The behavior of how Always Included Shaders works is that all Variants will be built for those shaders, Instancing variants however will be built based on Graphics Settings Instancing Stripping. In this case, since the terrain is in a bundle, but the shaders are in the build, the terrain data cannot influence how the shaders are built. This is a known limitation that we are not fixing.

If you take the sample project provided, and remove the terrain shaders from the Always Included Shaders list in Graphics Settings (or reset Graphics Settings), rebuild bundles and player, everything, including instancing, works correctly due to this fix.