The 2008 national industrial market showed mixed performance with stronger activity levels continuing in the western provinces and steadily weakening activity in the east, particularly in Ontario and Quebec. While both the Canadian dollar and oil prices have retrenched from recent highs, soft US demand for Canadian goods resulting from the credit crisis and faltering consumer confidence will have a significant impact on manufacturing output and the overall health of the industrial market in 2009.

Market dynamics

Despite upticks in vacancy, tight market conditions persist in the western markets. Limited supplies of serviced industrial land and strong user demand contribute to the near record low vacancy rates that continue to be seen in the Vancouver (2.3%), Calgary (3.2%) and Edmonton (1.4%) markets. Significant distribution related activity is also driving growth in both Regina (2.0%) and Winnipeg (2.3%), each recording vacancy declines in 2008. Vacancy continued an upward trend in the Toronto market (7.1%) as economic conditions in the province of Ontario softened and manufacturers continued to struggle. Vacancy was also on the rise in Montreal (8.5%), with a significant amount of space returning to the market in the form of older, lower clear height product. In Ottawa (3.6%), vacancy declined once again in 2008 with increased demand for, and shortage of supply of, high cube distribution space.

Just as massive investments in the Alberta oil sands were really starting to pay off, crude prices dropped over $100 per barrel to below $40 by the end of 2008, a price which diminishes the economic potential for oil sand producers. As a result, many companies will delay or shelve development plans indefinitely. This will have ramifications for business activity in Edmonton, arguably the manufacturing hub of the energy sector, as well as Calgary where warehousing and distribution activities have been on the rise. Alberta has been through this boom bust cycle before and while the economy benefits significantly from the energy sector cities such as Calgary and Edmonton are striving to diversify their economies to provide a buffer from the energy swings.

The automotive sector has been a driver of industrial growth and activity, particularly in southern Ontario, both directly and in the spin off jobs created to service this sector as a whole. However, the troubles facing the domestic auto sector are certainly adding another level of anxiety to the marketplace as many companies with close ties to the sector are feeling significant strain as the necessity of a bailout for the “big three” North American automakers, becomes more real. Only time will tell what the fate of the North American automotive sector will be. Suffice it to say, not only are the automotive manufacturers themselves facing a dismal outlook for 2009, but so too are the suppliers which support them.

Declining container shipping volumes, as a result of the slowing global economy, will have an impact on port activity on both the east and west coasts of North America and related industrial development and transaction velocity in and around major port facilities. Intermodal shipping is likely to remain soft until a rebound is seen in the US economy. Despite lower volumes, development at Port Metro Vancouver continues with additional capacity planned for Roberts Bank. Port Metro Vancouver represents the amalgamation of three regional ports making it the most diversified port in North America. Container traffic at the Port of Prince Rupert recorded solid growth in Q3 2008 at a time when US ports are losing volume. However, the port announced it has delayed expansion plans on its container terminal, which were supposed to take place in 2009, for at least 18 months. The Port of Montreal recorded container growth of roughly 10% for the first nine months of the year, stronger than both Halifax, which recorded a decline in cargo volumes for the year, and Vancouver, according to the Port Authority. The Port of Montreal is now benefiting from a weekly container ship link with the Port of Valencia in the Mediterranean, launched by Mediterranean Shipping Company (MSC).

Rental rates

With low vacancy and bullish landlords, rental rates have continued to feel upward pressure in markets such as Calgary, Edmonton and Vancouver. Land values and construction costs appear to have peaked in 2008. Rates will continue to feel upward pressure going into 2009; however with the amount of new supply delivered in 2008 and scheduled for delivery in 2009, combined with softer economic conditions, rental rate growth may stabilize over the near term. In Toronto and Montréal, rental rates have remained fairly flat and are expected to experience a moderate reduction in 2009, resulting from declining leasing activity, increasing vacancy, and the fact that available space is taking longer to lease.

In 2009, landlords will be facing competition not only from other property owners but also from their own tenants. With many companies beginning to downsize their operations in the face of the current economic realities, the sublease market is becoming quite active. Typically, these sublease offerings are marketed and transacted at below market rates placing pressure on landlords in markets with more available opportunities and on landlords with large holes to fill in their portfolios.

Development activity

New construction remained strong in 2008 with roughly 20 million square feet of new supply delivered to the Canadian market. The market responded positively to new supply. In hot markets, such as Calgary and Edmonton, developers experienced very little vacant carry upon building completion.

The pace of new construction will slow considerably in 2009 as the financing of projects and the ability to attract tenants becomes more challenging. Similar to the office market, conservative lending practices have kept supply relatively in check over the years and reduced the risk of overbuilding.

Speculative construction will likely come to a halt, with build to suit providing the main source of new industrial space over the near term. Developers who do go ahead will likely be offering more aggressive rates to companies with Triple A covenant as these will be the only type of financeable leases. Many projects in the proposed or planned stages may not commence with development until the economy shows signs of improvement and tenant demand picks back up.

Potentially impacting future new supply levels are the development charges levied in certain municipalities. For example, development charges levied by some municipalities in and around the Greater Toronto Area have been hiked to levels which could prove to be a substantial disincentive for development within the boundaries of those municipalities – in certain cases the charges levied exceed the initial land costs. A prime example would be the substantial increase in development charges in the Region of Halton, which were approved in mid-2008, and in the City of Guelph, which is undergoing review for a proposed substantive increase.

Serviced industrial and employment lands remain in short supply in most markets across the country. ICI land sales remained stronger in western Canada while in Toronto sales declined 16% for the year. Land sales in 2009 are forecast to slow across the country as developers’ need for liquidity in the market may defer them from tying up capital in a longer term hold such as land, and debt financing remains a challenge. Companies or individuals looking to purchase land in this market environment may have to either wait for the economy to improve or find other sources for capital.

Tenant challenges and opportunities

Where tenants may have been weighing their options to buy versus lease industrial products in 2008 given the low interest rates, in 2009 the difficulties in gaining financing could sway the decision in favour of leasing. In addition, many owners/users may become pressured sellers as mortgage re-financings come due and they find they are not able to meet their debt obligations. Distressed owner/users may look to sale/leaseback arrangements in order to free up the necessary capital to run their operations. There will also be a growing trend of space available for sublease in select markets as firms try to supplement their cash flow and rightsize their space requirements.

Tenants that do not have an immediate requirement may sit on the sidelines waiting for the market to “hit bottom” before making a move, or look to renegotiate their existing lease on a short term basis. Renewal activity has been on the increase in most markets as tenants take a wait and see approach. Other tenants may take advantage of the sublet market and secure space at below market rents.

Similarly to the office market, a pricing disconnect will likely exist between tenants looking for “fire sale” pricing and landlords looking to avoid deep discounts. This pricing disconnect will also exist for purchasers/sellers of industrial real estate and will effectively decrease transaction volumes making it more difficult to determine the real market value of assets.