rising interest rates and an evolving economic environment. Experts within the industry highlight that the challenges faced this year are paving the way for a protracted period of adaptation and transition extending into 2024 and beyond.

The Pressures of 2023

“Last year, the narrative was to hang on until 2024. Now, we’re looking ahead, anticipating challenges that may last until 2025 or even later,” notes Raymond Wong, Vice President of Data Solutions Delivery at Altus Group. Investors are now trying to navigate the delicate balance of finding capital sources, especially for office properties and land. With ongoing struggles in price discovery for both buyers and sellers, the horizon appears clouded.

According to Altus Group’s economic growth forecast, we can expect flat economic growth in 2024, with a hope for momentum to build later in the year. A more normalized growth rate may not be feasible until 2025. “Across the provinces, economic growth is witnessing a significant slowdown, barring Alberta, which seems to be an outlier,” indicates Peter Norman, Vice President and Chief Economist at Altus Group.

Bright Spots Amid Challenges

Despite these economic headwinds, there have been some positive developments. Encouragingly, data has begun reflecting a gradual increase in the return-to-office rates. Demand remains robust for multi-unit residential buildings and industrial properties, although buyers are exercising caution to mitigate risks associated with leverage.

Nonetheless, the near-term scenery for real estate investors and operators appears challenging. Rising operational costs necessitate a search for efficiency improvements, such as leveraging AI technologies for enhanced operational productivity.

Population growth has emerged as a significant factor influencing both the Canadian economy and the commercial real estate sector. Recent statistics indicate that Canada’s population surged by over one million in the year leading up to mid-2023, doubling the pace of the previous year. Remarkably, 98% of this population growth comes from international sources, including new residents, foreign workers, and international students. “While population growth is crucial for the real estate sector, the rapid pace of this change is generating waves of challenges,” remarks Norman.

Ontario is attracting a remarkable 38% of the new population, with Quebec at 18% and Alberta and British Columbia each claiming 15%.

Economic Headwinds

While economic growth appears flat, employment figures remain surprisingly resilient. Canada is on track to create around 325,000 net new jobs in 2023, surpassing pre-pandemic averages. However, the concurrent rise in the unemployment rate reflects increased participation in the labor force, largely due to new immigrants.

Inflation is also under scrutiny. According to the Bank of Canada, while inflation conditions are improving, the pace remains insufficient. “We face an increased likelihood of further interest rate hikes, potentially later this year or early next year,” warns Norman. This situation may extend the period of elevated interest rates, impacting various economic layers.

Debt service ratios, which are rising rapidly, constitute another major concern for households, limiting their ability to engage in broader economic activities. “Expectations for 2024 indicate that debt service ratios will rise further due to continued interest rate increases,” adds Norman.

Decline in Transaction Volumes

The relentless rise in interest rates combined with an ongoing price discovery process is contributing to a slowdown in transaction volumes. Year-to-date activity in 2023 is down by 37% compared to 2022. However, Wong notes, “Investment activity isn’t as far off the mark as initially feared.”

In excluding land transactions, the industrial sector stood out with over $12 billion in sales, followed closely by multi-family apartments at nearly $8 billion. Yet, financing remains a significant obstacle as buyers face challenges in uncovering capital sources, despite consistent demand for industrial and multi-family units.

Real Estate Investment Trusts (REITs) continue to focus on food-anchored retail centers, suburban multi-unit residential properties, and industrial assets, while the demand for all types of office spaces has dropped significantly. “The appetite for purchasing is still strong, but timing and deal availability present persistent challenges,” Wong reveals.

Industrial Performance Remains Steady

Data indicates that overall industrial availability rates have climbed from 2.6% to 3.6% in the past year, reflecting slight softening due to economic changes and higher rental rates. Despite this, rates remain low, and demand for new industrial space continues to be robust.

Vancouver and Toronto have experienced notable rent increases, with averages approximately 40% higher since 2020 and Montreal rents rising by about 63%. Currently, Vancouver has the highest market costs, averaging $27.24 per square foot (psf). Buyer interest is pushing cap rates down to around 4.5%, albeit financing costs are now typically between 5% and 8%.

The Shift in Office Space Utilization

Toronto’s office market is witnessing a gradual resurgence, with average weekly occupancy now around 54%—significantly peaking at 69% mid-week. This upswing is partly attributed to companies enforcing return-to-office mandates. However, many organizations still face challenges in promoting compliance among their workforce.

Nationally, office vacancies currently sit at around 17.6%, with Calgary showing the highest rates at 23.9%. “The office availability rate appears to be stabilizing, which is promising given prior extreme fluctuations,” Wong notes. Although leasing activity has slowed to 9.9 million square feet, the demand for Class A office space remains stronger than for B and C spaces.

Growing Concerns in the Housing Market

Recent data from the housing resale market indicates a decline in activity, with year-to-date home sales through September totaling 356,912, a drop from 412,910 during the same period in 2022. This cooling trend, despite heightened interest rates, mirrors a return to pre-pandemic sales patterns.

Numerous factors weigh on future housing market dynamics. A notable shift is observed in the short-term rental market, where a rising number of properties initially bought for Airbnb purposes are being reintroduced into the market for sale. Higher interest rates and ongoing mortgage renewals are likely contributing to this supply influx.

Most markets are witnessing a cooling in condominium apartment sales, down by 30-40%. A dip in available inventory, stemming from paused launches, and a drying-up investor market are significant contributors to this trend. However, the demand for new rental housing remains strong as rental households account for nearly half of household growth—a figure now adjusting to about 40%.

The slowing rate of new construction is noteworthy. Developers have experienced a decrease in project launches, with Toronto’s new projects halved over the last 18 months. Projections indicate that new housing starts will plummet to around 188,000 in 2024 and further decrease to 171,000 in 2025, while the country continues to face significant population growth. This situation is likely to exacerbate housing affordability challenges.

Conclusion: Navigating an Uncertain Future

As we stand at the cusp of 2024, the real estate market is poised for a markedly transformative year, characterized by rising operational costs, evolving buyer preferences, and mixed market signals. While some sectors demonstrate resilience and room for improvement, numerous challenges loom on the horizon.

Understanding these dynamics is crucial for stakeholders, as they strive to navigate the intricacies of the market in the coming year. The intertwining themes of economic growth, population dynamics, and demand-supply mismatches will shape the trajectory of real estate in Canada for years to come.