According to an analysis by the National Bank of Canada, Canadian banks' earnings are at risk as the commercial real estate industry struggles to make a comeback. Commercial real estate loans are the second-largest lending exposure of the country's top six banks. It represents around 10% of the six banks' lending portfolios, trailing behind residential mortgages. A 2008-like recession could lead to profits decreasing by 9% next year, while a 1990-like recession could lead to a 26% loss in earnings.
Rising interest rates and record office vacancies driven by remote work have affected rent prospects and impacted investors and commercial real estate owners.
The National Bank of Canada report revealed that the Bank of Montreal, Toronto-Dominion Bank, and National Bank had around 100% exposure to office space. The Royal Bank of Canada had the highest exposure of around 20%.
National Bank of Canada analyst, Gabriel Dechaine, said the commercial real estate portfolio of the banks had grown faster than the overall wholesale portfolio over the past seven years. He added that office exposures, which represent 12% of the average Big-Six outlook, are particularly worrisome. Dechaine believes with the current financial uncertainty indicating a recession; investors will maintain a cautious stance toward the Big Six banks. Canadian banks are not as exposed to volatility as U.S. banks.
According to a recent CBRE report, Canada's national office vacancy has surged to a record high of 17.7% in Q1 of 2023. In 10 of the last 12 quarters, net absorption has been negative, meaning office space listed in the market outnumbered office space leased to tenants. In Toronto, the office vacancy rate reached 15.3% for the first time since 1995. Montreal (16.5%), Ottawa (13.2%), and Vancouver (10.4%) also saw record-high vacancy rates. The report said newer and highly amenitized buildings continue to show strength and stability, while old buildings have failed to attract new tenants.
The high vacancy rate has caused fewer projects to commence construction. Canada's current active development pipeline is 11.2 million sq.ft, the lowest since 2017. CBRE Canada Chairman, Paul Morassutti, said the office market is in the midst of an evolution similar to the retail experience in the past ten years.