Canada has a numerically slight presence with disproportionate weight in Lee & Associates’ newly released third quarter commercial real estate results. The overview of 44 markets across the United States along with Toronto and Vancouver purports to be a North American report — encompassing about 2.1 billion square feet in office, industrial and retail assets and 600,000 multifamily units in the two Canadian cities, and 36.7 billion square feet of the same property types and 17.3 million multifamily units in the U.S. markets.

For comparison, the report combines Toronto and Vancouver into a scoped Canadian index to be held against the 44 markets lumped into the U.S. index. From this nation-to-nation perspective, Canada generally stands out with lower vacancy rates, higher market rents, higher sales values and lower cap rates.

Toronto notably registers the lowest industrial vacancy rate — pegged at 1.3 per cent — while also hosting the fifth largest inventory of industrial space at nearly 837 million square feet. However, with about 10.4 million square feet of new space under construction, it lags the development pace of U.S. markets like Dallas, Atlanta and Chicago where more than double that volume is now in progress.

“Industrial real estate in the Greater Toronto Area continues to see rising demand from e-commerce fulfillment, food and beverage and paper products,” notes Daniel Smith, vice president and principal with Lee & Associates. “Average asking net rental rates continue to trend upwards quarter-over-quarter with landlords pushing for high watermarks specifically related to premium mid-to large-bay space.”

Similarly, Maria Fayloga, Lee & Associate director of research, points to strong demand for distribution/logistics space in Metro Vancouver — seen in the 3.7 million square feet of new development now in progress, including multi-storey facilities in Vancouver and several projects in the suburban cities of Richmond, Surrey, Delta and Langley.

“The industrial rental and investment market continues to experience growth with stable rents and steadily increasing market prices,” she says. “The industrial real estate sector is expected to remain strong heading forward with vacancy rates at 2.1 per cent this quarter.”

That represents the second lowest industrial vacancy rate in the 3rd quarter survey. In addition, Vancouver boasts: the lowest industrial cap rate, at 4.6 per cent; the lowest retail vacancy rate, at 1.6 per cent; the second lowest office vacancy rate, at 3.6 per cent; the second highest office market rent per square foot, at USD $45.03; and the highest office sales price per square foot at USD $671.

Toronto also cracks multiple top-5 lists in the office sector with: the fifth lowest vacancy rate, at 5.1 per cent; the fourth highest market sales value at USD $435 per square foot; the second highest tally of space under construction at nearly 13 million square feet; and the second lowest cap rate at 5.5 per cent. A retail vacancy rate of 2 per cent is the second lowest in the survey, after Vancouver.

Canadian pension funds buy U.S. multifamily assets

Multifamily vacancies are likewise tighter in Toronto and Vancouver — at 1 per cent and 2.6 per cent respectively — than the 6.7 per cent average across the U.S. index. Market rents, at USD $1,710 in Toronto and USD $1,680 in Vancouver, are also well above the U.S. index average of $1,364, but fall out of top-five range and trail far behind list-topping rents of USD $2,712 in New York City and USD $2,414 on Long Island.

Vancouver records the highest per unit sales price at USD $462,000 and the lowest average cap rate at 2.5 per cent. Toronto’s cap rate of 3.9 per cent is also lower than in most U.S. cities, while an average per-unit sales price of USD $276,000 surpasses the U.S. index average of USD $204,749.

Canadian pension funds are among the purchasers in the U.S. market. Alberta Investment Management Corporation (AIMco) acquired a 275-unit building in Miami for USD $89.6 million and a joint interest in a 184-unit in Pasadena. The latter USD $16.8-million acquisition is listed as the second priciest multifamily deal in the Los Angeles/Tri-Cities area during the third quarter. In a more substantive outlay, Oxford Properties Group paid USD $320 million for a 461-unit building in Seattle, representing the largest multifamily deal in that city in a 12 month period.

Turning to new product, approximately 51,000 units under construction in Vancouver and Toronto amount to less than 9 per cent of the tally in U.S. markets. However, at the city level, Vancouver has the third highest number of new multifamily units in progress, at 31,996, after New York and Dallas-Fort Worth.

