The Bank of Canada’s recent rate cuts are reshaping Toronto’s commercial real estate landscape, presenting both opportunities and challenges for investors. With interest rates trending downward and market fundamentals showing signs of stabilization, the Greater Toronto Area (GTA) commercial property market is entering a transitional phase marked by evolving financing conditions and shifting valuation metrics.
Current Interest Rate Environment and Bank of Canada Policy
The Bank of Canada has maintained its monetary easing trajectory into 2025, with its January 29th announcement lowering the lending rate by 25 basis points to 3%. This follows a more substantial 50 basis point cut in December 2024, continuing the cutting cycle that began in June 20242. According to TD Economist James Orlando, the central bank is demonstrating a willingness to increase the interest rate gap with the United States despite potential pressure on the Canadian dollar2.
The central bank’s statement indicates confidence in the economy’s resilience, noting: “Lower interest rates are boosting household spending and, in the outlook published today, the economy is expected to strengthen gradually and inflation to stay close to target”2. This policy direction suggests a continued accommodative stance, barring unforeseen economic disruptions.
Implications for Commercial Real Estate Financing
The interest rate environment directly impacts commercial real estate financing conditions. For 2025, debt availability is generally expected to improve, though lenders are maintaining selectivity based on asset classes, locations, and borrower profiles5. After a highly selective approach in 2024 that left many lenders behind on their capital allocation budgets, financial institutions are now exploring a wider range of assets and markets5.
Financing activity is increasing across various commercial property types, including previously challenged sectors such as enclosed retail and office properties. This trend is expected to continue throughout 2025, driven in part by anticipated increases in real estate investment volumes5. The real estate debt market traditionally follows equity activity, suggesting a reciprocal increase in lending as buyer capital re-emerges in the Canadian market.
Office Market Dynamics in the GTA
The Toronto office market is showing early signs of stabilization after significant pandemic-related disruption. According to CBRE, Toronto’s downtown office vacancy rate was hovering around 18.3% as of mid-January 20251. While this represents a substantial increase from the pre-pandemic rate of approximately 2%, market experts believe vacancy may be approaching its peak1.
Supply-side fundamentals appear relatively favourable, with only 1.9 million square feet of new supply in the development pipeline, 49% of which is already pre-leased1. CBRE notes that even with minimal leasing activity through the end of 2025, the impact on overall vacancy would be just 1.2%, keeping the rate below 20%1.
A particularly encouraging indicator is the reduction in sublease space, which has decreased from 3.7 million square feet in Q3 2024 to approximately 3.1 million square feet by December 20241. As a percentage of overall vacancy, sublease space has fallen to 20.7%, down significantly from a pandemic high of 44%1. This trend suggests improving occupier confidence and is considered a leading indicator of market health.
The Impact of Lower Interest Rates on Office Investments
Lower interest rates are likely to enhance the attractiveness of office investments, particularly for well-positioned properties in prime locations. Reduced borrowing costs improve investment yields and may encourage recapitalization of existing properties. However, lenders are incorporating more conservative market assumptions into their underwriting, particularly regarding vacancy rates and rental growth projections5.
Industrial Market Performance
The GTA industrial market is experiencing a period of adjustment after several years of exceptional performance. Tenant activity has increased since Q4 2024, particularly among smaller-scale industrial users requiring less than 100,000 square feet1. Larger occupiers have remained more cautious, though overall demand is projected to increase in 20251.
Rental rates have moderated from their peaks, with GTA industrial rents decreasing from $18.35 to $17.18 per square foot1. CBRE projects that rates will decline slightly in early 2025 before potentially stabilizing mid-year1. With development starting down and the possibility of increased absorption, rents could begin rising again in the latter half of 20251.
The current market environment is characterized as balanced, offering tenants more options and negotiating leverage compared to the extremely tight conditions of recent years. Landlords are providing incentives like free rent and tenant improvement allowances to attract and retain tenants1.
Impact of Interest Rates on Industrial Property Values
The moderation in industrial rental rates has been partially offset by the positive impact of lower interest rates on property valuations. As borrowing costs decrease, investor demand for industrial assets has remained relatively strong, helping to maintain capital values despite the slight softening in rents.
Cap Rate Compression and Property Valuations
The relationship between interest rates, bond yields, and capitalization rates is central to understanding commercial property valuations. Historically, cap rates maintain a spread above the risk-free rate (10-year government bond yield), with this spread typically widening when bond yields are lower and compressing when yields peak3.
Based on historical trends, with 10-year yields close to 3.25%, cap rates for multi-family properties might peak around 5.5% across Canada3. As interest rates continue to decline, there could be downward pressure on cap rates across commercial property types, potentially supporting valuations even in markets with modest rental growth.
