West Island Industrial Real Estate in the Current Canadian Economy - October 2022

An article by John Burrascano, Industrial Commissioner, PME MTL Ouest-de-l'Île.

Over the last two years, we have gone through the most dreadful economic recession since the 1930s to a very hot economy, accelerating a record-breaking labour shortage, and, now, serious worry about tipping into recession. What does this mean for Montréal and West Island industrial real estate?     

A Glimpse of the Overall Economic and Pandemic Picture

The elimination of the majority of COVID-19-related governmental public health measures by the Canadian and Québec governments has allowed these economies to excel. Our society is still adapting to living with the COVID-19 disease which means our economic well-being is susceptible to how it continues to unfold. Our immediate economic performance is also subject to the war in Ukraine, international supply-chain limitations, and rising inflation and associated interest rate hikes, affecting household and corporate demand for goods and services.

Specific to the Province of Québec, TD Economics¹ concludes that considering a slow start early in 2022 caused by the Omicron variant,

the beginning of the year can generally be described as having an overall strong start across industry. Quebec’s economy, in fact, outpaced Canada’s 3.1% GDP performance, settling at 6.9% in the first quarter of this year, according to Autorité des Marchés Financiers.

Despite this, the TD Economics report states “…we expect Québec to endure a significant slowdown beginning in the second half, as rising interest rates and elevated inflation weigh on household and business spending”. The good news is that the same report conveys key economic indicators show the weaker economy will affect the Province less than the rest of Canada. Deloitte³ forecasted in June that “…we put the odds of a slowdown at 60% versus a recession at 40%...Economic modelling suggests that a pronounced slowdown is the most likely scenario…” Société des Caisse Desjardins⁴ concurs as the institution believes interest rate increases will lead to an economic slowdown and a mild recession in Canada in 2023. Other very recent reports referred to point in the same direction as they confirm that the global economy continues to slow and the risk of recession is worldwide.

This graph below showcases that the forecast is a clear and important decline in economic growth between now and 2023, in all selected jurisdictions.

The Pandemic and Industrial Building Market in Montréal and the West Island

COVID-19 still exists and we really do not know if and how it will affect the economy and the real estate sector in general by the end of the year and into the beginning quarter of 2023. Nonetheless, for the 10^th quarter in a row, the industrial vacancy rate sits below 2.0% for the Greater Montréal Metropolitan Area (GMA)⁵.

It has been confirmed by JLL⁵, however, for the first time in a while, there are apparent signs of decreased demand for industrial space to lease throughout the GMA because of continually rising net rental pricing, and, according to Colliers International⁶, a lack of industrial space to lease.  Added to this, JLL⁵ says that a lot of activity in the industrial market is taking place in the North and South shore areas of Montréal with about 6.5 million square feet of industrial space now under construction in those regions. Companies wanting to rent industrial facilities may find some solace from the supply of soon-to-be-completed buildings built on-spec.

The pandemic has accelerated the rise of hybrid work. From the on-set of the crisis to the present, large numbers of people were forced to work from home. It caused most business owners to rethink their spatial needs. It was particularly evident for business activities needing 100% office space. Many such corporate owners did not renew their leases or they sought less space.

Though overall demand for industrial space is currently weakening, the demand for such facilities to buy or rent was extremely strong throughout the pandemic.

The office component of industrial space was also reconsidered by corporate owners and some may have decided to reduce their square footage office needs, however, the high demand for actual industrial space was virtually unaffected. All indications are that hybrid working is here to stay and companies who decide to embrace the hybrid work model generally will require less office space but the office space maintained will be put to greater and more varied use.

Pricing

In the fourth quarter of 2021, Colliers International⁷ reported that scarce supply of existing industrial space resulted in an average asking net lease rate of $9.23 per square foot in the GMA.  Roughly 8-months later, in Q2, 2022, the average asking net rental rate shot upwards to $13.77 per square foot⁶. That is a 49.2% increase! These prices are an average across all types of leasable industrial space. In the case of the West Island, excluding Lachine, the average asking net rental rate is $14.00 per square foot from $10.95 about 8-months ago, representing a jump of 27.9%. For Lachine it is $13.93 per square foot from $7.69, rising 81.1%!  For comparative purposes, let us not forget that, using Pointe-Claire as example, it cost an average $5.62 net per square foot to lease an industrial space in the final quarter of 2016⁸.

With reference to average asking sale price for an industrial facility, CBRE⁹  reported that it cost $153.95 per square foot to buy in the GMA in the second quarter of 2021. By Q2, 2022, the price hit $211.54, a price hike of 37.4%¹⁰. As a point of reference, using Pointe-Claire once again as example, in Q2, 2016, it cost an average of $56.03 per square foot to buy an industrial facility¹¹!

Industrial land prices continue to rise throughout the GMA during the last six quarters¹⁰. At the beginning of the year, Tamperguard purchased 63,000 square feet of land on St. Régis in Dorval at about $40.00 per square foot and Rosefellow recently purchased about 1.4 million square feet of vacant land along the north side of Trans-Canada Highway in Kirkland at about $50.00 per square foot.

