ORANGE COUNTY, CA—Distribution expansion is returning to the infill market, where e-commerce companies are looking to place smaller industrial buildings in order to be closer to consumers, Rick Ellison, executive director with Cushman & Wakefield's industrial properties group. The trend is moving the focus away from just the Inland Empire, where many mega-warehouses are located.

“The Inland Empire was attracting a lot of distribution tenants, where the focus was 'bigger is better' and the attention was on massive-scale distribution buildings in the 1.5-million-plus-square-foot range,” says Ellison. “But now, with the desire of having same-day or next-day delivery, a lot of e-retailers want to be closer to the population-dense markets.”

These retailers are looking to establish smaller distribution centers in order to reach customers quickly, and in many cases these centers will be located in infill markets, says Ellison. “We think we're seeing just the very tip of that trend, and it will continue to pick up steam in the next year. The initial demand is in medium- to higher-income neighborhoods in coastal communities that have more buying power. OnTrac landed a building in Santa Ana with the interest of being able to distribute to the coastal communities of Orange County, and we're hearing about similar transactions in L.A.”

Ellison says the tight Orange County industrial market that is also land constrained is helping fuel demand for construction of these centers, which will likely come from redevelopment of existing obsolete buildings. “We anticipate the vacancy rate to remain very low, and it may not be able to dip very much lower. This will drive lease rates.”

Industrial leasing activity dipped in the first quarter, according to C&W, mostly because with the vacancy rate so low—3.77% at the end of the second quarter, according to a new report from Voit Real Estate Services—there isn't much room for it to decrease, says Ellison. Also, sales activity cooled in the first quarter from Q4 2013 because there aren't a lot of sellers in the market. “But every new comp is reaching a new peak value. Interestingly, lease rates are still 10% to 15% off peak, and some small buildings haven't hit their peak. We're expecting another 10%-to-15% increase in lease rates by the end of the year.”