Investors find commercial condos a challenge for cash flow

High per-square-foot costs and interest rate hikes cool demand for Metro Vancouver industrial strata, despite soaring leases and near-zero vacancies

The 185,000-square-foot IntraUrban Crossroads, Surrey’s second-largest industrial strata space, was primarily bought by owner-users | PC Urban Properties

Real estate investor interest in strata commercial projects has cooled as high per-square-foot prices and rising interest rates make rentals a questionable cash flow, commercial agents say.

Strata industrial is a relatively new concept wherein the space is sold, like a residential condo, rather than leased.

Such developments have come to dominate industrial development in Metro Vancouver, where 7.7 million square feet of space is under construction and the industrial vacancy rate is around 0.2 per cent, lowest of any major city in North America.

Three of the five largest industrial developments underway in the Metro region are strata projects. 

The latest is by PC Urban Properties and Nicola Wealth, which partnered to acquire 2660 Barnet Highway in Coquitlam in September for $24 million. The 3.48-acre site will be used to develop 100,000 square feet of small-bay industrial strata product for owner users and investors.  

The strata space is touted to allow businesses to acquire workspace and enjoy the benefits of real estate appreciation combined with a set monthly mortgage cost, rather than being exposed to rising lease rates. 

The average industrial lease rate in Metro Vancouver increased to a record high of $20.44 per square foot in the third quarter 2022, compared to $17 per square foot at the start of the year, and up from around $13 per square foot a year earlier, according to Colliers.

Many speculative developers, therefore, also bank on investors purchasing a portion of the strata space and renting it out to owner-occupiers.

That concept is now nearly dead, agents say.

“It is a challenge for strata investors today,” said Kelvin Luk, principal of Luk Real Estate Group with Madonald Commercial  in Vancouver.

Purchasers, including the investors who represent about a third of the market, are dealing with a different environment, particularly as interest rates continue rising. CBRE reported that average strata sale prices hit $640 a square foot in the second quarter, up 11 per cent since March – an increase greater than anywhere else in the country. In parts of Vancouver, strata industrial-office space is selling for north of $800 per square foot.

Even with the record-high leases, investors face problems generating positive cash flow by leasing out strata space, Luk said, adding the cost of financing adds a recent, steep barrier.

On October 26, the Bank of Canada raised its overnight lending rate to 3.75 per cent in the sixth rate increase this year.

While owner-occupiers may qualify for 80 per cent to 100 per cent financing of their strata commercial space, an investor would be required to put down 30 per cent to 50 per cent and would also be subject to higher lending rates, Luk explained.

Luk said high land costs have persuaded industrial developers to build the multi-storey projects, but “it is harder to sell or lease space above the ground floor.”

William Maunsell, an associate vice-president at Luk Real Estate Group, suggested several planned commercial strata projects will be scaled back or delayed as investor demand wanes, though he could not point to specific locations.

Maunsell said an outlier is strata medical office space, which he said remains a top seller to both owner-occupiers and investors, especially in Vancouver.