In the ever-evolving terrain of industrial real estate, staying abreast of the latest market trends is crucial for large institutional investors, especially when considering the liquidation of privately held partnership interests. The August 2023 Industrial National Report from Canada, sourced from CoStar, provides a wealth of information that is vital for strategic partners and capital groups looking to optimize their investment strategies in the realm of real estate private equity.
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Market Overview: A Tight Industrial Landscape Amidst Economic Headwinds
As strategic partners in the investment sphere, we recognize the importance of a robust understanding of the current economic climate. The Canadian industrial market is grappling
with the dual challenges of elevated inflation and the looming threat of a recession. Despite these hurdles, the industrial sector has shown remarkable resilience, maintaining a tight market with a national vacancy rate at a near-historic low of 1.7%. This scarcity of available space has naturally led to a decrease in leasing volumes and net absorption rates.
Leasing Dynamics: Adapting to a Market with Scarce Availability
Demand and Activity Trends:
Strong demand from the logistics sector and the burgeoning e-commerce industry has buoyed the Canadian industrial leasing landscape. This sustained demand has historically kept leasing activity at near-record highs. Yet, the current year has introduced a significant challenge: a critical shortage of leasable space in key markets, which has led to a marked suppression of industrial leasing activity. As we entered the first quarter of 2023, the amount of space leased fell to just under 10 million square feet, the lowest since 2015.
Net Absorption and Market Response:
Despite the recent slowdown, the 12-month net absorption rate remains at historically high levels, with Q2 2023 estimates of around 26 million square feet. Although the monthly demand has slowed, the annualized trend still exceeds the long-term average of 22 million square feet. CoStar data indicates that the market still has a strong appetite for industrial space—Any available space has a nearly 50% chance of being leased within six months.
Vacancy Rates and New Supply:
An increase in new supply has been a positive sign, yet it hasn’t been sufficient to loosen the tight grip on the market. CoStar forecasts that vacancy rates will remain low for the foreseeable future, with no immediate rebalance in sight. All types of industrial properties are experiencing these record-low vacancies, with flex and specialized spaces in particularly high demand.
Tenant Profiles and Major Deals:
Manufacturers, logistics operators, and retailers predominantly drive the leasing activity. A significant lease renewal by Campbell Company of Canada in Brampton, Ontario, exemplifies the competitive nature of the market, where tenants are eager to secure their existing spaces despite tight conditions.
Expansion of E-commerce and Alternative Users:
E-commerce giants like Amazon are aggressively expanding their presence, not just in established industrial areas but also in emerging markets. Meanwhile, alternative users such as cold storage, life sciences, and data centers are incrementally driving leasing demand.
Lease Term Trends:
The majority of industrial leases are direct, with an average term of five years. However, the current scarcity of space has led to a growing preference for shorter lease terms, reflecting a desire for flexibility or a strategic maneuver to navigate the limited availability.
Strategic Adaptation in Leasing:
In conclusion, the Canadian industrial real estate market’s leasing strategies are evolving in response to the unprecedented scarcity of available space. High demand continues to shape the market, compelling tenants and landlords to adopt a more agile and strategic approach. Looking forward, the capacity to swiftly adapt to these conditions will be essential for securing industrial space in this competitive environment.
Construction Trends: Balancing Supply with Soaring Demand
Construction Activity and Market Response:
The Canadian industrial sector has long faced the challenge of aligning new supply with the surging demand. Recently, there has been a significant uptick in construction activity, with approximately 60 million square feet of new space currently in development across the nation. The concentration of this increase in land-constrained markets like Vancouver signals a positive development. However, this new supply only represents about 3% of the current inventory, which, while substantial in absolute terms, is relatively modest, especially in critical distribution markets such as the Greater Toronto Area (GTA), where the new supply is even more limited.
Geographic and Regulatory Constraints:
Land supply has been a pressing issue in Vancouver for years and is now becoming increasingly problematic in the GTA. This is due to both physical geographic limitations and regulatory land use constraints, which together exacerbate the cost and extend the timeline for new developments. In contrast, markets like Calgary and Edmonton face fewer barriers, with a more abundant supply of developable land, allowing for a steadier delivery of new industrial products despite higher vacancy rates. The cost differential in Alberta, compared to Vancouver, is also a significant reason why Calgary and Edmonton are becoming key distribution hubs for Western Canada.
Developer Creativity and Market Expansion:
Industrial developers, particularly in the GTA and Vancouver, are compelled to be innovative due to fundamental supply constraints that show no signs of abating. This creativity is not only leading to the exploration of new markets outside major urban centers, such as the Greater Golden Horseshoe or Abbotsford/Chilliwack but also to the development of denser industrial products on smaller land parcels.
