caTORONTO (Reuters) - Canadian mall owners are adding condos and apartments to their shopping centers, seeking to capitalize on a supply-constrained housing market while reducing exposure to a struggling retail sector.

A worker walks to a nearby cafe from RioCan's ePlace project, a commercial/residential development in Toronto, Ontario, Canada December 19, 2017. REUTERS/Chris Helgren

Developers such as RioCan REIT REI_u.TO, Canada's largest property trust, and the property units of some Canadian pension funds are turning prime land that has historically not been put to best use - such as parking lots or low-rise retail - into housing in one of the world's most expensive, supply-constrained residential markets.

In the greater Toronto area, there were 12,500 new homes available to purchase in October, less than half the average between October 2000 and 2015, according to Altus Group.

The rental market is just as tight. Toronto has a 1 percent rental vacancy rate, according to the Canada Mortgage and Housing Corporation. That was despite the highest level of rental construction in 25 years in the third quarter, according to Urbanation Inc.

Home prices have surged more than 60 percent in Vancouver and 40 percent in Toronto in the last three years. Even pullbacks in these markets this year following policies to dampen price gains appear to be reversing on continued demand and limited supply.

“The population is growing and there’s no real land left” in Canada’s biggest cities, said RioCan Chief Executive Ed Sonshine. “Demand for retail space isn’t growing... it makes perfect sense on so many levels.”

In Toronto, RioCan is creating ePlace, a development with about a fifth of the retail space of some of its other malls, 1,100 condominiums and apartments, and some offices.

The 466 rental apartments will add the first of 10,000 residential units the shopping center developer plans to own by 2025 across 50 properties.

Buyers are responding. All the condos at ePlace, expected to be completed by early 2019, have already been sold.

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Even owners of thriving malls are joining in.

Yorkdale Shopping Center in Toronto is Canada’s most productive mall, with C$1,653 ($1,285) of sales per square foot for the year ended June 30, according to a Retail Council of Canada study.

But owner Oxford Properties, the real estate unit of the Ontario Municipal Employees Retirement System, is seeking to add as many as 1,496 residential units, offices and hotel space under a planned revamp.

Oxford is betting that better public transit and technological changes such as autonomous vehicles will reduce demand for parking, said Bradley Jones, head of retail at Oxford.

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Rising retail vacancies, exacerbated by the demise of Sears Canada and Target Corp’s Canadian operations over the past few years, “have caused even more people to start thinking that there are alternate uses for part of their sites,” said Matthew Smith, head of national retail investment at Jones Lang LaSalle.

And, if a concentration of retailers around transport nodes is weighing on businesses despite their location, changing some to residential could reduce that burden, Smith said.

It’s not simply about plopping a few apartments on or adjacent to existing malls, however. Owners like Cadillac Fairview (CF), a unit of the Ontario Teachers’ Pension Plan, have concluded that the traditional mall, anchored by department stores with chain stores and fast-food restaurants in between, may no longer be as profitable.

CF plans to spend about C$2 billion to add residential units at four of its malls, in addition to one under construction in Toronto, said Finley McEwen, its senior vice president for development.

Many of the redevelopments include “turning the malls inside out,” putting specialty stores, sit-down restaurants and other non-traditional mall occupants facing outward, which, combined with the residential units, create a space that’s more alive, McEwen said.

“Mixing uses creates a vibrancy after hours, they create safer streets ... And they become naturally more attractive,” he said.

($1 = 1.2861 Canadian dollars)