Market Watch

Spotlight: Industrial Property

The Industrial Property Crunch in Canada

By Mark Hannah

Mark Hannah is Managing Director, Real Estate at Nicola Wealth Real Estate.

Inflated Rents, Lack of Options

Ca na dia n busi nesses requiring industrial real estate are feeling the pinch these days. Soaring land prices in Canada’s major markets are resulting in limited rental opportunities, ultimately forcing industrial users out of urban sub-markets and into outlying locations. According to CBRE’s third quarter report, the national industrial vacancy rate is 2.9 per cent. Toronto and Vancouver lead all major markets in Canada with record-low vacancy rates of 0.7 per cent and 1.4 per cent respectively.

Through the 1990s and 2000s, rental rates were flat with plenty of options for tenants to choose from in Canada’s urban epicenters, Toronto and Vancouver. This allowed industrial users and businesses to reasonably afford “market rent” without impacting their businesses. Over the past eight to 10 years, the diminishing industrial zones neighbouring metropolitan areas, coupled with the push to re-zone industrial properties for higher density buildings, has forced users out notwithstanding the desire by many municipalities to preserve their industrial inventory. As a result, rental rates have more than doubled.

Prior to 2010, Toronto rental rates historically trended in the $5.00 to $6.00 per square foot (psf) net range and have recently escalated to the $8 to $12 psf net range (depending on the unit size). In Vancouver, rental rates were stagnant in the $6 to $7 psf net range for the similar time frame and have also experienced similar rent inflation in the $8 to $13 psf net range (depending on the unit size).

Why have escalating rents become the current standard? The increase has happened organically for several reasons. First, diminishing land supply, due to the previously mentioned causes, and strong demand resulted in an extreme rise in price for the remaining properties available for industrial use. Next, new construction provides some supply to the market but at significantly higher rental rates in order to compensate for high land prices, GST, government development cost levies, and the increased cost of labour and materials. This has in turn had a trickle-down effect to standing inventory whereby both new and existing supply are experiencing considerably higher rents. On a positive note, the economy appears to be robust with many industrial user groups such as e-commerce, food production, film production, third party logistics, distribution, cold storage, cannabis and last

Net absorption / overall asking rent

3,000,000 Greater Vancouver Greater Toronto

2,500,000

1,500,000 1,250,000 1,000,000 750,000 500,000 250,000 0 2014

2,000,000

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Net Abs orp tion , SF

As kin g Ren t, SPSF 2018 Q2 2019 $14 12 10 8 6 4 1,500,000

1,000,000

500,000

0

-500,000

mile delivery of products flourishing, fuelling the need for more industrial inventory over the long-term. These businesses contribute substantially to the demand for industrial spaces of all sizes. The swelling interest is causing a major problem for tenants. Availability is limited and economic rents rose by 12 per cent last year alone, according to JLL’s recent Q3 2019 Industrial Report. There appears to be no relief in sight as the primary culprit is soaring land prices.

There is a general shortage of all industrial space, but the lack of supply is particularly apparent in the small (2,500 to 7,000 sf) and mid (7,500 to 20,000 sf) bay size ranges where opportunities are scarce. Properties that have excess land/yard area are being marketed for sale at inflated prices based on a “higher and better use,” making it uneconomical for the traditional owner and/or user. This has priced many of the small to mid-bay users out of the market forcing them away from urban locations and into outlying markets.

Meeting the demand of industrial users in major markets, primarily Toronto and Vancouver, is a challenging issue. According to Avison Young’s Q3 2019 Industrial Report, three million square feet of new inventory will be completed this year in Vancouver and Toronto will add 9.5 million square feet. While this new supply is good news, it is not enough to meet the demand.

The Challenges and Solutions Government at all levels (Federal, Provincial and Municipal) cannot be expected to con

There appears t o be no re lief in si ght as t he primar y cu lprit is soari ng land pri ces .

trol land prices but they can contribute in other areas. Developing new product is imperative to ease the stress on the market but there are considerable barriers to doing so, very high development cost levies ( DCL’s) being one of them. These costs could be lowered to offset the upfront cost of a new project. For example, in Mississauga, Ont. the DCL’s are as high as $25 psf whereas in Richmond, B.C., they are as high as $12 psf. This is a significant burden driving up construction costs and resulting in high rental rates being required to warrant new construction.

Municipal governments can help by improving the inefficient approval process for developers. Land prices are already very high, and the drawn-out approval period adds conside rably to the overall project cost for developers. Fast tracking approvals will ensure there is ample supply to meet the demand. Provin cial governments can contribute in several areas including eliminating the Property Transfer Tax ( PTT) on land acquisition for development. They could also offer attractive low interest rate construction financing as it does with multi-family rental apartment buildings, to help encourage developers to build new product.

The Federal government can have a big impact encouraging new supply of industrial product by eliminating the GST on new buildings as this cost is passed along to the tenant in the rental rate. In many areas of the United States, the local governments have established “Opportunity Zones” and “Property Tax Holidays” to help encourage new development.

As a result of these conditions, there has been a movement by developers to build multi-level (vertical) industrial projects for both small and large bay distribution users to meet the demand from both strata/condo and lease requirements.

Supply & Demand

7 714% 7% 6 612 6 5 510 5 4 48 4 3 36 3 2 24 2 1 12 1 0 00 0 -1 -1 -2 -3 -2 -1 -2 -3 (MSF) (MSF) 2014

2014 2013

2013 2012

2012 201120102009 2015

2015 Net Abs orp tion Vacanc y Rate 10-year avera ge Availabili ty ra te 2016

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2017 2018

2018 YT D 2019

YT D 2019 Greater Vancouver Greater Toronto