Downtown Toronto office vacancy fell to almost a four-year low in the second quarter, says a new report from Newmark.

Vacancy in the core dropped to 10.8%, its lowest level since the fourth quarter of 2022, as demand for premium office space continued to strengthen.

The vacancy rate declined from 11.1% in the previous quarter and 13.7% a year earlier after peaking at 14.4% in the third quarter of 2024.

But the downtown office sector is taking “a bit of a breath” after four quarters of strong growth, said Andrew Petrozzi, Newmark’s head of Canadian research and the report’s author, in an interview with Connect.

“Obviously, we’re at a better place than we were a year ago, quite different,” he said. “Two main reasons for that: There is a bit of slowing in leasing demand, and there’s a tightening availability of trophy and even class A space.

First-half net absorption totalled approximately 1.6 million square feet, already exceeding the 10-year annual average of about 595,000 sf . Most of the demand was concentrated in trophy and class A buildings in the Financial Core, with spillover activity boosting Downtown West.

Leasing activity in the Financial Core remained the strongest among downtown submarkets during the first half of the year, although the surge created by return-to-office mandates slowed by mid-year as the supply of class AAA and class A space tightened. The gap between availability and vacancy in the Financial Core widened to about 390 basis points, while class A vacancy fell to 5.9% even as availability increased to 9.6%, signalling more tenants were marketing space ahead of future moves.

“What’s interesting is that head lease vacancy is coming down in all asset classes,” said Petrozzi. “So, you’re seeing it throughout the market, which is a great sign.”

“B and C [vacancies] still remain elevated by historical standards, but you have started to see that curve bend downwards in terms of head-lease vacancy. So, I expect to see that trend to continue.”

Sublease vacancy held near multi-year lows at approximately 1.2% across downtown, with Class A sublease vacancy tightening to 1.0%, indicating that tenants have reabsorbed most of the excess space that became available during the pandemic.

Despite the improving market, older office buildings continued to lag. Downtown West, Downtown North and Downtown East all recorded vacancy rates above the downtown average, while Class B and Class C buildings, which account for about 29% of downtown inventory, continued to experience elevated vacancy. The report said many of these properties will require repurposing or conversion, although zoning restrictions, high conversion costs, heritage protections and limited municipal incentives remain obstacles.

Petrozzi expects the tech sector to post large occupancy gains in various downtown nodes. He also anticipate that the financial-services sector will continue to post strong occupancy gains.

“Obviously, all tenants have been very interested in locating in the Financial Core,” he said. “That’s where the market is tightest.

“We’re also seeing companies interested, as they always have been, in Downtown South. Some of that demand has spilled over, particularly into Downtown West and, to a lesser extent, into Downtown North and Downtown East. But in regards to where tenants want to be, it’s clear, based on the statistics, that they want to be in the Financial Core.”

Petrozzi does not expect newly imposed U.S. tariffs on imports of many Canadian goods and U.S. President Donald Trump’s threated 50% tariffs slated to kick in August 19 to have a negative impact on the Toronto office sector, based on the market’s reaction to the first round of threatened tariffs in early 2025.

“What we ended up seeing, actually, was a surge in absorption and vacancy declining, and those were because of reasons unrelated to the tariffs,” said Petrozzi. “But the last time this happened, there wasn’t an impact, and in fact, the market posted some of the strongest numbers in a decade. So, I’m unsure of what [impact] future tariff threats may have.”

Newmark said new downtown office development could resume later this year if demand remains strong, but the development pipeline is shrinking and currently has no new projects underway beyond those already under construction.

Petrozzi previously told Connect that he does not expect a major new office project to launch in downtown Toronto, or any other major Canadian market, until the late 2020s. But he now has a different outlook.

“I think there is, perhaps, an increasing likelihood of perhaps two or three mid-sized buildings going ahead instead of one giant one,” he said.

The new towers will likely be well-located in a desirable submarket, such as the Financial Core, he added.

Pictured: Downtown Toronto

Photo: Shutterstock