Canada’s commercial real estate valuations may be at greater risk of decline than previously anticipated due to higher interest rates, says the country’s top banking regulator.

All commercial property segments are facing increased risks due to higher borrowing costs as construction markets show signs of a slowdown, said the Office of the Superintendent of Financial Institutions in a semi-annual update of its 2023-24 annual risk outlook.

OSFI rated CRE as a greater lending risk now compared to April.

Office, development and construction are the riskiest CRE segments, but all commercial property sectors face increased risks, says OSFI. As high vacancy increases pressures, the office sector’s outlook remains difficult, as demonstrated through increasing strategic defaults, falling REIT values, rising U.S. commercial mortgage-backed securities delinquency and special debt-servicing rates.

“In addition, negative [credit] rating migration seems to be lagging changes to the risk environment,” says OSFI. “This indicates that risk assessments, risk rating models, and collateral valuations may not appropriately reflect the risk environment.”

But DBRS Morningstar reported recently that Canada’s Big Six banks can withstand office market declines.