Industrial real estate, on the “comeback trail” for much of 2011 with vacancy rates falling and rental rates rising, looks poised to continue to make gains in the coming year, according to a Real Estate Forum panel of executives.
Perhaps the participant best positioned to answer the question of just what the future holds for industrial space was Joe Mazzocco, a partner with KingSett Capital. KingSett purchased the massive ING-Summit portfolio of 32 million square feet of industrial space just over a year ago with the intention of turning around what had been an underperforming holding.
“In acquiring the ING portfolio one of the major pieces was that we could improve the occupancy of that portfolio which was really a call on the Canadian economy,” he said. The vacancy rate of much of KingSett’s portfolio had a vacancy rate of about 15.5%, or more than double the national average of 7.5%.
KingSett has spent the past year whittling that rate down, though Mazzocco admitted it remains in the double digits currently. “There is no doubt it has been a great year, we have been very happy with results right now.” He credits low interest rates, capital chasing real estate but chalks most of the improvement up to the improving state of the economy.
“There is no question with thousands of tenants that there is going to be a bankruptcy here and there but in general our clients have had a very good year,” he said.
Zeroing in on the key Greater Toronto Area market, which represents about one-half of Canada’s entire industrial space inventory at 750 million sq. ft., panel moderator Jim McIntosh, a senior vice-president of Colliers International, asked: “Why don’t you increase your rental rates?” pointing to graphs that show rents in the GTA are 20% lower than the national average despite vacancy rates of just 5%.
Mazzocco explained how rental rates have remained firm despite the decline in manufacturing there caused by the double whammy of a weak U.S. demand and a high Canadian dollar. Industrial tenants have generally hung onto their space, even in the cases where the actual manufacturing has shifted overseas.
As well, many of the smaller bay tenants that KingSett has the most experience with want to buy the real estate that they operate in, and the company is happy to oblige. “Before we bought ING I personally struggled with why a user would want to buy real estate. They look at it differently.” In many cases, that property will serve as the pension for the business owner in retirement after their business is sold or stops operating when they no longer run it.
“That guy who would have paid a higher than the average rental rate is just buying it and he doesn’t end up on the stats,” he explained. “The demand to buy in that smaller bay product is phenomenal. The difference between what the building is worth if we leased it versus selling it to a user is significant. We actually have debates internally when we got a lease offer and say, “We can’t do that because that is less value than if we sell it. ’”
Fellow panellist David Ward, director of acquisitions with Morguard Investments which owns 24.6 million sq. ft. of industrial space, said that excess smaller industrial space in markets such as Toronto has forced landlords to offer concessions to reduce vacancy over the past few years.
“There is no doubt it has been a tenant’s market,” Ward said, especially for smaller space. “Landlords are tripping over themselves in giving concessions. We have had to be really creative, we have had to be very flexible in terms of shoring up occupancy and I know we are not alone in the market place.”
Kevan Gorrie, vice-president of industrial property with Oxford Properties Group, did not see a dramatic turnaround in Toronto. “Landlords are going to continue to chase tenants, it is going to be a tenant’s market for at least another 12 months.”
The Montreal market remains a city where industrial landlords like KingSett “have to be the most creative,” said Mazzocco. Morguard’s Ward described much of the Montreal market’s space as obsolete, unable to accommodate 53-foot trailers, for example.
For Ward, the real Montreal story is happening just over the provincial border in Cornwall, Ont. The border city has suddenly developed into a distribution center destination for large retailers such as Wal-Mart, Shoppers Drug Mart, Costco and Target. He chalks the interest up to cheap, available land, proximity to the U.S. and the perception it has friendlier labor laws.