Watt Matters: The Impact of Heavy Power on Industrial Real Estate

September 13th, 2024

“For every action, there is an equal and opposite reaction.”

• Isaac Newton

When riding a wave at its peak, few seldom stop to think about the next sequence of events as it inevitably comes down.

This doesn’t mean that every bull run is followed by a crash.

That said, humans are known for their over-indulgence in both optimistic and pessimistic scenarios; the former manifesting as the largest industrial pipeline in the GTA’s history while the latter took form as enormous overflow and stockpiles following the pandemic.

As we work through supply-side shocks and integrate new technologies, businesses change. And these changes are reflected ultimately in the real estate footprint underlying the operation.

This has led us to a point where the GTA industrial market just saw the highest industrial vacancy rate in a decade, with the largest quarterly negative absorption in 14 years, and the first average rent decline in 8 years.

Heading into the tail-end of 2024, we expect a flurry of transactions as tenants weigh their options, look to re-organize and enhance their spaces, as well as to take advantage of more moderate pricing. 

We also forecast the changing landscape and shift towards the on-shoring of manufacturing to result in a strong demand for heavy power facilities and design-build opportunities. General industrial users and logistics and warehousing tenants will continue to purchase and lease, albeit at reasonable levels relative to the recent boom.

That is why, for this week’s newsletter, we will embark on an examination of how macroeconomic shifts are impacting tenants’ needs and shifting the focus towards heavy power facilities. 

Electrifying Expansion: What’s Behind the Need for Heavy Power Capacity? 

The convergence of several trends are having an enormous impact on the manufacturing, warehousing and general industrial landscape in Canada and the United States. These phenomena are not only creating demand for industrial space as an asset class but are reflected in Tenants seeking specific features when leasing, purchasing, or constructing.

Below we will highlight a few key drivers that have led to the current situation:

Post-Pandemic Supply Chain Resilience: Most of us remember the supply chain bottlenecks and product shortages brought about by insufficient labour, offshore quarantines, jam-packed ports, crazy shipping costs, panic-buying by consumers, and a lack of domestic manufacturing to fill the gap. This saw a pivot from the JIT (just-in-time) model to a JIC (just-in-case) approach of stockpiling goods in overflow warehousing; the latter largely fueling the post-pandemic industrial expansion.

In the medium- to long-term, companies have made plans and taken steps to bring back (at the very least, a portion of) their operations to the U.S. and Canada in order to both protect domestic consumers (especially for critical goods such as food, pharmaceuticals, computing, etc.) and to mitigate risks associated with a dependence on imports.  

LA Port during quarantines.

Automation as an Operational Necessity: During the pandemic itself, many businesses experienced the aforementioned labour shortages and began to put in place automation technologies, such as warehouse management systems, robotics, automated pick-and-pack systems, conveyors, etc. 

Today, although the situation is not quite the same, hiring people is expensive compared to the cost to do so overseas. Thus, various automation systems – along with the rise of AI – are being deployed to improve efficiencies and to maximize productivity of employees and the real estate/equipment within the operational footprint… and they all require power to run.

Fully automated warehouse: a snapshot. Source: Interlake Mecalux.

Elevated Cost of Construction: It’s no secret that constructing industrial facilities in the Greater Toronto Area is incredibly expensive. Land, labour, materials, development charges, and other associated costs of navigating the process mean high values and strong rents. Despite the stabilization of values and recent rent reductions, new state-of-the-art facilities still command $17-$20 PSF net rents and $400+ PSF values. Any tenant looking for newer product – whether to purchase, lease, or construct – is going to want to squeeze every ounce of output or throughput with minimal labour.

Political Tensions: Although different, the effects of escalating political tensions could be similar to what was seen during the economic shutdowns. Tariffs, sanctions, etc. could all result in shortages, and – depending on how inelastic demand is – could force producers to open operations in North America. 

Automation in semiconductor manufacturing. Source: KUKA AG.

Semiconductor Shortages: As an offshoot to the previous point, and as of 2023, Taiwan had a 68% market share of advanced semiconductors, with the Taiwan Semiconductor Manufacturing Company (TSMC) reportedly accounting for over 50% of the global market. 

As a result, the United States (and Canada) are taking steps to reduce this over-reliance and build in more supply chain predictability and independence. 

Per Cushman & Wakefield’s research, “One of the stated goals of the CHIPS and Science Act is to increase U.S. semiconductor production capacity through the investment of $280 billion. Most of that ($200 billion) is directed at scientific R&D and commercialization, but there is $53 billion earmarked for semiconductor manufacturing, R&D and workforce development and $24 billion allocated for chip production tax credits. Currently, seven U.S. semiconductor manufacturing sites, totaling over 750,000 SF, have been proposed or are currently under construction.”

The Rise of AI and Data Centers: As Artificial Intelligence grows exponentially and its applications continue to proliferate throughout all industries, we will see a new focus on Data Centers. These will not only be critical to providing the required computing power but, as more critical infrastructure becomes dependent and integrated with AI, having domestically-located centers may be required to safeguard against risks such as conflicts and cyber-attacks. The only downside is that few regions can physically produce and supply the necessary power without completely tapping out the grid. 

Inside a Microsoft data center. Source: CNET.

A Changing Industrial Landscape

As discussed thus far, changing technologies coupled with evolving supply chains have created a need for manufacturing while the previously red-hot demand for warehousing and logistics space has cooled. 

Overall Vacancy & Asking Rent. Source: C&W Research.

In Q2 2024, nineteen blocks of space larger than 100,000 square feet hit the market, adding over 4 million square feet of vacancy; accounting for most of the 8.4 million SF of newly available space. As of writing, there are currently 286 spaces of over 100,000 SF listed on market for lease or sub-lease in the GTA across approximately 150 properties (a mix of new development and existing product). Furthermore, there are 37 sublet opportunities of over 50,000 SF, looking GTA-wide.

At a high level, most of this added inventory is stemming from logistics and warehousing…. It is businesses no longer needing overflow warehousing space, firms losing contracts or winning bids smaller than anticipated, and/or from tempered growth forecasts. Additionally, some businesses are not only pulling back the offensive but are actively cost-cutting through the rightsizing or consolidation of their operations. 

Overall vacancy is flirting with the 4%-mark, something not seen in almost a decade. Notably, average asking rents declined 2.9% QOQ and 0.7% YOY; the first downward shift in eight years. 

Space Demand/Deliveries. Source: C&W Research.

The GTA industrial market saw negative absorption of 2.9MSF in Q2 2024 – a 14-year low – bringing the year-to-date total to negative 4.4 MSF. 

Furthermore, developers are being cautious with new, speculative construction; looking more to process existing pipeline than to kickstart new projects while offering more design-build opportunities.

While this may sound like all negative, it is simply the counter-reaction to the explosive growth seen during- and post-pandemic. Businesses will need to reset their footing before jumping again and this is a natural part of the cycle.

The bright spot in all of this are the press releases, investment/funding announcements, and the anecdotal conversations we are having with tenants looking to open up manufacturing facilities in Southern Ontario. From automotive/EV and food and beverage to plastics… and from data centres to printing and packaging; moves are being made.

Industrial properties with heavy power capacity are at a distinct advantage when opportunities are being presented. We believe this often overlooked feature will be an absolute necessity for most future industrial development.  

Conclusion:

Goran Brelih, SIOR

Executive Vice President, Broker
Cushman & Wakefield ULC, Brokerage.
www.cushmanwakefield.com

Office: 416-756-5456
Mobile: 416-458-4264
Mail: goran.brelih@cushwake.com
Website: www.goranbrelih.com