Industrial Market With Below 1% Vacancy?

RIVERSIDE—Charley Black, SVP of Lee & Associates' Temecula Valley Office, has been in the business for 27 years. And yet, he tells GlobeSt.com that he has never seen a market like this one. "The Southwest Riverside County industrial market is in total gridlock with a vacancy rate below 1%."

Sale prices and lease rates have regained almost all that was lost during the Great Recession, Black continues. "Based on prior market cycles, by now one would expect several speculative industrial developments under construction (it's always occurred before)."

However, Black says, he doesn't expect to see any spec buildings under construction in Murrieta, Wildomar or Menifee until at least 2017. "And there's no certainty we'll see new buildings then."

So why the gridlock?  Black says that after a few failed escrows and many discussions with developers, engineers, and governmental officials, he concludes it is due to the following:

• The type of developers who historically have built spec buildings in Temecula / Murrieta are now extinct. Today, the entitlement process is long, demanding, expensive and complicated.  An entire real estate cycle may come and go from the time a developer starts planning a project until the time he is able to build it. 
•  Construction financing is extremely difficult to obtain. Local banks have little or no interest in financing speculative construction. The banks who survived the last downturn have no taste to jump back into speculative construction financing. Federal regulators aren't giving the banks any financial incentive to stick their necks out either. If you can find a loan, terms will be tougher. As the old saying goes, the only ones who can qualify for a construction loan are the ones who don't need it.
• Construction costs are higher across the board.  Labor, materials, architecture, engineering…everything costs more now. 
• The cost for permits, fees, and regulatory approvals have increased considerably. Title 24 requirements are now much more expensive. Water quality, water conservation, storm water retention – detention...the list goes on. Water and sewer hookup costs will cause anyone severe heartburn. City Hall is not always to blame here….the source for many of these new layers of regulations originate in Sacramento and / or Washington D.C.
• With all of the higher costs, smaller building development simply isn't as profitable anymore. "I've contacted virtually industrial developer in Southern California to tell them about the opportunities here in SW Riverside County's industrial market. Most are not interested. They're busy constructing 1-million-square-foot behemoths 40 minutes north, then leasing and then selling them to Wall St. and Insurance Pension Funds at 4% cap rates." These developers have all the equity partners they need. Their profit margins are much higher in building one 800,000 square foot building vs. building 10 buildings that are 8,000 square feet. "One of my best clients told me just last week that he's no longer going to consider a 5 acre or 10 acre project.  The 'brain damage' to entitle a 50 acre development is the same as entitling a 5 acre project. He said that he might as well 'go big' if he's going to subject himself to the pain." 
• Landowners need to adjust their price expectations. As mentioned – building prices have once again reached 2006 levels. But that doesn't mean land values are once again back to 2006 levels. With all of the additional costs in 2016 that didn't exist in 2006, how can a developer expect to pay the same price for vacant land? Answer: they can't. In 2006, one could buy a finished 1 acre lot for $8 per square foot, construct a 15,000 square foot building and be "all in" with their total construction cost at $105 - $110 per sq. ft.  With that same land value in 2016, that same developer will be "all in" at $135 per square foot. Assuming a developer needs to see a 20% profit on cost, then the building will need to sell for $168 per square foot. Today's building sale prices will need to increase another $35 to $40 per square foot. before developers can afford to pay $8 per square foot for finished land.  

The above factors have definitely left a vacuum n this market, and perhaps an opportunity for someone who can endure the pain, Black says. To sum up, Black points out that he recently ran a summary of all vacant, existing industrial space for lease between 8,000 and 20,000 square feet in the combined cities of Temecula, Murrieta, Menifee, Wildomar and Lake Elsinore—which comprises a total market size of approximately 17.5 million square feet. "Total number of buildings available was one," he says. "And the only way it qualified was because it consisted of two separate but adjacent suites of 6,500 square feet at 2,000 square feet each." But Black says he bets he will have it leased by next week.

To read more on the industrial market in the surrounding area, check out the following story:

Strong I.E. Activity, Despite Lack of Inventory