West Island Industrial Real Estate in the Current Canadian Economy - September 2019

A brief by John Burrascano, Industrial Commissioner, September 25, 2019

In the last two-to-three year period, the demand for industrial real estate buildings for sale or lease has been spectacular throughout the Greater Montréal Metropolitan area (GMA). It has been around one year that the industrial market has been in the position where there is an important lack of supply because of persistent demand for industrial product. This has caused net asking lease rates to increase. The sale price of such buildings has also increased. Montréal’s industrial market has not seen price increases of significance in almost 25-years. An existing industrial space that typically leased at $4.75 per square foot three or four years ago now rents between $6.25 to $6.50 per square foot, net. According to CBRE (Q2, 2019: 1-2), the median asking sale price for industrial buildings in the GMA is $94.18 per square foot. One year ago in Q2, 2018 this price was about $70.00 per square foot. This extremely positive pricing situation is a far cry from what the market used to command, essentially, one of no price increases in 25 to 30 years and there were plenty of political, economic, and, I state sweepingly, societal reasons keeping pricing at bay.

Certainly, today’s marked improvement in Montréal’s industrial real estate market is reflected in the West Island’s industrial space absorption rate. Prior to the massive upturn about three years ago, the West Island’s (excluding Lachine) industrial vacancy rate hovered between six to eight percent, and, by and large, above that of neighbouring Ville St-Laurent having the biggest industrial park in the Province of Québec. Over the last three-year period, however, as of Q2, 2019, the West Island’s industrial vacancy rate made great strides and dropped to 1.7% according to Colliers International (Q2, 2019), a rate that demonstrates unusually better performance than Ville St-Laurent with a rate of 2.4%. And, it was accomplished at a time when the West Island is not serviced by a Metro station nor the coming light rail transit system. This situation has pleasantly left me and my fellow economic developers awestruck.

I am not so naïve to believe that this amazingly positive situation can be maintained for a prolonged period of time. It is almost surreal. In fact, it crossed my mind many times that just as quickly as the industrial real estate market improved, the momentum could be lost. After all, historically, for decades, the Province of Québec and Montréal have had economies that lagged behind leading Canadian Provinces and cities.

In fact, just when we all thought it would be ‘’smooth sailing’’, at least for a while, boom! We are struck down by evidence suggesting the world and Canadian economies are headed toward an important slowdown. There is even talk about a looming recession.

The current anticipated economic slowdown does not come as a surprise as at the beginning of 2018, National Bank of Canada (2018) had forecasted the trend of a slowing Canadian and Québec economy to take place between 2017 and 2019, due principally to American protectionist trade policy. At that time, for the Province of Québec, the bank forecasted real GDP growth rates of 3.0% for 2017; 2.3% for 2018; and, 1.3% for 2019. That forecast appears to have become reality right now and for the same principal reason, the American trade dispute with China. Today, the Fédération des Caisses Desjardins (September, 2019: 2) concludes that the real GDP growth trend for Québec is 2.5% for 2018, 2.5%(f) for 2019; and, 1.5%(f) for 2020.

At this juncture, we cannot read into the ‘’crystal ball’’ enough to say with certainty that we are headed toward significant economic upheaval, especially because there are still some important positive indicators showing signs of vitality. The big picture, however, tells the story of a slowing global economy caused by international trade tensions, particularly between China and the USA. And, according to Desjardins’ Economic & Financial Outlook report of August 19 of the present year (page1), a usually strong German economy produced a drop in GDP in the second quarter of 2019 mainly due to global trade issues, and Britain’s GDP contracted in the Spring of 2019 due to the BREXIT deal and the planned exit of Britain from the EEC. The same report says that the Province of Québec is feeling the woes of the slowing global economy and international trade tensions as the provincial economy has been losing ground in international exports since the outset of this year. A strong labour market in Québec has allowed for continued consumer spending and demand for housing resulting in maintaining the economy buoyant. One can add that the lessened threat of a higher interest rate environment is a contributor as well. Even though Desjardins’ Economic & Financial Outlook report of September 23rd, 2019 (page 1), says that there is surprising economic vitality in Québec, global protectionism and trade obstacles are affecting the Province and are causing exports and business investment to limit the growth of its GDP to 1.5% in 2020. According to the same report, the risk of recession is now more elevated in many economies. The risk of recession is high for the United States, Germany and many emerging economies, especially, China. It has become clear that the international trade war must be alleviated in order for the global economy to prosper.

So, where does Montréal and West Island industrial real estate go from here? At this point it is very difficult to predict where Montréal and West Island industrial real estate is headed in lieu of record-breaking demand for industrial building stock and associated record-breaking vacancy rates. Montréal has now entered uncharted waters. We’ve never been in such a position and we’re not sure of where matters are headed:
CBRE’s Montréal Industrial report for Q2, 2019 (page 1), says, ‘’…hypothetically, should the demand stay as strong as in the previous six quarters, it would take less than a year and a half to absorb the remaining stock if no new speculative construction is delivered’’. Another outcome that’s sure to emerge is that with no added speculative construction of industrial product, continued lack of supply of such product, and sustained demand shall lead to even more increases in industrial lease rates and average sales price.

One would easily conclude that if there is a lack of existing industrial building supply, it is logical for developers to construct new facilities. But, there are two main reasons why this does not necessarily hold true for Montréal and its West Island. First, there is a lack of vacant industrial land on the Island of Montréal. Second, because of economic uncertainties, particularly the current threat of a slowing general economy, developers are very hesitant to proceed with speculative construction because the economy may be in optimal standing when the decision to proceed with a new-build is taken, but, the economy may not be in good standing by the time the project is completed.

At this point in time, I sense that the demand for industrial product will begin to subside and developers will not proceed with speculative construction in view of greater uncertainties surrounding the overall economic outlook and potential for recession in the US which almost inevitably affects the Canadian economy and business confidence; overall economic growth is expected to weaken in coming quarters. In addition, coupled with anticipated decrease in demand is that users, tenants, and investors are coming to the realization that this is the worse time to transact on property because pricing has, and, in all probability, shall continue to increase significantly in an industry environment offering a lack of industrial product and no speculative construction; it is currently, a seller’s market.

•    (f) means forecasted.

Bibliography

CBRE 
 ‘’Fasten Your Seatbelts’’
 Marketview—Montreal Industrial, Q2, 2019

Colliers International
Industrial Market Report (Table). Q2, 2019

National Bank of Canada
Monthly Economic Monitor. National Bank of Canada Financial Markets, February, 2018

Fédération des Caisses Desjardins.
‘’China-U.S. Trade Tensions Rattle Financial Markets’’ Economic & Financial Outlook. Economic Studies, August 19, 2019.

Fédération des Caisses Desjardins
‘’Economic Growth Will Weaken Further’’. Economic & Financial Outlook. Economic Studies, September 23, 2019