Industrial growth slows, while office sector loses last year’s gains

As in Canada, industrial has remained the steadiest U.S. sector throughout 2020. While 104.5 million square feet of net absorption across the 44 U.S. markets Lee & Associates surveys is the most sluggish growth since 2012, nearly half of that space — 51.9 million square feet — was taken up in the third quarter. A 5.7 per cent vacancy rate as of September 30 demonstrates a 20 basis point increase since Q2, but also reflects the delivery 67 million square feet of new space to the market over the summer. And there is much more new space coming.

“Most of the record 331 million square feet under construction is spec logistics product. Some 200 million square feet is slated for delivery over the next two quarters, a high-water mark in the current cycle,” the Lee & Associates report states. “Nevertheless, industrial property should continue to outperform other commercial real estate categories. There’s also speculation that much of the sudden growth in e-commerce may be sustained after the pandemic ends.”

Highest market rents are found in California and New York, with San Diego enjoying the chart-topping USD $16.62 per square foot. The top five record average market rents well above Vancouver’s USD $13.88 per square foot or Toronto’s USD $11.81 per square foot. However, more modest rates across the entire U.S. index pull the average down to USD $8.86 per square foot. The average market sales price sits at USD $109 per square foot across the 44 U.S. cities versus an average of USD $174 per square foot in Toronto and Vancouver.

In contrast to the continued growth in the industrial sector, 55 million square feet of office has been returned to the market thus far this year, with 61 per cent or 33.6 million square feet of that negative absorption occurring in the third quarter. That pushed the U.S. index vacancy rate up 50 basis from Q2 to rest at 10.8 per cent. More than 153 million square feet of new office space is currently under construction, with about 53 million square feet of that scheduled to hit the market by spring 2021. Meanwhile, an uptick in sublease space mirrors trends in Canada.

“There has been a dramatic rise in available sublease space, now at 144 million square feet with 60 million square feet added since March,” the report tallies. “Leasing activity in August was 50 per cent less than at the start of the year. Since July, fewer than 150 leases have been signed for blocks of space larger than 10,000 square feet.”

New York records the highest market rent at USD $57.72, with the average across the U.S. index at USD $34.30. New York also registered the highest market sales price at USD $661 per square foot, while the U.S. index average was USD $316 per square foot.

Nominal retail rent growth as vacancies increase

Nearly 38 million square feet of negative absorption thus far in 2020 contributes to the 5 per cent retail vacancy rate in the U.S. index. Across nearly 11.6 billion square feet of inventory, that represents more empty space than Toronto and Vancouver’s combined retail inventory of 569 million square feet.

Among 18 markets specifically spotlighted in the report — including New York, Los Angeles, Chicago and Toronto — only two leasing deals in excess of 100,000 square feet were inked during the third quarter. The majority of transactions involved less than 50,000 square feet, and that’s certainly the case in the Greater Toronto Area, where the largest reported deal of the quarter was for 9,349 square feet in suburban Newmarket.

“The Toronto retail industry seems to have reached a tipping point, allowing e-commerce to emerge as the logical successor to traditional brick-and-mortar models. Due to the lockdown and warnings to avoid high-traffic indoor areas, many shopping malls and underground pathways will inevitably see a large reduction in shoppers for the foreseeable future,” muses Nicole Moniz, vice president, retail, with Lee & Associates. “Foot traffic in assets with essential-based retailers remains high, as well as neighbourhood street-front. ‘Shopping local’ has gained momentum and the perception of safety is higher.”

That’s a general outlook throughout the North American retail industry. Across the entire database, rents have not actually declined, however 0.1% rent growth in the third quarter is the slimmest margin since 2009. Across the U.S. index, average market rent is pegged at USD $21.61 per square foot, while New York commands the highest market rent at USD $43.46 per square. Market rent of USD $31.31 and USD $30.50 respectively in Vancouver and Toronto once again exceed the U.S. index average.

Construction starts have fallen to historical low levels in 2020, although more than 52 million square feet of new retail space is under construction in the 44 U.S. markets Lee & Associates surveys. Only New York, with 3.4 million square feet in progress has more retail construction underway than Toronto, where more than 3 million square feet is in the pipeline.

“Long term, there’s anxiousness whether merchants will regain their share of lost trade after the pandemic as online purchasing of consumer goods has become routine for more shoppers,” the report states. “Acquisition, underwriting and financing activities are challenged to accurately assess risk in a post-COVID environment. Nevertheless, a considerable amount of well-financed investors are on the sidelines, raising capital and alert to distressed opportunities.”