Robust yields ongoing for industrial landlords

Robust yields ongoing for industrial landlords

Q3 2022 sees continued rent growth and low availability rates
Monday, October 10, 2022
By Barbara Carss

Warehouse and logistics space continued to deliver robust yields for industrial landlords through the summer of 2022. CBRE Canada’s third quarter overview reveals a national availability rate of 1.5 per cent along with 9.6 million square feet of positive absorption, while Colliers Canada’s national market snapshot highlights the unprecedented breaching of the $20-per-square-foot threshold for average asking net rents in Vancouver and vacancy rates below 1 per cent in six of the 12 metropolitan areas surveyed.

Market analysts and asset managers express confidence that the industrial sector will be buoyant into the future despite current global economic uncertainty. Speaking during the recent Bloomberg online Canadian finance conference, Kevan Gorrie, president and chief executive officer of Granite REIT, acknowledged a slowing of the e-commerce escalation that supercharged space demands throughout the pandemic interlude, but outlined other factors that bode optimistically for market prospects.

“Just based on where market rent growth is going, we think 2023 and 2024 at least are going to be very strong years,” he said. “Although we’re seeing tenants deal with cost pressures, they’re still looking to take up modern space and really enhance it and modernize their supply chain capabilities.”

In Canada, CBRE pegs the Q3 average net asking lease rate at $12.89 per square foot (psf) across the 10 markets it surveys, up more than 29 per cent from the average in Q3 2021. Drilling down to individual markets, Montreal saw the steepest gains with a 68 per cent year-over-year increase in net asking rates, taking the average up to $14.82 psf. Vancouver, Toronto and Ottawa also commanded net lease rates above the national average, with Vancouver posting a chart-topping $20.67 psf.

Colliers Canada analysts identify the prevailing trends in markets like Calgary, where the availability rate dipped to 2.2 per cent during Q3. Landlords there have pulled back on offering leasing inducements and sitting tenants have been signing renewal agreements earlier than customary. Meanwhile, proximity to the Greater Toronto Area factors into Waterloo’s 0.5 per cent availability rate and related pressure on the region’s agricultural land, prompting forecasts that more zoning change proposals will filed in the coming months.

Supply chain dynamics alter requirements for space and market proximity

Elsewhere in southwest Ontario, Granite REIT has a 1.7-million-square-foot facility in development in Brantford, as part of a major building program that includes seven other projects set for Ohio, Tennessee and Texas. Gorrie confirmed the development program targets “certain markets that we have a lot of conviction in.” That dovetails with evolving supply chain dynamics as world events both impede just-in-time delivery and underpin a more inward perspective for governments and business.

Among the trends flowing through to industrial property demand, he cites expanding inventory footprints in the warehouse/distribution sector and a migration of manufacturing away from cheaper labour sources toward closer proximity to the markets they serve. As well, widening of the Panama Canal to accommodate supertankers has boosted the profile of the port of Houston and associated logistics routes, which are emerging to complement the port of Los Angeles’ conventional dominance.

“We’re seeing tenants like Amazon and others that are taking more space — 5 to 10 per cent more space — that they’re carrying as inventory now to basically guard against future disruptions,” Gorrie advised. “A lot of companies are building resiliency and redundancy into their supply chains, and a lot of them are shifting those transportation corridors to the east coast.”

He also reports an uptick in companies relocating from eastern to western Europe, and predicts that new incentives for electric vehicles in the U.S. will create demand for manufacturing space. As of Q2 2022, Granite REIT had recorded 15 per cent year-over-year rent growth in the United States along with nearly 10 per cent year-over-year increases in the Netherlands and Germany. It also awaits portfolio-wide lease renewals in upwards of 25 per cent of its existing holdings over the next two years.

“We feel we’re probably 20 per cent below market in terms of rents,” Gorrie submitted. “Maybe Amazon takes up less space moving forward over the next couple of years, but that has been replaced in terms of demand by other companies that continue to build out their e-commerce and their omnichannel supply chains.”

New developments reflect evolving facility operation requirements

“The supply of industrial space continues to lag behind demand regardless of a slowing economy and record levels of construction in many Canadian cities,” concurs Paul Morassutti, vice chair, valuation and advisory services, with CBRE Canada. “There is the potential for some moderation of industrial rental rates. However, a deceleration in the rate of rental growth should not be confused with a decline in rental growth.”

Currently, CBRE tallies nearly 43 million square feet of new supply in progress across the 10 markets it surveys. That’s mostly speculative development, which the firm’s analysts attribute to “continued confidence and demand” and characterize as a “healthy” pipeline that remains at less than 5 per cent of the existing inventories in most of those markets. Meanwhile, more than 71 per cent of the space scheduled to be completed this fall has already been pre-leased.

The largest shares of new supply are under construction in Toronto (more than 15 million square feet) and Vancouver (more than 10 million square feet), both of which post Q3 availability rates below 1 per cent. Together, those two markets have already seen 8.7 million square feet of positive absorption thus far this year, including the summertime completion of Amazon’s 700,000-square-foot two-storey distribution centre in Burnaby, B.C.

The latter exemplifies the new direction of development Gorrie foresees. Just as industrial tenants’ transportation costs are often multiple times greater than real estate expenditures, he notes that rent is increasingly getting packaged within larger facilities operating budgets.

“If you look back 20 years ago, you’d have a large warehouse with maybe five people driving forklifts. Today, you could have thousands of workers in there. You have fulfillment centres that are five storeys and three of those levels are robot-only,” he mused. “The amount of investment behind the door that tenants are making in these facilities is worth more than the building itself. That’s great for our sector just to see the level of investment in automation and mechanization behind these buildings.”

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