Nexus Industrial REIT just wrapped up their Q1 2024 earnings call, and while the headlines focused on temporary vacancies and higher interest expenses, something else caught my eye. There's a strategic play unfolding at Nexus, a calculated gamble that could pay off handsomely if market conditions cooperate.

At the heart of this potential power move lies the unassuming term "transitional vacancy." It's used to describe a period when a property sits empty as a tenant upgrades to a larger space within the REIT's portfolio. On the surface, this sounds benign, even positive. After all, it signals tenant growth and a preference for staying within the Nexus ecosystem. But dig deeper, and a more complex narrative emerges.

Nexus is actively encouraging these "transitional vacancies." They're deliberately orchestrating tenant shifts, pushing for bigger spaces and betting on their ability to not only backfill the smaller, vacated properties but to do so at significantly higher rents.

Case Studies: A Calculated Approach to Vacancies

This strategy is evident in two specific cases. First, there's the 29,000-square-foot cross-dock facility in Southeast Calgary. The previous tenant, Canada Cartage, outgrew the location and was promptly ushered into a spacious 83,000-square-foot facility newly acquired by Nexus. This left the smaller property temporarily vacant, but Nexus swiftly leased the building portion to a new tenant at a starting rate of $19 per square foot. While this is lower than Canada Cartage's $23, it includes rapid rental escalations, reaching $24 by 2031.

But here's the kicker: Nexus isn't stopping there. They plan to develop a new 115,000-square-foot small bay industrial building on the remaining excess land, a highly sought-after asset type in the area. At market rates, this development could yield a 12% return on a $15 million investment, significantly boosting the total income generated by the site.

A similar scenario played out in London, Ontario, at their 220,000-square-foot Exeter Road property. One tenant upgraded to a 70,000-square-foot space within another Nexus building, while a second tenant vacated a challenging office portion. This left Nexus with 68,000 square feet vacant, but they're in final negotiations with a new tenant for the entire space at a "significant rental lift."

Kelly Hanczyk, Nexus CEO, even hinted at an impressive $10 per square foot rate, a substantial increase from the previous blended rate of $6.50 to $7.

The Gamble: Assumptions and Risks

These examples showcase a bold approach. Nexus is taking short-term hits to same-property NOI, confident in their ability to backfill with upgraded tenants and higher rents, ultimately boosting overall portfolio performance. It's a calculated risk, reliant on several key assumptions.

Sustained Industrial Demand: Nexus is banking on sustained industrial demand, particularly for small bay industrial spaces. They're betting that Calgary and London will remain landlord-friendly markets, allowing them to command premium rents.

Proactive Leasing Success: They're assuming their proactive leasing strategy will continue to pay off, securing new tenants before vacancies significantly impact cash flow.

If these assumptions hold true, Nexus could reap significant rewards. The backfilled Calgary property, combined with the new development, will generate more income than when Canada Cartage was the sole tenant. The Exeter Road property will see a massive rental uplift, potentially exceeding a 50% increase. This strategy, if successful, could drive strong organic growth in 2025 and 2026, as Hanczyk himself hinted at.

However, there are risks:

Demand Slowdown: A slowdown in industrial demand or a surge in competing supply could hinder Nexus' ability to backfill quickly and at desired rates.

Tenant Upgrade Backfire: Their aggressive approach to tenant upgrades could also backfire, leaving them with extended vacancies and lower cash flow.

Financial Snapshot

Market Cap (as of Q1 2024) $491,128,800

Targeted Dispositions $200 million+

Calgary Cross-Dock Development Yield Projected 12% on $15 million investment

Exeter Road Potential Rental Increase 50%+ on 68,000 square feet

Visualizing Nexus's Portfolio Strategy

The chart below illustrates Nexus's shift towards a pure-play industrial portfolio through strategic acquisitions and planned dispositions.

The Bottom Line: A High-Stakes Game to Watch

Nexus Industrial REIT is making a bold bet, leveraging "transitional vacancies" to drive future growth. It's a calculated gamble, hinging on favorable market conditions and their operational execution. The coming quarters will reveal whether this strategy leads to triumph or trouble.

"Fun Fact: The Canadian industrial real estate market is booming, driven by e-commerce growth and supply chain reconfigurations. Vacancy rates are at record lows in many major cities, creating a competitive environment for tenants and potentially supporting Nexus's gamble."