While there are concerns about potential headwinds, industrial remains the top-performing commercial real estate asset class in Canada.
And that's expected to continue according to a three-person panel of executives, who’ve spent considerable time in acquiring, developing and managing industrial real estate, at the Feb. 28 RealCapital conference at the Metro Toronto Convention Centre.
The four men discussed industrial real estate performance, issues and challenges during the session. Colliers vice-chairman Gord Cook moderated the discussion and offered an introductory overview of the sector.
Industrial started seeing substantial rent growth in 2017, when the availability rate was around three per cent — about three times as high as it is now. It was already a landlord's market when the COVID-19 pandemic hit and led to tremendous e-commerce expansion.
“That had a very strong ripple effect for not only the occupiers of industrial real estate, but the outlook of investment and where those investment dollars should be spent,” Cook said.
“Those fundamentals through COVID saw strong absorption levels and even further rates of growth within rental rates.”
Canadian industrial investment hit a record in 2021 after the pandemic-induced doldrums of 2020. That continued through early 2022 before a steady stream of interest rate hikes slowed activity.
Outlook for 2023
Triovest chief investment officer Prakash David said he’s working on three deals at the moment and is bullish on industrial real estate, but still thinks there will be a slowdown in activity.
He’s especially high on core-plus and value-add properties where environmental, social and governance elements can be improved to increase sustainability and profitability.
“We still feel really good about development because we have the fundamentals,” David said. “We think there are still good tenants out there and a lack of good space, notwithstanding a lot of new supply coming on in certain markets.
“So we'll continue to invest there, but we're going to be more disciplined about the way we underwrite and probably not bet that we're going to absorb that space as quickly as we might have, or that rents will grow as quickly as we might have thought last year.”
“Industrial is a great asset class that has strong fundamentals and leasing can do well,” Choice Properties senior vice-president of office and industrial Andrew Reial said. “If it's a well-located property with great functionality, I think people will want to be there.”
Dream Industrial REIT senior VP and head of investments Bruce Traversy thinks the first and second quarters of the year will likely be a bit slow, but he believes there are many buyers interested in value-add industrial real estate where they can increase rents.
There's less enthusiasm for properties with long-term leases and relatively small annual rent increases, he added.
“The short-term view is tough to swallow as you wait for that cash flow to improve,” Cook noted.
While David thinks there will be continued industrial rent growth, Triovest is being conservative and cautious about its belief in hitting peak market rents at this point.
Property owners and brokers are becoming more open to selling pieces of a portfolio individually or in smaller bundles rather than as a whole because getting debt financing to make larger acquisitions has become more difficult for some buyers, according to Traversy.
More industrial development is needed
“The Canadian industrial development market has generally been under-supplying the market since 2008,” Cook explained.
“We had an exodus of merchant developers and we started to see more institutions building to core but, with the exception of maybe Alberta, the entitlement process for development always takes longer than expected.
“Land values and development charges were constantly running at a pace somewhat higher than rental growth until we hit about 2017.
"Through moderate absorption for over a decade, we continued to see those vacancy rates and availability rates drop to a level that was truly awkward to grow an economy. The benefit was dramatic rent growth.
“With the exception of Vancouver, we have a development pipeline that's under two per cent. You put that into context and most U.S. markets are typically building two to five per cent of new inventory for markets that typically have five to seven per cent vacancies.
“Put that in the context of the Toronto market, where we would actually need to develop about 45 million feet and put it into the market just to get back to a five per cent availability rate.”
The Toronto industrial market currently has less than 14 million square feet under development, with pre-leasing generally occurring within six months of launch, Cook added.
Industrial rents across Canada
Cook said industrial rents last year rose by 18 per cent in Vancouver, 31 per cent in Toronto, 41 per cent in Calgary and 74 per cent in Montreal.
That helped offset increases in land prices, construction costs and development charges.
Triovest just leased a 50,000-square-foot industrial building in Vancouver for $27 per square foot, with annual four per cent rent escalations built in.
Comparatively, David said industrial space can still be had for nine dollars per square foot in Calgary. While Montreal rents have risen rapidly, they still lag Vancouver and Toronto.
“We're investing heavily in Montreal and Balzac (a community north of Calgary) at the moment because we think they have room to run whereas in other markets I'm not sure they have as much,” said David.
Traversy said he thinks underwriting for five to 10 per cent rent growth is realistic.
Development postponements not expected
Cook wondered if some industrial developments might be postponed due to new underwriting, higher capitalization rates or concerns about capital markets and economic fundamentals.
“Most developers are in for the long haul as they've got the capital and balance sheet and I think they're going to drive on,” Reial said.
“If you go to tertiary locations where you're supporting Toronto but you’re an hour-and-a-half outside the city, maybe those numbers start getting a little riskier because there will be a flight to quality and being closer to major cities.
"But I think, for the most part, people will keep on driving forward.”
Even with older and smaller buildings, Reial said Choice is getting calls about space before it comes to the market.
New industrial space might be priced too low
Cook said lease renewals for 20- or 30-year old industrial buildings with clear heights of 22 to 30 feet are going for $17 on average, whereas new space with 40-foot clear heights, modern design and sustainability features are leasing for $18 to $21 per square foot.
He thinks tenants in those newer buildings are getting a great deal.
David agreed with Cook, but added: “We're building best-in-class assets so that when times get really tough, just like in the office market, there's a flight to quality and you know your cash flows.
"So right now, yes, we like that small-bay rent because you're really getting more rent than you want to for that space. But it's not the way to think of it over the long term and it will probably revert back.”
Choice has a lot of second-generation industrial product that’s performing well, in addition to its new developments.
“If you can afford $16 or $17 rents for 24-foot clear, paying $23, $24 or $25 isn't unreasonable in a new-generation building,” Reial said, because you’re getting 50 per cent more space with a 36-foot clear height.