Excerpts from BMO ReportCanadian Industrial CRE: Focusing On The Next Growth Markets
Canadian Industrial CRE: Focusing On The Next Growth Markets
During the pandemic, the strong performance of the Canadian industrial CRE sector has been underpinned by multiple structural drivers – e-commerce, supply chain strategies, and a change in customer preferences. We expect these drivers will persist post pandemic. As Tier I markets continue to tighten and effectively run out of space, investors and landlords have begun to focus on new markets. We believe that the basis of this focus is on population growth and migration patterns (the demand driver least discussed in our view), which is expected to set the narrative in the search for the next industrial growth markets.
Why This Report?
We have often been questioned on the strength of the growth runway for the Canadian industrial REITs in our coverage, and there continues to be areas of concern surrounding the sustainability of it among the investor base. Based on our analysis and feedback from the CRE broker community, we note that the industrial REITs in our coverage are actively looking to capture the existing growth runway and focus on their portfolio growth in a strategic manner. We have identified the next growth markets, which we believe, will set the narrative for the Canadian industrial CRE sector and will allow the industrial REITs in our coverage to allay investor concerns.
Proprietary Takeaways
Running Out Of Space: Record low availability rates, minimal supply growth, and increasing rental rates across Tier I markets have led tenants to look for alternative markets.
Populating The Supply Chain: Given the importance of Tier I industrial markets in the supply chain, industrial developers and investors are beginning to track population growth in the next industrial markets and are positioning their portfolios to gain a first-movers advantage.
Increased Focus On New Markets: Landlords, tenants and investors are focused on the next growth industrial markets – Brantford, Hamilton, Kitchener Waterloo Cambridge (Ontario), Montreal (Quebec) and Calgary (Alberta) – amid tightening supply pipelines in Tier I markets.
Companies Impacted
We see Nexus REIT (Restricted) and Summit Industrial Income REIT (See our note) as leaders of the pack within Canada, which have begun to deploy capital and are constantly circling new industrial markets.
As most industrial markets continue to get tighter, the focus is beginning to shift towards the next industrial growth markets. Based on our conversations with CRE brokers, there has been a notable increase in focus among industrial landlords on newer industrial markets outside of the current red-hot major markets, as rents increase, availability rates tighten, and the population continues to grow. According to CBRE, for all intents and purposes, Tier I markets such as Toronto and Vancouver, and to an extent, Montreal, have run out of space, leaving occupiers with no near term solutions.
While Tier I industrial markets such as Toronto and Vancouver are expected to further grow in population size, these markets continue to witness all-time high rents, unaffordable industrial land pricing, and a lack of industrial assets. Given the importance of Tier I industrial markets in the supply chain, industrial developers and investors are beginning to track population growth in the next tier industrial markets.
Summit REIT (SMU.UN-TSX, Outperform, Target Price: $25)
Summit is an internally managed REIT focused entirely on the industrial markets in Toronto, Montreal, and Alberta. Specifically, Summit is primarily focused on the light industrial sector — usually one- or two stories properties located in or near major cities. These properties generally support activities such as warehousing and storage, light assembly and shipping, call centres and technical support, as well as professional services and generally do not contain more than 3-5% of office space. In terms of Summit’s total portfolio at the end of Q3/21, the Ontario market accounted for 51.1% of the REIT’s total GLA and Quebec accounted for 22.8% of total GLA.
In April 2021, Summit acquired a modern 765K sf logistics and office complex in Montreal which further enhanced its presence in this market. Summit’s management remains bullish on the Montreal market and expect further capital inflows (acquisition of IPPs as well as development opportunities) into the market.
In October, SMU.UN also completed the acquisition of two newly constructed Class A logistics centres totalling 725K sf in Calgary, AB, for $126M (stabilized cap rate of 4.3%). As Calgary and Edmonton industrial markets have strengthened significantly over the past several quarters with improved occupancies and near-record absorptions, management also expect to selectively consider further growth opportunities in Alberta.
SMU.UN is currently trading at a 16.3% premium to our NAV estimate. The significant fair value gain in Q3/21 driven by ongoing cap rate compression across its core markets was encouraging and further demonstrated the strength of the REIT’s portfolio. With the improvement in the Alberta market and ongoing tightening in the red-hot Ontario and Quebec markets, we expect the strong leasing momentum will continue across the REIT’s portfolio. In light of rising bidding wars on the acquisition front, we believe the REIT’s development and intensification pipeline will continue to drive long-term NAV growth.