Flight to Quality Continues to Shape Market Recovery
Overall office vacancy reached 16.1% in Q2 2026. While essentially unchanged from Q1 2026, the market continues to improve on a year-over-year (YOY) basis, with vacancy declining 80 bps. The Class A segment followed a similar pattern, as vacancy in both the Central and Suburban markets remained stable quarter-over-quarter (QOQ) while tightening compared with Q2 2025. Vacancy trends in Class B and C properties were less consistent. In the Central market, vacancy in these lower-tiered assets held relatively steady for the previous three quarters before rising to 21.0% in Q2 2026, returning to its Q2 2025 level. Suburban properties in these same asset classes had a similar period of stability, with vacancy increasing to 13.0% this quarter. Unlike the Central market, however, Suburban vacancy now sits 100 bps above year-ago levels.
Absorption levels were negative this quarter at approximately 163,000 square feet (sf). After first quarter revisions, this brought the year-to-date 2026 total to positive 114,000 sf. While absorption levels were strong in the Central Class A market at 1.3 million square feet (msf) in Q2 2026, largely driven by the completion of a fully pre-leased 1.4-msf office tower in Downtown Toronto, negative absorption occurred within every other market segment and asset class. The notable softening witnessed this quarter in lower tiered assets was not widespread across multiple markets but somewhat focused in Montreal, particularly in Class B inventory. While the flight to quality has been the prevalent theme in recent years as tenants consolidate into higher quality space and return to office policies have generally been favouring premium buildings, this movement of occupiers into higher quality space was particularly evident in Montreal this quarter.
Although direct vacancy increased slightly QOQ, it has generally trended downward since the beginning of 2025. The improvement has been most pronounced in the Class A segment, where direct vacancy has fallen 6.7% YOY. Sublet vacancy has also declined for 12 consecutive quarters and now accounts for 11.6% of total vacant space, down significantly from its peak of 21.5% in Q1 2021. The number of blocks of sublet vacancy is fairly evenly distributed in terms of original term expiries as well as various size segments below 50,000 square feet (sf). The lease term expiry picture shifts a bit when focusing only on the Central market, with blocks of space with original lease terms that extend beyond 2031 sitting at 35.0%.
While new leasing activity has slowed over the first half of 2026 in comparison to the last half of 2025, remains healthy at 5.9 msf in Q2 2026. Occupier demand remains focused within the Central Class A market, accounting for close to one-third of all new activity this quarter. The average new deal size in Q2 2026 was approximately 6,000 sf, slightly lower in comparison to last quarter. Central Class A transactions continued to outperform, posting the longest leasing commitments and largest footprints—averaging over six years and approximately 13,300 sf. Where tenants were disclosed, new leasing within the Finance and Insurance sector continued to dominate with close to 1.2 msf leased to date this year and 68 individual transactions.
The overall Canadian average net rental rate ended Q2 2026 at $23.03 per square foot (psf), a new benchmark. As the additional rent component remained unchanged from last quarter at $20.00 psf, the average gross rent climbed to $43.03 psf. While growth in the average asking net rental rate was witnessed across all asset classes in both the Central and Suburban markets, the primary driver behind the increase in the overall net rent this quarter was the Central Class A market as rates climbed by 1.9% QOQ. This reflects accelerated rental rate growth in many of the major cities within this market segment, particularly in markets with Class AAA/AA product.
New supply reached close to 1.5 msf in Q2 2026, almost all courtesy of a 1.4-msf office tower delivered in downtown Toronto. Roughly 1.9 msf remains under construction, the lowest quarterly total in 14 years, the bulk of which is set to be delivered by the end of 2026. This lack of new supply in the pipeline will continue to concentrate demand into existing premium buildings and result in continued tightening within that market segment.
