Industrial demand tightens and employers plan return to office

Key highlights

While 2021 reported an uptick in activity as compared to 2020, there was a tone of cautious optimism in the commercial real estate space throughout the year. However, with restrictions being lifted in the first quarter of 2022, as well as activity levels being elevated, the year has begun with a note of excitement in the industry.

Nationally, investment volume in 2021 totaled just over $80 billion dollars, an 83% rise from the previous year (Figure 1). Transaction counts increased amongst all asset classes, registering a 58% increase from 2020 further attesting to the resiliency of the industry.

Vancouver reported a total investment volume of nearly $16 billion, a 75% increase from 2020. Edmonton registered $2.5 billion in investments, a 6% increase over 2020 totals. Meanwhile, Montreal noted an investment volume of $11.3 billion, a 57% increase from the previous year.

This is a record investment volume for the Montreal area since 2016, and the first time that the Greater Montreal Area has reported an increase in the double digits. The land sectors (ICI and Residential) performed well throughout 2021 outperforming all other asset classes, composing 39% of all transactions conducted, and 41% of total investment volume.

The industrial sector also continued to do well throughout 2021, reporting an investment volume of $16.9 billion, representing 21% of total investments for the year. The multi-family asset class also garnered investor interest, accounting for 18% of all transactions conducted, and 17% of total volume, with an investment volume of approximately $13.9 billion.

According to Altus Group’s Investment Trends Survey (ITS) for Q1 2022, Industrial assets make up three of the top five preferred products (Figure 2). This follows the same trend seen in 2020 and 2021 and is a result of the shift towards e-commerce heightened by the pandemic, as well as the demand for logistics and fulfilment space elevated by ongoing supply chain issues, especially within the last year.

Vancouver and Montreal have retained the second and third spots as most preferred markets by investors, with Edmonton taking the second last spot, just before Calgary with all three markets noting an upswing in their momentum ratio.

Overall capitalization rates have remained steady as compared to the previous quarter in all four benchmark asset classes, a trend that should continue through 2022. However, cap rates will remain dropping for core assets as these are experiencing strong demand.

Figure 1 - Year-over-year transaction volume (2020 vs. 2021)

Figure 2 - Property type barometer – All available products (Q1 2022)

With restrictions lifting, the labor market was quick to bounce back, after a plunge in employment levels. According to Statistics Canada, employment levels climbed by approximately 73,000 in March 2022, plunging the unemployment rate to 5.3%, the lowest rate on record since 1976.

Employment gains in March were led by the retail trade, construction, health care and social assistance, as well as information, culture, and recreation industries. This coincides with the loosening of restrictions, lifting of the proof of vaccination requirements, and capacity limits being lowered.

Staff previously laid off due to closures of restaurants, retail, and recreation spaces were able to return to work, more than offsetting the losses seen in January 2022 when tighter restrictions were imposed. The labor market when looking at the construction sector will continue to remain especially tight.

Meanwhile, supply chain shortages, and high commodity pricing exacerbated by the current geopolitical climate are expected to persist. When looking at Alberta, Ontario, and Quebec specifically, and comparing employment rates to the same time last year, employment rates have increased by 4.9% in Montreal, 0.9% in Edmonton, and 1.2% in Vancouver as of March 2022.

This growth has been catalyzed by the easing of restrictions, and lowered capacity limits as employers are accelerating their return to office plans. Tight labor market conditions, and low unemployment rates can be expected to remain throughout the year but may face volatility as the impacts of the sixth wave of the Covid-19 virus become more apparent.

Office tenants continue to reimagine space as needs evolve and availability rates remain sensitive

Office availability has been rising since early 2020, and this trend has continued into the first quarter of 2022, with the national availability rate sitting at 16%, the same as Q4 2021, but a jump from the 15.1% recorded in Q1 2021 (Figure 3).