Very few parcels of land at less than $40.00 per square foot exist in the West Island and there are a few lots priced above $60.00 per square foot, offering developers the ability to build multi-storey structures or projects requiring flexible zoning. An ample amount of industrial land for lease does exist.

Vacancy Rates

In Q4, 2020, the industrial vacancy rate for the West Island was 1.0%¹². By Q4, 2021, the rate fell to 0.7%⁷. In the second quarter of 2022, the rate stands at 0.1%⁶.

For Lachine, it had a vacancy rate of 1.5% in Q4, 2020¹², which rose a tad to 2.0% in Q4, 2021⁷. The rate is 0.4% in Q2, 2022^6.

For the purpose of benchmarking, the vacancy rate for the Greater Montreal Metropolitan Area for Q4, 2021 was 0.8%⁷. Colliers International, Q4, 2021: 3). In Q2, 2022 it decreased to 0.6%⁶.

Conclusion

Our Canadian, provincial, and regional economies have been confronted by the Covid-19 pandemic, the war in Ukraine, supply-chain impediments, and rising inflation and interest rates.

Yet, demand for industrial space to lease or buy persists, however, a lot of demand and construction of new industrial facilities has shifted to the North and South shores of Montréal.

The GMA currently has a very low vacancy rate sitting at 0.6%, but for the first time in numerous recent quarters, it is confirmed that demand for industrial space is beginning to wane, principally due to lacking industrial product and associated rising rental rates.

The work-from-home model did not affect the demand for industrial space, however, may have caused business owners to reconsider the square footage of office space needed in their industrial space.

At the end of 2021, the average asking net rental rate in the GMA was $9.23 per square foot and quickly rose to $13.77 per square foot by the second quarter of this year, representing a huge increase of 49.2%. For comparative purposes, in Q4, 2016, it cost tenants an average of $5.62 per square foot net to rent an industrial space in Pointe-Claire. The cost of an industrial building has also risen considerably as at the end of 2021 it cost an average $153.95 per square foot compared to $211.54 per square foot in Q2, 2022, for a rise in price of 37.4%. As a comparative, it cost $56.03 per square foot to buy an industrial building in Pointe-Claire in the second quarter of 2016. The price of vacant industrial land continues to rise, now commanding between $40.00-$50.00 and more per square foot in the West Island.

It is confirmed that commencing in the second half of 2022, there will be an economic slowdown and by 2023, it is forecasted that Canada shall experience a mild recession. The risk of a global recession is very high.

In terms of outlook, the GMA and West Island industrial real estate market is in massive need of new industrial space as demand for rental space persists. Some of the demand will be absorbed by soon-to-be-completed facilities. Higher inflation will cause interest rates to rise further producing a slower economy resulting in less industrial asset investment levels in the GMA. At this juncture, net lease rates for industrial space are expected to continue to rise, however, there are signs in the industrial marketplace that indicate confirmed less demand for such space may result in lower net lease rates. It is difficult at this point to assess how much of a drop in price we can expect. Facing important net rental rate increases, many tenants faced with lease renewal will opt to renew their existing leases or seek space in secondary markets such as Coteau-du-Lac, Beauharnois, and Salaberry-de-Valleyfield.

The expected downturn of the Québec economy as well as persistent global supply-chain limitations, in all probability, will temporarily impact corporate and consumer confidence leading to lesser demand for goods and services, including industrial space. An unfortunate upsurge of Covid-19 forcing governments to reinstate public health measures would only exasperate the situation.

The vacancy rate in the GMA has reached a level of stabilization and it will be interesting to see how a slower overall economy will affect the rate in coming quarters.

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Sources

TD Economics., 2022, Provincial Economic Forecast; Alberta and Saskatchewan to Top Growth Leadership This Year.

Autorité des Marchés Financiers, 2022. Economic and Financial Review.

Deloitte, 2022. “Rising Interest Rates and Inflation to Slow Growth.” Economic Outlook.

Société des Caisse Desjardins, 2022. “Rate Hikes Will Lead to an Economic Slowdown; We Expect a Mild Recession in Canada Next Year.” Economic and Financial Outlook, by Desjardins Economic Studies.

JLL, 2022. “Greater Montreal Area; Vacancy remained below 2%, while rental rates continued to surge.” Industrial Insight, Q2, 2022.

Colliers International, 2022. Montréal Industrial Market Report. Q2, 2022.

Colliers International, 2021. Montréal Industrial Market Report. Q4, 2021.

Colliers International, 2016. Montreal Industrial Market Report, Q4, 2016.

CBRE, 2021. “Too little construction breaking ground.” Marketview-Montréal Industrial, Q2, 2021.

CBRE, 2022. “Montreal industrial market holds its own.” Figures-Montreal Industrial, Q2, 2022.

CBRE, 2016. “Manufacturing is Alive and Well in Montreal.” Marketview-Montreal Industrial, Q2, 2016.

Colliers International, 2020.  Greater Montréal Area Industrial Market Report, Q4, 2020.                                  

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