October 6, 2022
Canadian REITs & REOCs
Rise in office vacancy pauses, while industrial hits record low
Our view: Overall, we see CBRE’s Q3/22 Canadian market updates as supportive of our positive outlook on industrial fundamentals and neutral to our view on office. National industrial availability hit a new low of 1.5%, while net rents continued their ascent to new highs. Set against slowing economic traction and decelerating e-commerce growth, demand from manufacturing, distribution, and businesses building supply chain resiliency is providing a strong offset. With both Dream Industrial (DIR.UN) and Granite (GRT.UN) trading at high-5% to low-6% implied cap rates, we see valuations as attractive. In office, the slight downtick in national vacancy marked the first quarter of improvement since the start of the pandemic, aided by a high level of pre-leasing on new supply completions. As well, a pick-up in the return to office should support stronger leasing ahead. However, we believe vacancy will likely resume an upward trend in the coming quarters, particularly as tenants leave backfill space behind as they relocate to recently completed buildings. Given its track record of operating outperformance, healthy growth profile, and discounted valuation, Allied Properties (AP.UN) remains our preferred office pick.
Industrial: Availability at record low, driving another quarter of solid rent growth
Per CBRE, Q3/22 national availability hit a low of 1.5% (-10 bps QoQ, -50 bps YoY), while average net rents rose to a record $12.89/sf (+5% QoQ, +29% YoY). As summarized in Exhibit 1, availability in Vancouver (0.8%), Toronto (0.9%), and Montreal (1.2%) remain the lowest among major markets, while Calgary posted the largest sequential decline. In contrast, Ottawa experienced the largest increase. With limited availability, it’s not surprising that Montreal, Vancouver, and Toronto continue to put up the strongest rent growth of +11%, +9%, and +6% QoQ. New supply under construction declined to 43MM sf nationally (2% of inventory), with 55% pre-leased. The national average sale price increased to $264/ sf (+3% QoQ, +32% YoY), including Vancouver at $680/sf, Toronto at $383/sf, and Montreal at $235/sf.
Office: Vacancy edges lower on downtick in suburbs, while downtown holds steady
Per CBRE, national office vacancy ended Q3/22 at 16.4% (-10 bps QoQ, +70 bps YoY). Positive net absorption was mainly attributable to high levels of pre-leased new supply completed in the quarter. Suburban vacancy decreased to 15.9% (-10 bps QoQ), aided by the appeal of shorter commute times. Downtown markets were stable at 16.9% (flat QoQ), with rising demand from engineering and financial services in select markets, partly offset by downsizing and slow returns to office as employers re- evaluate workplace strategies. The flight to quality in downtown markets remains on display, with Class B vacancy (21.4%) 710 bps above Class A (14.3%), a spread that has expanded from 520 bps at Q4/20. Of the 10 markets tracked by CBRE, half posted positive net absorption, with the strongest gains in Toronto.
Asking rents stable sequentially, while pipeline of new supply drops. National average asking Class A net rents ($22.17/sf) were relatively flat with last quarter (+5% YoY; likely due to new supply at higher rents), as a drop in suburban rents was largely offset by higher downtown rents (net effective rents are not available, but are likely under pressure in our view). Recent completions drove new supply under construction down 16% QoQ to 12.7MM sf (2.6% of inventory, -50 bps QoQ), of which 54% is pre-leased. Sublease space as a percentage of inventory was stable at 3% (flat QoQ) and still above the LTA (1.8%).
Among major downtown markets, Montreal vacancy increased the most sequentially, rising to 16.1% (+80 bps QoQ). Downtown Toronto vacancy declined to 11.8% (-10 bps QoQ). National average asking downtown Class A net rents edged up to $25.30/sf (+1% QoQ), with the largest gain in Calgary (+8%).