Cameron Driscoll

The Orange County industrial market closed Q1 with negative absorption, but the event was entirely driven by a single tenant: JC Penney. The retailer vacated 1.1 million square feet in North Orange County, creating negative 872,683 square feet in absorption for the first quarter and bumping the vacancy rate to 3.3% for the market, according to research from JLL.

“The JC Penney vacancy took the market from a positive 209,709 square feet absorption to negative 872,683 square feet,” Cameron Driscoll, managing director at JLL, tells GlobeSt.com. “Additionally, there is 422,000 of new construction completions that also had an impact on absorption. In general, absorption tends to be somewhat static in a market with prolonged low vacancy rates. One or two large vacancies can really move the needle in a tight market with very little new construction.”

Despite the negative absorption for the first quarter, Driscoll says the store's move out will have minimal impact on the industrial market. “This vacancy is totally unique and does not compete with anything in Orange County or L.A. County. If anything it may compete with other 700,000 to 1 million-square-foot buildings in the Inland Empire,” he says. In fact, this new supply could fulfill demand for mega-box spaces close to population centers. “This is very rare as all available properties of this size are in the Inland Empire and are 40-60 miles from the port,” adds Driscoll.

Still, the leasing activity for large industrial spaces, like this, can be challenging, particularly in an infill market. “Absorption for a building of this size is difficult to predict,” says Driscoll. “Its size makes it unique and the pool of tenant's looking for 700,000 to 1 million square feet is fairly shallow. Ultimately I think there's a large tenant out there that can monetize the benefits of proximity to the population and the ports. I expect it will lease within the next 12 months in the lows $0.70's nnn/sf.”

Because this is a rare asset for a very specific industrial user, Driscoll says that landlords or rental rates. In fact, in the same quarter that the space came to market, rental rates increased an average of $0.93 per square foot, triple net. “The vast majority of space in OC is between 10,000 to 50,000 square feet, so a vacancy like the JC Penney building does not have much influence on other landlords and tenants,” says Driscoll.

For landlords in the Inland Empire, however, this vacancy could provide leverage. Industrial facilities in the Inland Empire are more on par with an industrial facility this size, and its location could be an asset for the right user. “I could see users leveraging this building against the Inland Empire market as it provides them an option that is much closer to the ports and population,” says Driscoll. “The location of the JC Penney building will be preferred by tenants that have a heavy volume of inbound containers from the port and/or need proximity to population density for e-commerce fulfillment.”

The negative absorption, however, is not a reflection of a shifting market or changing fundamentals. Industrial activity and demand in Southern California remains healthy. However, Driscoll does have some concerns about the length of the cycle, and advises caution. “The industrial market is still strong although I believe this business cycle is getting long in the tooth,” he says. “E-commerce is a new demand driver that did not really exist five years ago. Additionally, a lack of available industrial land has kept developers from over building during this cycle. In a nutshell demand is still strong an supply is low. We expect rental rate appreciation to continue although at a slower pace than recent years.”