NEWPORT BEACH, CA—The ports are one of the reasons the Southern California industrial market attracts so many developers, including REDA Bascom Ventures. recently reported that the developer broke ground on two industrial developments totaling 500,000 square feet. To get more information on the projects and why the developer is bullish on the Southern California market, sat down with REDA principal Jason Krotts. Both these developments are in two major Southern California markets. Why were you attracted to these sites?

Jason Krotts: In the case of the Malt Avenue Distribution Center, we saw an opportunity to redevelop a site containing three functionally obsolete buildings in a market with high barriers to entry, very low vacancy and high demand. We strongly believe in the in-fill markets of Southern California as the Greater L.A. submarket has had four consecutive quarters of positive net absorption. The site’s proximity to the ports of Los Angeles and Long Beach as well as the large population base being serviced from Southern California makes it an attractive opportunity. 

In the case of our Fontana project, the Hemlock Distribution Center, the Inland Empire has always had strong demand for industrial buildings. We believe the Inland Empire is one of, if not the strongest, distribution markets in the country and possibly globally. Over the past seven quarters, the Inland Empire absorbed over 25 million square feet. The location of this submarket within Southern California makes it attractive because user’s occupancy costs can be substantially lower than those in other parts of Southern California. The proximity to the ports of Long Beach and Los Angeles as well as the transportation corridors not only link Southern California to the Inland Empire, but also link it to the balance of North America.

We believe one of the economic engines driving Southern California industrial real estate are the ports. 69.2% of Asian import TEU’s enter the U.S. via West Coast ports and 70.4% of these TEU’s are handled at the Ports of L.A./Long Beach. Additionally, 42% of all imports to the US travel through the ports of L.A./Long Beach and about 50% of these imports are shipped east. Today, all US ports handle approximately 2 billion tons of domestic import/export cargo annually. By 2020, this number is expected to double.

Both of these markets are attractive for e-commerce users as well. U.S. e-commerce sales were up 16.9% year-over-year in 2013 totaling $263.3 billion, but only accounting for 5.8% of all US retail sales. Over the past 10 years, online sales are up over 185% and are expected to grow annually by 10-14%. There has been a shift in the consumer patterns and people are purchasing more and more online as opposed to traditional brick and mortar retail stores.  These shifts have caused retailers to reorganize their supply chain and look at locations that are in-fill or located near or close to transportation and logistics hubs such as FedEx and UPS. Do you plan to sell or lease these properties, and why? 

Krotts: Our long-term goal is to create a portfolio of quality income producing assets for our partners and investors. However, given the demand in the market, lack of quality product, the spread between lease rates and sales prices, we would be open to entertaining all options as long as they made sense economically for our partners. What is the cost of each development? If you plan to sell, can you talk about the targeted sales price and the return you expect?

Krotts: The combined cost of the two projects is close to $45 million. The Malt Avenue Distribution Center is being developed all cash and the Hemlock Avenue Distribution Center is being developed with a construction loan of $17.9 million from Bank of the West. If our partners elected to sell these assets, we would expect to sell them at a price that would provide us with the appropriate risk adjusted return relative to market conditions. At the beginning of the industrial upswing, big box facilities were in the highest demand, but these are mid-sized facilities. Do you think that is where demand is now?

Krotts: While the big-box market has been in demand, the smaller buildings have been ignored. Now, in all reality this segment of the market probably saw the most distress as the user profile is different than that of big-box. About 24-36 months ago we started looking into historical data for deliveries and absorption annually. What we saw was demand (over a 10-year period) outpaced the supply and there was very little supply with nothing planned in the smaller size range. When the market shifted and the economy started to climb out of the recessionary hole we had dug, the larger buildings were the first to take hold.  As the recovery has strengthened, we have seen some creep into the smaller building sizes. Although it has taken a while, we believe this size range is poised for growth.

Currently, I think there is demand in all sizes. For example, 80% of all Inland Empire transactions in the first quarter of 2014 were less than 100,000 square feet. Yet, there is over 16 million square feet currently under construction, most of which is for buildings greater than 500,000 square feet. When you move back into the in-fill markets of Greater L.A., the sizes of buildings are typically smaller. However, last year two big-box buildings were built on spec totaling over 1 million square feet. The larger of the two, a 615,000 square foot building was successfully leased the entire building to one tenant. We are lucky to be in such a strong, active market.