Toronto's Construction Cost Surge: Impact on Commercial Property Valuations in 2025

The Toronto real estate market is experiencing significant upward pressure on construction costs, creating ripple effects throughout the commercial property sector and challenging traditional valuation models. This increased cost burden is reshaping how developers approach new projects while influencing commercial property valuations across office, industrial, and retail segments. While construction costs continue their upward trajectory, lagging Net Operating Income (NOI) growth presents a complex valuation challenge that property stakeholders must navigate in Toronto’s evolving real estate landscape.

The Unprecedented Rise in Construction Costs

Toronto has emerged as a global hotspot for construction cost escalation, with data showing the city experienced the second-highest building cost increase worldwide. Between January 2020 and August 2023, construction costs in Toronto surged by a staggering 40.5%, placing it behind only Prague (49.3%) in a global ranking of 25 cities1. This dramatic increase has continued into 2025, compounding challenges for developers and investors in the commercial property sector.

The most recent data from Statistics Canada reveals that construction costs have maintained their upward momentum throughout 2024. In the second quarter of 2024, non-residential building construction costs increased by 4.3% year-over-year across major Canadian metropolitan areas, with the quarterly growth rate accelerating slightly to 1.1% compared to the first quarter4. This consistent pattern of cost inflation has created significant hurdles for new commercial development projects in Toronto.

Among non-residential buildings, factories and warehouses have experienced the most substantial cost increases, followed closely by transportation buildings and offices, all advancing by slightly more than 1% in the second quarter of 20244. This targeted pressure on industrial and office construction is particularly significant for Toronto’s commercial real estate sector, which has seen shifting investment patterns across different property types.

Key Drivers Behind Rising Construction Expenses

Several interconnected factors have contributed to Toronto’s construction cost surge. Supply chain disruptions originating during the COVID-19 pandemic continue to impact material availability and pricing, while skilled labor shortages have driven up workforce costs substantially1. These challenges are compounded by Toronto’s restricted bidding process for construction projects, which limits competition and contributes to maintaining higher prices1.

The construction industry also faces mounting pressure from interest rate fluctuations, building code updates, and regulatory compliance requirements that add layers of complexity and cost to development projects4. While the Bank of Canada reduced the overnight rate to 3.25% in December 2024, the impact on construction financing has been gradual and insufficient to offset other inflationary pressures2.

For developers, these cost increases translate directly to higher investment requirements and extended capital commitment periods. The Building Industry and Land Development Association (BILD) reports that lengthy approval timelines—averaging 20.3 months across Greater Toronto Area municipalities—add substantial carrying costs to projects3. These delays, combined with various governmental fees, taxes, and charges that account for approximately 25% of total house-building costs, create significant financial pressure on both residential and commercial development3.

Commercial Property Market Response to Cost Pressures

The escalating construction costs have triggered notable shifts in Toronto’s commercial real estate investment landscape. In 2024, the Greater Toronto Area reported $17.5 billion in transaction volume, representing a 21% decline compared to the previous year2. This reduction in activity suggests that investors are exercising caution in an environment where replacement costs are rising faster than property income potential.

Industrial Sector Dynamics

The industrial sector, while moderating from previous highs, remains a focal point of investment activity with nearly $5.6 billion transacted in 2024, despite a 27% year-over-year decrease2. Notable transactions highlight current market valuations, with premium industrial properties commanding significant prices. For instance, Prologis purchased Canadian Tire Corporation’s 1.6 million square foot distribution center in Brampton for $258.1 million ($160 per square foot), while Unilever acquired a 744,000 square foot Brampton warehouse for approximately $121.4 million ($163 per square foot)2.

These transactions demonstrate that despite rising construction costs, well-positioned industrial assets continue to attract substantial investment at price points that reflect the high replacement cost of new construction. The industrial sector’s resilience is supported by Toronto’s strategic location and robust demand for logistics space, though availability rates stabilized at 5.3% by late 20242.

Office and Retail Sector Challenges

The office sector has faced more pronounced challenges, with transaction volume falling to $1.6 billion in 2024—a steep 46% decrease year-over-year. This decline reflects both the increased cost to develop new office space and persistent uncertainty about future workspace demand patterns. Investment activity has increasingly concentrated on premium Class-A office spaces that can command sufficient rental rates to justify today’s elevated replacement costs.

