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The industrial real estate sector’s 2019 rate of total return far outpaced any other on the MSCI/REALPAC Canada Annual Property Index, and it’s looking good in 2020 – largely due to the continuing impact of e-commerce.

Teresa Neto, chief financial officer for Toronto-headquartered Granite REIT (GRT-UN-T), was part of a recent wide-ranging panel discussion at the Toronto Region Board of Trade after the index results were released.

She said online sales accounted for just 4.4 per cent of total Canadian retail sales in November of 2019. That compares to 11.2 per cent in the United States in Q3 2019 and 15 to 20 per cent of retail sales in some European and Asian countries.

“We still have a tremendous amount of runway in Canada on e-commerce.

“That’s going to continue to drive logistics, e-commerce and warehousing, not to mention the population growth we’re experiencing in our major cities in Canada. We’re bringing in 320,000 to 340,000 immigrants every year.”

Industrial rents exploded in 2019

Christina Iacoucci, managing director and portfolio manager for BentallGreenOak, said industrial rents “just exploded” in 2019.

For example, Neto said Toronto experienced 20 per cent growth in industrial rents. That helped widen the total return spread between industrial and residential, the second-best performing sector on the index.

“On the residential side, rents have grown as well, but there’s going to be a cap on what people can pay for rent versus home ownership,” said Iacoucci. “The other thing that’s slowing down on the residential side is that there’s a lot of demand, pressure and movement on new build.

“Construction costs have gone through the roof and really slowed down the development of new purpose-built rentals.”

Neto pointed out rent represents just five per cent of costs for logistics companies, while transportation accounts for 30 to 40 per cent.

By reducing transportation costs two per cent, she said tenants can accommodate large rent increases without suffering too much.

Industrial development is a challenge

While there’s plenty of desire for more industrial development, and Neto said e-commerce is driving 30 to 40 per cent of it, it’s a challenge in Vancouver and Toronto due to a lack of available land. Rents also have to be in the $10- to $12-per-square-foot range to get a five per cent return in those cities, she added.

This has led to companies seeking infill properties to redevelop into modern industrial assets. Scarce land availability has also led Granite to do most of its recent development in the U.S. and Germany.

Neto believes cold storage for groceries and pharmaceutical products will be the next wave of e-commerce and warehousing growth.

She said food delivery leaders in the Netherlands and Germany are starting to do interesting things with artificial intelligence and she believes that will move into Canada as well.

Repositioning underperforming retail sites

Iacoucci said some underperforming retail sites could be converted to last-mile delivery light industrial properties, and they might even be able to get higher rents.

“I don’t think every site is right for residential, but there is a huge demand for last-mile delivery. It’s difficult to find sites large enough to have these distribution centres.”

CBRE executive vice-president and managing director Jon Ramscar acknowledged the repositioning of retail sites with mixed-use redevelopment in major markets.

However, he said such moves have less potential in secondary and tertiary markets, where retail is often performing worse.

The retail sector is pulling back because a lot of money previously invested there is now going to industrial, Ramscar added.

Co-working is here to stay

On the office front, Ramscar said co-working spaces are here to stay.

While WeWork was burning through cash at an unsustainable rate before a restructuring which began late last year, Ramscar said there are other companies operating in the space and CBRE is working with many them due to the demand.

Ramscar said downtown Toronto has the lowest office vacancy rate in North America and new construction is 80 per cent pre-leased. Since there aren’t a lot of available office space options, co-working sites can fill gaps and provide a valuable service.

Large fund managers are going global

Panel moderator and REALPAC chief executive officer Michael Brooks asked about the recent trend of large fund managers going global and diversifying.

Toronto-based Sun Life Financial Inc. (SLF-T) merged Bentall Kennedy, the North American real estate and property management firm it acquired in 2015, with global real estate investment firm GreenOak Real Estate last year to create BentallGreenOak.

The company now manages about $63 billion in office, industrial, retail and multiresidential assets for about 750 institutional clients.

Iacoucci said these moves were made by Sun Life in response to the desires of institutional investors.

They’re becoming more interested in real estate because it provides better returns than bonds, equities and debt, and they’re looking for further portfolio diversification.

“If you look within Canada, there are only so many locations and asset types that you want to invest in,” said Iacoucci. “We needed to have a much larger reach for our clients.

“I think a lot of companies like ourselves are seeing this as a competitive advantage to be able to deliver these global diversification plays.”

Foreign investment in Canada

Brooks said five of the top 10 biggest global real estate investors are Canadian. He asked about foreign real estate investment coming into Canada.

Ramscar said 70 per cent of the foreign investment in Canadian real estate in 2016 was Chinese and last year 70 per cent of it was German.

He noted Canada remains a safe haven for investment and is becoming a larger tech player, so the foreign appetite for Canadian real estate remains strong in Toronto and Vancouver and is growing in Montreal.

Environmental, social and governance

While pension funds and major institutional investors have been dealing with environmental, social and governance (ESG) concerns and reporting for years, public companies are now making it a bigger priority.

“In the last 12 months I’ve seen a massive shift, where our investors are demanding more and more information on ESG,” Neto said of Granite REIT, which has a $3.9-billion market cap and $4.5 billion of assets under management in North America and seven European countries.

“It’s challenging as an industrial REIT because most of our leases are very much triple-net and tenants manage most of their energy use.”

Neto said global automobile parts supply company Magna International, which is Granite’s largest tenant and represents 40 per cent of its revenue, won’t share information. However, it does produce its own ESG report.

Granite is asking tenants for ESG information, gathering as much as possible, and will report on what it has while also committing capital to its own ESG programs.

“When pension funds started reporting ESG, the industrial portfolios were left out,” said Neto.

“If we’re not ready to communicate to our investors about ESG, it’s going to be a problem for us and we’re going to limit our access to capital. That’s a bad thing for our returns.”

Source: RENX.ca