Economics of Higher Density Developments:
For high-density or multi-story industrial developments to be financially viable, rental rates need to be sufficiently high. Currently, most Canadian markets, with the exception of a few on the west coast, have yet to reach the rental rates necessary to support such projects. However, if the tight market conditions persist, these types of developments could become more feasible and economically attractive.
Forecasting Industrial Vacancy Rates:
Our projections, based on current demand and supply fundamentals, indicate that industrial vacancy rates will continue to compress, potentially hovering near 2% for the foreseeable future. This bullish outlook suggests that landlord-favorable market conditions could prevail indefinitely. Nonetheless, new supply could increase beyond our current expectations if there are policy changes related to development or if the expansion into new locations materializes.
In summary, the construction sector within Canadian industrial real estate is at a pivotal juncture. Developers are navigating a complex landscape of geographic and regulatory constraints, which necessitates innovative approaches to new developments. The potential for high-density industrial projects is on the horizon, contingent upon the continuation of current market conditions and the evolution of rental rates. As the market moves forward, the balance between demand and supply will be critical in shaping the future of industrial real estate in Canada.
Sales Momentum: Industrial Real Estate as the Investment Darling
Investment Climate and Transaction Volumes:
The Canadian industrial sector has solidified its position as the most sought-after asset class in the property market. In 2022, the transaction volumes for industrial properties nearly hit $13 billion, a figure that comfortably surpasses long-term averages. Despite recent economic uncertainties and tightening capital market conditions, experts expect the industrial 
asset class to maintain its superior performance. Investors’ sustained interest is likely to keep sales of industrial properties robust, with early indicators revealing a strong relative appetite for sector investment.
Dominance in Property Transactions:
The first quarter of 2023 has already seen industrial property sales reach $7 billion, confirming the sector’s dominance in the property transaction space. This figure includes a significant entity-level transaction where Dream Industrial REIT, in a strategic partnership with GIC Real Estate, acquired Summit Industrial Income REIT for $6 billion. This acquisition is a clear indicator of the confidence investors have in the Canadian industrial market, highlighting the sector’s strategic importance and its potential for growth and capital appreciation.
Pricing Trends and Regional Highlights:
The demand for industrial properties, coupled with a shortage of available products, has kept prices at elevated levels across Canada. As of Q2 2023, the average sale price per square foot stands at $293. Some of the most expensive transactions have been land value sales, particularly in high-demand regions like Vancouver, where a warehouse in Richmond sold for an impressive $599 per square foot.
Cap Rate Compression and Investment Outlook:
Cap rates for industrial properties have seen significant compression, especially for top-tier assets. Even after the recent rise in interest rates, prime industrial cap rates in markets like Toronto and Vancouver remain below 4%. These low cap rates reflect not only the expectation of strong rental growth but also, in specific locations, the potential for redevelopment.
Investor Sentiment and Economic Considerations:
With industrial cap rate spreads to interest rates narrowing more than other property types, such as office and retail, some investors are beginning to question the rationality of current industrial pricing and whether an adjustment is due. However, others remain optimistic about the sector’s future rental growth prospects and are willing to navigate through the current economic uncertainty before making further acquisitions.
Future Prospects and Market Confidence:
The fundamental strength of the industrial sector continues to support investor interest, even as the future of investment demand amid rising interest rates remains uncertain. Expectations hold that the industrial asset class will continue to attract investors, presenting opportunities for further growth and investment. In essence, considerable momentum remains in the industrial real estate market, indicating its continued preference as an investment choice in the foreseeable future.
The sales activity within the Canadian industrial real estate market reflects a strong confidence in the sector’s fundamentals. Despite external economic pressures, the industrial asset class remains a top performer, with high transaction volumes and sustained pricing levels. The strategic acquisitions and the continued interest from investors underscore the sector’s resilience and potential for growth, reinforcing its status as a favored investment destination.
Closing Remarks
In the Canadian industrial real estate market, leasing dynamics are currently defined by high demand and scarce availability, with robust interest from sectors like logistics and e-commerce driving leasing activity to near-record levels despite a historic low in available space. On the construction front, there’s a surge in activity, with approximately 60 million square feet of new space underway, signaling a positive response to the pressing demand. However, geographic and regulatory constraints continue to challenge the pace of new development. Sales momentum remains strong, with industrial properties commanding premium prices and low cap rates reflecting investor confidence in the sector’s fundamentals. The industrial asset class, with its resilience and potential for growth, continues to outshine other property types, maintaining its position as a top-tier investment destination. This trifecta of leasing, construction, and sales trends underscores a market with a robust appetite poised for sustained activity and investor interest well into the future.
Note: This blog post is based on the Industrial Canada National Report from August 2023, credited to CoStar, and aims to provide information only.