CIBC Notes EQUITY RESEARCH
May 27, 2024 Industry Update
Industrial REITs: Is The Shine Coming Off?
Positive Outlook Despite Some Headwinds
Our Conclusion
Industrial REITs’ valuation has compressed, reflecting not only macro
headwinds in the form of higher rates, but also a broad normalization in
fundamentals. Negative supply and absorption headlines have had a far
greater impact on sentiment than what we view as reasonable. Factoring in
lower rents, our stress test suggests that the same-property growth outlook
for industrial would still be better than most sub-sectors. We believe large-
cap industrial REITs are positioned to generate ~3x-or-better SPNOI growth
than retail for instance, yet trade at similar valuations.
Key Points
Absorption Trends: Recent moderation in absorption is more than just a
normalization from peak demand in 2021-2022, and is below historical
norms. For instance, absorption in Toronto over the last four quarters was
~0.3MM sq. ft. while the market has typically absorbed ~10MM sq. ft.
annually. An influx of supply at the same time as demand is normalizing
explains this dynamic. National availability is also ~100bps higher including
the impact of unleased supply. In the U.S., while there is significant regional
variance, absorption in Q1/24 was 35MM sq. ft., well below the 10-year
average of 91MM sq. ft.
Months Of Supply Scenarios: We estimate ~40 months of supply for
Toronto and Montreal using normalized absorption and ~50 months
nationally. Combining vacancy and new supply, months of supply in Toronto
increases to ~1,500. At recent absorption rates, we estimate ~92 months of
supply in the U.S., well above the 62 months estimated using normalized
absorption. The combination of declining absorption and growing supply is
unprecedented and while our analysis is more illustrative than scientific,
suffice it to say that headwinds from growing vacancy will likely persist for a
long period of time.
Rents Have Room To Fall But Cushion Is Large: There is a weak
correlation between rent growth and months of supply; however, a much
stronger -0.9 correlation exists between the former and vacancy. Looking to
the most pronounced period of softness, the GFC (albeit the weakness was
not supply-driven), vacancy in Canada increased by ~260bps, and rents
declined 8%. We estimate at unchanged occupancy and 10% lower ON
market rents (plus lower spreads in other regions), 2025 SPNOI for DIR and
GRT would be negatively impacted by ~100bps and be in the range of 5%-
8%.
Performance And Valuation: Industrial REITs are trading 23% below NAV,
which is in line with the sector at 22%. YTD the sub-sector has lagged the
XRE by ~250bps. Implications For DIR And GRT
Vacancy has increased marginally for both REITs, while leasing spreads are thus far intact.
At current spreads across all markets, we estimate 2025 SPNOI in the range of ~6%–9%
(table, Exhibit 9). Focusing on Ontario and assuming $16.50/sq. ft. for market rent, the
implied mark-to-market (MTM) for Dream and Granite’s 2025 leases is ~120% and ~100%,
respectively. At flat occupancy, and reducing ON market rent by 10% (plus lowering MTM for
other regions), 2025 SPNOI would be negatively impacted by ~100bps, but still be in the mid-
to-high single digit range.