Credit spreads for top-quality real estate assets steadily tightened throughout 2024 amid strong lending competition and compression in corporate bond spreads5. For best-in-class properties, financing has been achieved at levels very near the “risk-free” rate, suggesting limited room for further spread compression in this segment5.
Retail and Mixed-Use Properties
Toronto’s retail landscape is evolving, particularly with the city’s focus on integrating retail and services into residential neighbourhoods. Proposed zoning changes could dramatically alter the development potential for mixed-use properties, with implementation potentially beginning as early as spring 20254.
For investors, mixed-use properties present distinct financing challenges. These properties typically require larger down payments, often around 35%, compared to lower requirements for purely residential investments4. Additionally, mixed-use properties face higher property tax rates—potentially three times those of comparable residential properties—which impacts overall returns4.
Lower interest rates may partially offset these challenges by reducing debt service costs, but the specialized nature of mixed-use financing means these properties will likely continue to command premium lending rates compared to single-use assets.
Debt Markets and Lender Behavior
The debt market outlook for 2025 indicates normalization in credit spread dynamics. The substantial gap between the tightest and widest spreads observed in 2024 is expected to contract toward historical norms as lending competition increases5.
Lenders are incorporating more conservative market trends into their underwriting processes, particularly regarding vacancy assumptions. This shift reflects a more cautious outlook for the next few years and will impact loan economics, potentially affecting loan amounts and debt service coverage covenants5.
Despite these more conservative underwriting standards, the overall improvement in debt availability should provide support for transaction activity across property types, contributing to a more liquid investment market in 2025.
Risks and Challenges
Despite the generally positive outlook created by lower interest rates, significant risks remain for GTA commercial property investors. Properties acquired or refinanced during the high-rate environment of recent years may face challenges if their debt structures are not sustainable. Conservative lender underwriting could limit refinancing options for properties with performance challenges5.
Market-specific risks also include potential oversupply in certain submarkets, particularly in the office sector where work-from-home practices continue to influence space requirements. The industrial market, while fundamentally sound, is experiencing a recalibration after a period of exceptional performance that may moderate returns compared to recent years1.
Conclusion
The GTA commercial real estate market is entering a more favorable phase as interest rates decline, though the impact varies significantly across property types and locations. Office properties are showing early signs of stabilization after substantial pandemic disruption, while the industrial sector is adjusting to more balanced market conditions following its extraordinary performance cycle.
Lower interest rates are likely to support property valuations through potential cap rate compression, though this effect will be tempered by lenders’ increasingly conservative underwriting standards. The improved debt availability expected in 2025 should facilitate increased transaction volume, providing greater price discovery and market liquidity.
For investors in the GTA commercial property market, the current environment offers selective opportunities, particularly for well-capitalized buyers who can navigate the more stringent financing requirements while benefiting from the reduced cost of debt. As the market continues to normalize following several years of disruption, a strategic approach focused on property fundamentals rather than financial engineering will likely yield the most sustainable returns.
Citations:
- https://www.cbre.ca/insights/articles/toronto-real-estate-outlook-2025
- https://stories.td.com/ca/en/article/bank-of-canada-rate-announcement-january-2025
- https://www.elevatepartners.ca/resources/find-out-where-toronto-real-estate-investment-cap-rates-might-peak-with-bond-yields/
- https://www.elevatepartners.ca/resources/toronto-retail-in-neighbourhoods-should-toronto-investors-embrace-the-mixed-use-trend/
- https://www.cbre.ca/-/media/project/cbre/dotcom/americas/canada-emerald/insights/canada-market-outlook/2025-Canada-Real-Estate-Market-Outlook.pdf
- https://www.elevatepartners.ca/resources/profitable-properties-for-leverage-in-toronto-real-estate/
- https://betterdwelling.com/overleveraged-home-buyers-represent-a-larger-share-of-canadas-mortgage-debt/
- https://www.zoocasa.com/blog/boc-jan-2025-rate-cut/
- https://www.credaily.com/briefs/cbre-predicts-cap-rate-compression-in-2025/
- https://www.altusgroup.com/insights/toronto-commercial-real-estate-market-update/
- https://www.reddit.com/r/TorontoRealEstate/comments/1howzhc/2025_gta_housing_market_boom_or_bust_which_side/
- https://www.ogrealtygroup.ca/most-lucrative-commercial-real-estate-investments-in-ontario/
- https://manvirbasra.com/investor-playbook/understanding-speculative-real-estate-investments-in-canada-risks-rewards-and-strategies/
- https://www.remaxwealth.com/insights/how-changes-in-government-policies-could-impact-toronto-real-estate-investment-in-2025-what-investors-should-know-now
