Projects like Orange County Commerce Center, a 232,000-square-foot industrial development that recently broke ground in Anaheim and Placentia, California, by Panattoni Development Company, are the type of large-box projects that pencil for industrial developers. | Courtesy Panattoni Development Company Inc.

How Math Plays a Role in OC Industrial Builds

Carrie Rossenfeld Industrial

From land prices to construction costs to lease rates, math plays a big role in where and how much industrial is built and which tenants will be drawn to it. SoCal Real Estate spoke with Steve Wagner, managing director in JLL’s Irvine, California, office, about how the numbers play into the Orange County industrial development game.

SoCal Real Estate: How do the numbers figure into where OC industrial developers build?
Wagner:
With an infill market like Orange County, developers need to be very opportunistic about where they construct projects. Most new industrial development projects in the last 10 years have been on excess corporate land (i.e., Boeing in Huntington Beach) or redevelopment of functionally obsolete manufacturing facilities (i.e., ITT Canon in Santa Ana) — not on former agricultural or vacant land like the Inland Empire and much of the rest of the country. This, coupled with the trend of functional industrial properties being razed and redeveloped to multifamily, creates very limited industrial development opportunities in Orange County and is pushing land values peaks to greater than $60 per square foot — double the peak of the previous 2008 recession highs.

Lease rates have been raising dramatically, and as they continue to rise, this will enable developers to pay higher and higher prices for land as they are simply solving to a return whether they are looking to build and lease/hold or build and sell. Construction costs have risen as well, and constructing a single 100,000-square-foot building is more cost effective than constructing three 33,000-square-foot buildings, so the trend has been toward constructing larger buildings to help with the yield.

The math now makes large-box industrial the most profitable at these peaking land prices, equal to or higher than yields for multifamily, which have been replacing industrial all over Orange County, and more than office and retail development yields today.

Steve Wagner | Courtesy JLL

How do the numbers impact where and how much space industrial tenants lease?
For distribution companies, there are several math equations that are important. Square footage is less important than cubic footage, meaning that a 32-foot clear warehouse with ESFR sprinklers that allows a company to stack five pallet-positions high is much more efficient than a 24-foot clear building where a company can only stack three or four positions high. To the company that is looking to maximize the “cube space,” it can pay 20 percent to 40 percent more in rent on the 32-foot clear (or even 36-foot clear, which is really the new minimum today throughout the broader Southern California market for building greater than 100,000 square feet) vs. the 24-foot clear building.

Another very important math equation is a supply-chain and logistics/network study. Simply put, where a company should ideally be located from the perspective of a) where their product is coming from, i.e., Ports of Los Angeles/Long Beach and b) where their product goes once it leaves its warehouse. E-commerce is changing the way companies distribute, and for example, we are seeing companies opening smaller (50,000-square-foot to 100,000-square-foot) distribution centers in population centers to allow for same-day shipping as a supplement to their larger (800,000-square-foot) regional distribution centers.

The math equations for manufacturing companies are more about the proximity to workforce — engineers for high-tech manufacturers and direct labor for more traditional manufacturers — and the utility capabilities of a specific building.

How does the math influence where industrial investors buy in this market?
Orange County is filled with very entrepreneurial business owners that like to own their real estate for many reasons. OC is unique in this regard, as other markets throughout the country have significantly fewer owner-occupiers. When evaluating purchasing a building, business owners will consider the cost to lease vs. owning a comparable building, what their loan payment would look like utilizing an SBA loan (10 percent down) vs. a traditional loan (25-plus percent), the tax advantages of owning vs. leasing, how long they intend to occupy a property, and how much are they planning to invest in equipment and infrastructure. Commercial real estate is cyclical like other asset classes, so at some point we will see a correction in pricing, but we have seen a steady rise in value since bottoming out in 2010, so that will also play into the decision-making process as well.

What else should our readers know about the math of industrial space?
There are a number of other ways math influences deals. Tenants need to pay attention to the operating expenses, not just the Base rent when comparing options. For example, a building with an $0.80/SF/NNN rent and $0.15/SF operating expenses is a more stable transaction than a $0.75/SF/NNN rent and $0.23/SF/operating expenses. Different annual rent increases, free rent, length of lease term, early occupancy, downtime, etc. all factor in to the overall economics of a deal and need to be considered by both Tenants and Landlords. Lastly, we have seen Tenant Improvement (“TI”) construction costs rise dramatically so both tenants and landlords need to pay attention to cost estimates when negotiating the TI package.