Industrial Rates Rise Even as Absorption Slows

The San Diego industrial market continued its reign during the start of 2018 with record-level leasing activity. While momentum slowed somewhat, with vacancy increasing 20 basis points to 4%, net absorption was 107,860 square feet—with North County and Carlsbad leading the market—and rental rates increased to record highs, up $0.91 to $1.42 per square foot, according to the 1Q18 report from CBRE. To find out more about the market dynamics—like who is leading leasing activity and what industrial spaces are in the highest demand—we sat down with market expert Sean Williams, VP at CBRE.

GlobeSt.com: What do you think is driving this surge in industrial leasing activity?

Sean Williams: The post-recession run for industrial has been strong, particularly for our market based on the port activity at L.A. and Long Beach. That means that some of these big-picture active industries are driving a significant amount of demand, both macro and micro in San Diego. Those industries are really the consumer products and services division, not just from an ecommerce perspective; the education sector, which we call industrial space; and then warehousing and storage has been great in support to some of those consumer product services and also for ancillary uses for existing occupiers of space that need more warehouse space. Additionally, a couple of San Diego staples in defense and construction have also been significant drivers. I think that what has caused the surge is continued success and strong performances under those segments. When you look at the talented labor force and the quality of life here, it is a big driver for smart people to want to remain here and work in some of the non-warehouse industrial uses.

GlobeSt.com: What sizes ranges have been most popular, and what types of spaces are the most sought-after?

Williams: Historically, the smaller size segments in San Diego have been the real driver. The average size tenant in San Diego is somewhere between 3,000 and 5,000 square feet. From a product-type standpoint, on the low-finish side, functional warehouses are really a driver, and by functional, I mean a good amount of dock doors and excess trailer parking. So, it is functional warehouses for low-finish product. On high finish, power has become more and more of a critical factor. The older buildings that San Diego has weren’t built to today’s power standards. Image is also important. Some of the vintage buildings aren’t the contemporary look that everyone is looking for.

GlobeSt.com: For that reason, have you seen more value-add or redevelopment projects?

Williams: The problem is that the vacancy for true warehouse space is so tight for central San Diego is that there aren’t a ton of opportunities to do that without a lot of displacement for tenants.

GlobeSt.com: Lease rates have hit all time highs as a result of the tight supply. How has this activity impacted asset values and investment sales?

Williams: Leasing comps are really enticing appetites to buy. The challenge is that because there isn’t much new inventory coming onto the market, it is hard for institutional investors to justify even a huge bump from their basis in sale prices versus the stable cash flow that does have a good basis that is taking advantage of these lease rates. Those owners aren’t able to sell a property in San Diego and then find another property in San Diego. On the private capital side, we are seeing good demand from trade buyers coming from a whole variety of places. They are looking to trade out of low cap rate deals by their standards and trading into low San Diego cap rates.

GlobeSt.com: Activity is already hitting record levels. Do you think this is the beginning of a long-term trend?

Williams: I think there is a long road ahead of us. With the exception of the product under construction in Otay and North County, there is no more product coming out of the ground. There are multiple people knocking down doors to find product. So, unless there is some really significant negative action happening where people start closing down shop or moving out altogether from San Diego, we are dealing with an existing inventory that is going to remain tight for the foreseeable future.