SOUTHERN CALIFORNIA—Up and down the coast of Southern California, lack of industrial inventory is the biggest problem for the sector, stunting growth for investors, developers and users seeking space in this highly desirable region. GlobeSt.com spoke exclusively with three Voit Real Estate Services brokers—Seth Davenport, SVP in the Anaheim office; and Todd Holley, VP, and Weston Yahn, associate, in the San Diego office—about what the barriers are, why the market is so tight and what lies ahead for the sector in this region.
GlobeSt.com: What are today’s barriers as you see them in our rapidly changing industrial market?
Holley: Lack of industrial inventory is the biggest problem. Many companies are being forced to expand their search for suitable facilities beyond their preferred areas. This can affect a business in many ways including increases in employee commute times as well as distribution and transportation costs. This brings employee retention issues into the picture as frustrated workers look for jobs closer to home. Rising land cost is also posing a challenge for conventional industrial product. What little development there is tends to be in more heavily improved facilities that can command much higher rents. Even existing industrial buildings are being converted to R&D for the same reason, which squeezes supply even further.
Davenport: The single biggest barrier and challenge in today’s market is the vacancy rates. While Orange County is at 2%, when you actually evaluate the market statistics on specific sub markets or specific sizes, that rate shrinks dramatically and in some cases is actually 0%. Whether a buyer or a tenant is looking for a space or an investor looks to place capital, this vacancy barrier makes competition fierce, concessions minimal and economics less favorable than you would find in a market with greater supply and therefore alternatives.
GlobeSt.com: What are the factors making for such a tight market, and how do you see it playing out?
Yahn: As the economy has improved over the past few years, businesses have been in expansion mode. Net absorption of space has been so strong that vacancy has declined to critically low levels. This combination usually acts a catalyst for new development, but land is scarce and expensive, making it hard for developers to respond with new industrial projects to satisfy demand. The existing base inventory is aging and becoming functionally obsolete, and that intensifies the competition for the more desirable and functional spaces that become available. We don’t see things changing much in the near term, and it may even take another market correction to reverse the trend and free up quality space for growing companies.
Davenport: Several factors have contributed to the low vacancy rate, but two stand out the most. First, the market was already effectively “built out” before we hit this latest boom. Without raw land for development, tenants and buyers are forced to consume available space without since the industrial base isn’t expanding. Secondly, residential in-fill redevelopment has consumed millions of square feet of industrial space as owners seek significantly higher values for residential re-zoning than they could hope for as an industrial site. As far as “how it plays out,” I don’t realistically see a positive solution that could create more vacancy without a significant rise in interest rates or a blow to the economy. With money as cheap as it is, buyers should continue to bid up values since their occupancy costs are lower as an owner than they are as a tenant, even at record-high prices. Without alternatives nearby, small business owners will have to decide whether they want to battle longer commutes or move out of state if they no longer wish to compete for real estate in this market.
GlobeSt.com: What options do industrial developers and tenants have when there’s seemingly nowhere to build or go?Yahn: The nominal amount of development continues to be outside the periphery of Central San Diego. Raw land in North County and South Bay has long been targeted for new industrial development and is now in play. The more recent opportunity for developers is taking place in Central San Diego. The emergence of the tech and life-science industries has sparked the demand for research-and-development properties. In 2015, venture-capital money for these industries increased 40% year over year. In short, the ability for tech and pharmaceutical companies to pay three times more than traditional industrial users has created an opportunity for redevelopment and forced pure industrial users out of prime real estate.
Davenport: Be creative, patient, flexible … and most importantly, trigger-ready. Whether a developer, tenant, investor or buyer, we have found that the people who are rigid in their requirements and parameters have a very hard time finding facilities or deals that are “perfect.” Given that there may only be a couple deals a year in that size range, it is the groups that are creative and flexible that see the vision and value in the deal and actually transact. Having vision is great, but we encourage our clients to be trigger-ready, which is also critical since there is most likely stiff competition motivated and focused on the same deal. Delays during the decision-making process, negotiations or in gathering financials can oftentimes be what costs clients the deal.
GlobeSt.com: What else should our readers know about today’s industrial market?
Holley: In 26 years of industrial sales and leasing, I’ve never seen the market this tight. It is important to know that the shortage of available space prolongs the process of completing a relocation. Even companies who are not contemplating a move in the near term are well advised to stay up-to-date on market conditions at all times, so they can respond quickly when the time comes to make a decision. Those who allow even three to six months to complete the relocation process may find themselves without viable options and may be forced to remain in space that is no longer efficient. Depending on the complexity of the transaction, it can take as much as a year to complete a transaction. Landlords aren’t making things easy either. They are demanding stronger credit, longer-term leases and offer little in the way of concessions like free rent and tenant improvements.
Davenport: One of the most interesting discussions we have is with regard to market timing and the cyclical nature of the market. We all agree that a correction is forthcoming, but no one is sure as to when or how deep it will be. While a lot of focus is on the debate of “What inning we are in?” I think that a more relevant discussion is, “How far is your horizon?” The nature of this market allows for it to be an ideal time to buy and sell for different reasons, based upon what a client’s timing needs are. Buyers, who intend to occupy their buildings for the next 10 years would be wise to purchase at all-time high prices, even if the market corrects in the next several years. With interest rates as low as they are, their cash flow is still better than the alternative of leasing, and the market has always proven that average prices consistently grow in the long term. For sellers, now is a great time to sell, especially if they intend to sell some time in the next five years. We have already seen appreciation rates begin to fall year over year and most agree that the market has already experienced its greatest growth.