Similarly, the retail sector reported $2.1 billion in transactions during 2024, down 20% from the previous year, with food-anchored retail strips emerging as investors’ preferred property type in the GTA2. This preference indicates a strategic pivot toward retail assets with stable income potential that can more reliably support valuations in an environment of higher construction and replacement costs.

The NOI Growth Conundrum

The critical challenge facing Toronto’s commercial real estate market is the growing disconnect between rising construction costs and the ability of properties to generate proportionally higher income. This imbalance creates significant implications for property valuations, particularly for newly developed assets.

Understanding the Valuation Gap

Commercial property values typically reflect a property’s income-generating potential, usually expressed as a capitalization of Net Operating Income (NOI). While construction costs have surged, market rents and occupancy levels have not kept pace, creating pressure on initial yields for new developments. This phenomenon is especially pronounced in the office sector, where remote work trends continue to impact space utilization and rental growth potential.

In the industrial sector, while demand remains relatively strong, the substantial increase in construction costs has outpaced even the robust rent growth seen in this segment. This has created a situation where replacement costs for industrial properties have risen faster than their potential income, compressing initial returns on new development.

Development Activity Constraints

The challenging economics of new construction are reflected in declining development applications across the Greater Toronto Area. Data from 14 municipalities shows applications fell to 1,225 in 2023 from 2,482 in 20213. This significant drop signals developers’ hesitation to initiate new projects in an environment where rising costs may not be fully recoverable through increased rental rates or sale prices.

Industry experts have expressed concern about the long-term implications of this trend. As Noorez Lalani, president of high-rise developer MOD Developments, commented, “It’s like you can see the storm coming… It’s going to be a heck of a lot worse”3. This sentiment reflects growing awareness that construction cost pressures, combined with insufficient NOI growth, create a potential supply shortage that could further distort market dynamics.

The Developer’s Valuation Balancing Act

Developers in Toronto face a complex balancing act as they navigate the challenges of escalating construction costs against market-driven limitations on achievable rents and sale prices. This tension is reshaping development strategies and investment criteria across the commercial real estate landscape.

Strategic Adaptations

In response to cost pressures, developers are implementing various strategies to maintain viable project economics. These include:

Scale optimization to achieve greater efficiency in construction and operations
Value engineering to reduce costs without compromising quality or functionality
Phased development approaches that allow for adjustment to market conditions
Focus on premium market segments where higher rents can better support increased costs
Exploration of alternative financing structures to manage higher development costs

For smaller and mid-sized developers with limited capital reserves, the current environment poses particularly acute challenges. The insolvency issues already appearing in Toronto’s condominium sector may foreshadow similar stresses in commercial development, with smaller, less-capitalized firms facing the greatest risk6. This trend suggests a potential consolidation within the development industry as projects increasingly require deeper financial resources.

Valuation Implications for Existing Assets

The rising cost to develop new commercial properties has significant implications for existing asset valuations. As replacement costs increase, the value of existing buildings—particularly those with stable income streams—tends to appreciate accordingly, assuming functional and locational attributes remain competitive.

This dynamic creates potential opportunities for owners of well-maintained existing properties, whose relative value position improves as the cost to develop competing new supply increases. However, this advantage may be partially offset if the property’s income growth potential lags behind construction cost inflation, creating a complex valuation environment that requires sophisticated analysis.

Conclusion: Future Outlook for Toronto’s Commercial Property Market

Toronto’s commercial real estate market stands at a crossroads where rising construction costs, evolving demand patterns, and interest rate fluctuations converge to create both challenges and opportunities. The unprecedented construction cost increases have fundamentally altered the economics of development and are reshaping valuation parameters across property types.

Looking ahead, several factors will likely influence how this situation evolves:

The pace and sustainability of construction cost inflation, which may moderate as supply chains stabilize and interest rates adjust
The ability of the market to absorb higher rents necessary to justify new development at current construction cost levels
Potential policy interventions aimed at accelerating approvals and reducing regulatory cost burdens
Adaptation of design and construction methodologies to enhance efficiency and manage costs

For investors and developers, success will increasingly depend on sophisticated market analysis, strategic timing, and the ability to identify opportunities where achievable rents can support current construction costs. The valuation balancing act will remain challenging, but those who can effectively navigate these complexities may find significant opportunities in Toronto’s evolving commercial property landscape.

Citations:

Toronto’s Industrial Real Estate: Boom, Valuation, and Market Dynamics

Transit Expansion and Value Lift in Toronto

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