The Vancouver market had the second lowest availability across all major markets, sitting at 9.6%, a drop from the 10% seen at the same time last year. Meanwhile, overall office availability has gone up in both the Montreal and Edmonton markets, with the Edmonton market having the second highest office availability and the Montreal market having the third highest.

In Montreal it has gone up from 14.5% in Q1 2021 to 16.9% in Q1 2022, whereas in Edmonton the rate rose from 19% in Q1 2021 to 19.8% for the same period this year. Office sublet availability fell in both the Vancouver and Edmonton markets when comparing the first quarter of 2021 to the same period this year, however, a slight uptick was seen in Montreal.

With sublet rates dropping in Vancouver, and the overall office availability being one of the lowest in the country, the revitalization of the office market is quickly emerging, and can be expected to pick up as 2022 progresses.

Meanwhile, in Edmonton, while the overall availability rate remains high, the sublet availability rate reporting a slight downturn is a positive indicator for the market. The Edmonton office market has been subject to quite a bit of volatility, with the oil price crash followed by the pandemic. Thus, while overall availability rates remain high, they have been mostly steady (within a percentage) over the last year implying that despite the many hurdles the market has experienced, it is staying resilient.

This trend is expected to continue throughout the year. The Montreal market has experienced a slight rise in both the sublet and overall office availability rates. However, despite this, tenants are not dumping their real estate.

Instead, they are accommodating to their employee needs by either renting bigger spaces, or promoting the hybrid model, and creating smaller offices in proximity to their employee residences. The focus on redesigning the office space to promote collaboration and rebranding of office spaces is expected to remain a priority throughout 2022.

With the pandemic triggering a reimagination of the traditional office model that we knew, new trends that have emerged are likely here to stay. After weathering multiple lockdowns, employers have slowly begun to plan their return to the office.

While the hybrid work model combining in person and going into the office is here to stay, the use of the office space has shifted. In general, instead of being used as a space for all things work related, the office is now a space that employees turn to in order to collaborate, and share ideas, with employees managing individual projects from home.

Employers will focus on having higher average square footage per employee, as well as upgraded ventilation systems and amenities. This will serve not just to accommodate physical distancing and safety needs, but also work to boost productivity and curate the office space to align with the new hybrid office model.

Figure 3 - Office availability rates (Q1 2021 vs. Q1 2022)

Industrial assets remain an investor favorite, with availabilities continuing to tighten

The shift towards e-commerce, plus the ongoing supply chain bottlenecks have ensured that the demand in the industrial sector has remained strong. With the national availability rate tightening from 2.9% in the first quarter of 2021 to 2.2% in Q1 2022, some of the largest cities continue to have the tightest availabilities.

Overall Capitalization Rates for the asset class have trended downwards for the past year, reporting a slight uptick in Q1 2022. Vancouver has the tightest availability across the nation, sitting at 0.9% as of Q1 2022, dropping from the 1.6% seen at the same time last year. The availability rate in Edmonton, the highest across the country, has also dropped, registering at 5.6%, as compared to 7.7% seen Q1 2021, while the Montreal availability rate has remained steady at 3.2% (Figure 4).

With industrial asset availabilities tightening, new supply on the market is also quickly being absorbed. This is especially noticeable in Vancouver, where the first quarter of 2022 saw 250,000 square feet of industrial completions, with 0% availability.

Demand outpacing supply in Vancouver has also led to an upward pressure on rents, with industrial product trading at a premium. This can be attributed to the topography seen in Vancouver. With the ocean on one side and the mountains on the other, there is not much space to build industrial product which can accommodate the constantly growing demand. Pressing demand has led to innovation when it comes to industrial product in Vancouver.

Trends such as stacking, and industrial usage mixed with asset types are becoming increasingly common in the city. However, the price to build such product is also higher, further contributing to the rising rents for industrial assets. The first quarter of 2022 has seen a continuation of this trend. With absorption remaining rapid, and supply being outpaced by demand, these trends are expected to remain throughout the year.

