A Quick Primer on Investing in Industrial Real Estate in the Greater Toronto Area

I wanted to give a bit of a primer on what I look for as a broker on behalf of my investor clients when it comes to industrial properties in the GTA. Below are some insights and tips about what to look for in industrial properties that make them most appealing in terms of both rent potential and future value appreciation. I work with a lot of tenants for these types of buildings and so I know exactly what tenants are looking for and what they are willing to pay a premium on rent for, as well as what is scarce in the market. I've incorporated those insights into the notes below. This is not an exhaustive list but provides some of the key items.

Attributes to Look For in an Industrial Property Investment


Location

This is an obvious one. Proximity to major highways is important, as is proximity to a major population node that will provide both client access for your tenant as well as a solid labour pool they can draw on for staff. These are obvious factors as to why markets like Mississauga, Brampton, Vaughan, and Markham are so popular. However, as the industrial market has been so red hot, there are increasingly opportunities in 'shoulder markets' just outside the core GTA that are being considered more and more by tenants. Often these markets - think Hamilton, Burlington, Newmarket, Bradford, Barrie, Durham region - provide a better return on investment and less competition on your purchase, while having increased upside potential as the values catch up to the rest of the GTA and as more and more tenants seek out these markets due to more affordability in these markets as well as the severely constrained supply in the more popular core markets.


Zoning

Generally not a huge issue as most industrial zoning classes will permit enough variety of uses that it won't limit your tenant base, but you usually want the most flexible zoning possible. More and more of my tenants that have some sort of manufacturing function are having a hard time finding spaces with the low supply out there and because of zoning restrictions and/or landlord restrictions, so it is beneficial to have a building that is zoned to permit manufacturing uses if you ever want to entertain that sort of use from prospective tenants.


Clear Height

Very simple, the higher the better. Tenants want the highest clear heights possible, especially if they are storing products as it allows for racking and the most efficient use of their square footage. Some manufacturing uses also require certain heights for machinery/equipment. Older buildings have lower clear heights (think 12-18 ft), mid-age buildings tend to be in the 18-22 ft range, and newer buildings are generally 24+ ft with some even providing 40 ft these days. You'll achieve a lower purchase price on a building with a lower clear height, and you'll still be able to attract decent quality tenants as not all tenants view this as a critical attribute.


Shipping/Loading Capability

This entails the number of truck level doors, the number of drive-in doors, and the envelope of space available surrounding the property for trucks coming in and out. The most critical factor from my experience is that there be at least one truck level door. Most tenants, and certainly the more established and more sophisticated tenants, have a need for truck shipping/loading. Hence, not having a truck level door severely limits your tenant pool to only a small slice of tenants who have no shipping requirement or only require a drive-in door. That being said, ideally you'd like to have at least one truck level door as well as one drive-in door. Lastly, very beneficial but not critical is to have an outdoor shipping envelope that has enough space for 53 ft trailer trucks to come in and out. Not all tenants require this, but some do and it provides a premium on the demand for your space.


Office Space

This one is not as important as you may think. Most industrial tenants do not need much office space and some don't need any at all. In general, the less office space a property has the better, because it's very easy to build out additional office space if necessary (carried out and paid for by the tenant), whereas it is not as palatable for tenants to bear the cost of removing office space that they don't need. The sweet spot is anywhere from 5-25% of total square footage, with the rest made up of warehouse space.


Freestanding vs. Industrial Condo

Freestanding is better, plain and simple. Tenants prefer it and it will also result in a higher value for the property whenever you decide to sell it. Why? First off, because you don't need to pay condo fees, but also because you own all the land (great for additional development or redevelopment of the property), there is more room around the property for shipping access, parking, etc., there is more privacy, and you have more control over how you manage/maintain your property since you don't need to answer to a condo corp. Sometimes it even provides additional space for outside storage (zoning permitting). That being said, you will pay more for a freestanding property than you will for an industrial condo property, and the rent difference is not always necessarily that significant.


Building Age

Newer buildings are usually better, plain and simple, because they have newer features (higher clear heights, more truck level and drive-in doors, LED lighting, ESFR sprinklers, etc.). BUT there are a few caveats - they cost more to buy, and they aren't necessarily in the best locations versus older buildings because a lot of the best locations were previously built on.


A Note About Pricing

As of the writing of this blog post, some of those "shoulder" submarkets I mentioned earlier tend to trade in a range of $300-400 PSF, while the most sought-after core GTA markets range from $400-600 PSF. Of course, many of the variables above dictate where they fall in that range.

A Note About Cap Rates

The Capitalization Rate, or "cap rate" as it's known, is a measure of the net operating income of an investment property versus the sale value of that property. If typical cap rates are known for a specific asset class, and if the annual net operating income (NOI) of a property is known, these figures can be used to reverse engineer a projected sale value for a property. The equation is as follows: Property Value = NOI / Cap Rate. The latest cap rates for industrial buildings (as of Q2, 2022) is around 4%. This means that if a property is tenanted for a net rent rate of $20 PSF per year (net rent does not include TMI), and if the building is 10,000 SF, then using a 4% cap rate the projected approximate value of that building should be as follows: $20 PSF x 10,000 = annual net operating income = $200,000. Taking that value and the 4% cap rate gives us: Property Value = $200,000 / 0.04 = $5,000,000. Cap rates in less sought-after markets will be higher than cap rates in the most sought-after markets.

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