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Relentless demand for Canada’s warehousing and distribution warehouses is pushing that segment of the real estate market into a new echelon, with industrial real estate in and around cities like Toronto and Montreal boasting some of the fastest rising prices in the world.
The warehouse space market is so strong that nationwide vacancy rates have fallen to an all-time low of 1.6 percent, according to commercial real estate services and investment firm CBRE Group Inc. Supply is so tight that some landlords have managed to raise rents more than 100 percent in churn and lease renewals.
The returns have attracted some of the world’s most sophisticated real estate players. In June, Prologis Inc. PLD-N, a huge industrial real estate owner in San Francisco, lands in the Greater Toronto Area to develop a new warehouse. The $500 million purchase price was nearly $2.5 million per acre, more than double the going rate five years ago.
However, there are fears that this may not last much longer. Major retailers have warned that the e-commerce boom has reached its limit, and this spring Amazon terrified investors by announcing plans to sublet some of its warehouse space. At the same time, interest rates have risen sharply, making commercial mortgages more expensive, and incessant inflation has dramatically increased development costs.
So far, though, industrial properties here have defied fears of an industry-wide cooldown, and markets in four Canadian cities are the tightest in North America. “The party isn’t over yet,” said Paul Morassutti, vice president of CBRE Canada. “It may not be as intense as it was, but it’s certainly not over.”
In mid-August, Summit Industrial Income REIT, which owns only Canadian warehouses, reported quarterly results and announced that the average rent increase this year on lease renewal or tenant revenue was 46 percent.
Summit also reported that the industry-wide national average rent rose to an all-time high of $12.25 per square foot. Five years ago it was less than $7.
Demand for warehouses took off around 2016 as e-commerce picked up steam, then skyrocketed due to the pandemic as consumers relied heavily on online shopping. While e-commerce growth has slowed of late as lockdown restrictions have been lifted, overall online sales are still rising, just at a slower pace.
CBRE estimates that for every billion dollars of e-commerce sales in Canada, approximately 1.25 million square feet of warehouse inventory is needed. That means an additional 90 million square feet of space could be needed over the next five years. Canada currently has 1.9 billion square feet of industrial space.
The need could be even greater as just-in-time inventory systems become more prevalent, with companies increasingly turning to onshore sourcing to mitigate the supply chain problems that have plagued them for the past 2½ years.
High transportation costs have also increased the value of industrial real estate, which Morassutti says is undervalued. Typically, logistics and transportation costs account for 70 percent of supply chain spending, while real estate accounts for only 5 percent of the burden. That means that for every dollar saved on logistics, for example by having warehouses closer to customers, a company could theoretically pay 14 times more in rent.
This month, Summit announced that it recently re-rented a one-story warehouse in Markham, Ontario, northeast of Toronto after just a month of shutdown, and increased its monthly rent by 42 percent. At another property in the GTA, the REIT again leased the space with no downtime — and a 117 percent rent increase.
Shares of Summit, which trade on the Toronto Stock Exchange, are up 223 percent in the past five years, including distributions. Rivals Granite REIT and Dream Industrial REIT, which own a mix of Canadian and international properties, gained 98 and 86 percent, respectively. The equivalent return for the S&P/TSX Composite Index is 57 percent.
As residential real estate has cooled so quickly in Canada in the past six months and commercial sectors such as office buildings are also struggling, there are fears that warehouses will also be affected. The main concern is that, with the pace of construction at an all-time high, the market will eventually be flooded with industrial real estate.
But even after all the properties currently under construction are completed, the total available square footage will increase by just 2.3 percent, according to CBRE.
As for the fear of Amazon scaling back in the US, which sent a chill throughout the industry, it just hasn’t materialized. “What’s interesting is that we’ve been watching the market pretty closely to see what Amazon is doing,” Granite REIT CEO Kevan Gorrie said during a conference call with analysts and investors this month, “and there are close to zero so far, it’s negligible, the number of assets Amazon actually wants to sublet.”
Because the industrial market has been so hot, it is widely believed that there will be some softening, especially in other countries. “There are some US markets that don’t have many land restrictions or development restrictions, and those markets are finding rents stabilizing much faster,” Brian Pauls, CEO of Dream Industrial, told analysts and investors during the company’s quarterly conference call. company.
“But certainly in the GTA and in Montreal we see that rents continue to rise,” he said.
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