Industrial Rents Outpace Rising Construction Costs

The rapid increase in Los Angeles industrial rents are outpacing rising construction costs, making new construction and redevelopment of industrial properties viable. According to research from CBRE, the rise in rents will support the construction of new warehouses and distribution facilities. We sat down with Kurt Strasmann, executive managing director at CBRE, to talk about how rising rents are fueling new construction activity in Los Angeles.

GlobeSt.com: Why have industrial construction costs increased so dramatically in Los Angeles? 

Kurt Strasmann: It is a combination of several factors but they all stem from an expanding economy and exceptional demand from occupiers.  As demand increases it pushes for new developments or repositioning of assets. This leads to pressure for pricing on building materials, labor, and other construction costs, in all product types—not just industrial. Thus industrial developers are not only competing against other industrial developers, they are competing against multi-family, office, hospitality, and investors/developers for many of the same products and people. Additionally, new regulations have added additional expenses. This puts pressure on all aspects of development.

GlobeSt.com: At this point, rents continue to outpace construction costs. Is there concern that will change? 

Strasmann: Yes on multiple levels. Land has basically doubled in the last three years, costs of construction materials have increased consistently and labor inflation is on everyone’s mind. The combination of all these factors and more are very concerning, as eventually it will catch up. Thus far rents have saved investors/developers from the increased cost. Rents will have to continue to move up to align with the increased development cost that has and will continue to increase.  Rents on quality product have gone up in excess of 10% annually for some time now.  Our prediction is that rents will continue to appreciate in the immediate future (next 12 months).  The upside of new buildings is that it allows occupiers to operate much more efficiently which allows them to pay additional rent.

GlobeSt.com: Why isn’t the Los Angeles market seeing more industrial construction, if the rents support new supply? 

Strasmann: Los Angeles is an infill market. Opportunities are very scarce. When opportunities are available, multiple investors/developers are very aggressive. Each new opportunity typically sets a new record in pricing due to this demand.  The LA infill market is one of the most, if not the most, sought after market in the nation.  It is big, diverse, has depth, infrastructure, and growth opportunities. The lack of development is only the result of the lack of opportunities.  It’s been built out over the last 50 years and it is not easy to find land or reposition plays.

GlobeSt.com: How does this same dichotomy play in the Inland Empire? 

Strasmann: It is different because of the availability of land. West IE is becoming an infill market.  The further you go east, the more opportunity exist. The expansion of the IE has been ongoing for the last 35 years. The Inland Empire West is closest to LA and OC and thus was the first in line for development and expansion for companies coming out of LA/OC looking for larger facilities.  Over time, larger plots of land were developed in the IEW which reduced supply and prompted developers and companies to look further east for more availability of large tracts of land (50-100 acres plus). This trend continues as most of the large tracts of land that are assembled or available (50-100 acres plus) are in the Eastern portion of the Inland Empire.

GlobeSt.com: Where are industrial construction costs and rents heading over the next year? 

Strasmann: Costs are increasing until this phase of the recovery slows down. There is too much demand still for high quality new product.