With Edmonton having the highest availability rate in the country, their industrial market added 70,000 square feet of industrial space with 100% availability rate as of Q1 2022. However, when looking at the just over 4 million square feet of under construction industrial space, an availability rate of almost 27% was noted.

This implies that the industrial space in Edmonton is also being absorbed, though it may not be as rapid as Vancouver. This is because when looking at Edmonton’s topography, it is far flatter than Vancouver’s, implying that there is more space to build product to keep up with the demand.

Combining its dropping availability rate, along with the absorption in the under-construction projects for Q1 2022, it can be deduced that while demand is tightening, supply is keeping pace keeping the market steady, and it is expected that it will remain this way throughout 2022, especially as investors spill over from white hot markets such as Vancouver into Edmonton, allowing demand to stay steady, if not slightly higher.

Montreal, also noting a drop in industrial availability, has added just over 1.3 million square feet of completed area to its industrial market, with a 9.5% availability rate in Q1 2022. A lot of this new square footage is in the area surrounding the Greater Montreal Area.

With the suburban areas ripe for redevelopment, developers are looking at seven preapproved zones of interest to build new product. While new supply is coming into the market, it is being quickly absorbed, as reflected by the availability rates, and an upward pressure of rents is also seen. These trends are expected to remain the same throughout 2022, especially as inventory remains limited with demand continuing to outpace supply.

In general, as rents continue to trend upward (as reflected in Table 1), and availabilities continue to remain tight, the strong demand for all industrial assets (industrial land, single-tenant, and multi-tenant) is expected to persist.

This is owing to their nature as an essential asset, especially at a time where e-commerce is booming, and global supply chain issues are ongoing. Assets with high redevelopment potential will trade at a premium. Moving forward in the industrial market, additional trends to watch include the rise of multi-story facilities as well as preference for assets with technological capabilities maximizing the efficiency of the asset.

Figure 4 - Industrial availability rates (Q1 2021 vs. Q1 2022)

The following are some of the notable industrial transactions conducted between Q1 2021 and Q2 2022. These transactions reflect the rising prices of industrial assets, along with the preference projects located slightly away from the city center. The biggest transaction from each region (Vancouver, Edmonton, and Montreal) is highlighted below.

Located in Burnaby, 5140 North Fraser Way was purchased by a private investor for $35 million from Coanda R&D in January 2022. The building includes approximately 24,000 square feet on one floor, and will serve as a two-storey, multi-tenanted industrial building, occupying a total of 75,251 square feet. It reflects a price per square foot of $465.

J. Diamond Properties Limited purchased a multi-tenant warehouse and distribution space in Edmonton in February 2022. This 93,000 square feet property was purchased for $18.75 million from The Plains Group and reflects a price per square foot of $455. The property is zoned for medium industrial use, and includes two, one storey single tenant industrial buildings.

Summit Industrial Income REIT purchased a three storey, multi-tenant warehouse and distribution industrial property from Canpro Investments in April 2021. The property asks for a price per square foot of $240, and measures 765,145 square feet. It is located in Point Claire and acts as head office distribution center to Aldo Group, as well as a home to SSENSE.

Figure 5 - Featured industrial transactions (Q1 2021 - Q1 2022)

Conclusion

Although 2021 was riddled with setbacks for the commercial real estate industry, the industry depicted resiliency with activity in early 2022 reflecting signs of optimism and excitement going forward.

The office market continues to remain sensitive as employers reimagine the office model and focus on accommodating their employees’ shifting needs. Conversations around office space reduction may still continue, however, as opposed to dumping their office space, employers will seek to use it to promote collaboration, productivity, and talent retention.

Industrial demand is expected to remain high owing to the ongoing supply chain issues, shift towards e-commerce, and the redevelopment potential the asset class offers. Having spent a year adapting to many setbacks, the commercial real estate industry has emerged as a strong space ready for continued growth and value creation in 2022.