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Sunday, August 26, 2018

GTA industrial prices will remain strong

By Richard Chilcott and Jonathan Yuan (Toronto)

How hot can it get?

Through the 1990s and early 2000s, the Greater Toronto Area (GTA) industrial market was balancing supply with demand. Following a robust market performance throughout the past few years, rents and property values kicked into overdrive during the first half of 2018. The GTA’s industrial leasing market has experienced record demand, leading to historic-low vacancy and, percentage-wise, double-digit rental-rate growth. Strong market fundamentals and the prospect of further rental-rate growth have driven up demand from all investor types (institutional, private, condo developers and users), leading to further compression in industrial cap rates and new highs in land value.
Inventory in the GTA industrial market stands at approximately 874 million square feet, including all classes of space. This number represents just shy of half the industrial space in all major markets in Canada combined.  The GTA is the fourth-largest industrial market in North America, behind only Chicago, Los Angeles and Philadelphia. Through the last two decades, regional industrial investors and tenants have experienced near-flat returns in terms of rental-rate growth as a result of product demand being in equilibrium with supply.

GTA industrial stock currently boasts a 1.6% vacancy rate. Together, regional population growth, shifting distribution and retail trends have created extremely strong demand for small-, mid- and large-bay warehouse/distribution-centre space. At the same time, supply of new product has been constrained by restricted availability of developable land, higher development charges and, until recently, a lack of economic rents capable of encouraging development of anything other than distribution centres.

The Greenbelt surrounding most of the GTA and the competing economic powerhouse of residential development have created a scarcity of developable land near large population centres. Industrial land in prime locations has achieved prices above $1.9 million per acre, while a significant market-rent increase throughout the region has not yet provided enough of a driver to counteract land and construction costs for mid- and small-bay product. Retail shopping trends are attracting more and more buyers online with a knock-on demand for warehouse space and last-mile distribution locations a short drive from consumers in urban areas. Larger distribution-centre product has been leasing well with rental rates pushed high enough for developers and institutional investors to add a steady supply of new product. Municipalities across the region continue to increase development charges well above the inflation rate. As a result of increasing construction and land costs, we will need to see even more rental-rate growth to encourage developers to satisfy demand across the sector.

When it comes to investment in industrial properties, rapid rental-rate growth is driving investor valuations, pricing in future market rents today.

Owner-users continue to play a significant role in higher-price-per-square-foot transactions. This group can rationalize its pricing metrics by comparing the gross leasing cost of occupancy with the cost of ownership and the ability to build personal wealth over time through capital acquisitions. It remains to be seen whether recent debt-cost increases will affect owner-users. Users seeking to buy smaller units have turned to the burgeoning industrial-condo market, where vendors are, in some cases, requesting prices near $400 per square foot. Will Vancouver-type pricing be seen in the GTA next? And, will we see more efficient use of land with multi-storey industrial units in this market following their emergence elsewhere in recent years?

Given the region’s population growth, and the physical and political constraints restricting new supply, we forecast that the upward pricing trend of the past few years will continue for some time to come.

(Richard Chilcott, a Principal of Avison Young, and Jonathan Yuan, a Vice President, are based in the company’s Toronto office. Both specialize in investment property brokerage and are members of the company’s Canadian capital markets group.)

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