From SoCal Real Estate’s August 2018 issueSouthern California is Prologis’ largest market. Given this position, we are uniquely positioned to assess industrial/logistics trends. Here are three things we are seeing in Southern California:
1. High demand and low supply — The greater Los Angeles/Orange County area has a remarkably diverse economy and is one of the most populous and affluent markets in the U.S. Since consumption is the main driver of logistics real estate, the area’s high concentration of consumers and businesses propels strong demand for logistics real estate and associated services. Simultaneously, supply is constrained due to a scarcity of developable land. Despite a tight market for space and relatively high rents, companies choose to locate their distribution facilities in the Los Angeles/Orange County area for fast access to the region’s high-income consumer population. This supply-and-demand dynamic is driving higher rents and replacement costs, as well as high tenant renewals and retention rates, due to relocation costs and lack of viable options. We expect this trend to persist with the continuing growth in ecommerce and the region’s economy.
2. Movement to infill — Logistics real estate that is within or adjacent to urban consumption centers is in high demand. In addition to meeting high customer expectations, customers can also use infill locations to optimize overall supply-chain costs. As distribution centers move closer to population centers, higher infill rents and labor costs can be offset by lowered transportation costs, which accounts for the majority of supply-chain costs (in contrast, rent comprises only about 5 percent of total supply-chain costs). These factors mean that infill development and redevelopment are the greatest opportunities in SoCal. To capitalize on this trend, we are starting projects this year in Vernon and Long Beach and are planning additional redevelopment projects in Los Angeles, Carson, and Compton, subject to entitlements.
3. Sustainable building features — More property owners and building occupiers are realizing the benefits of renewable energy, in terms of both the cost savings it can deliver for customers and the enhanced value for investors. Simply put, ESG is good business. It aligns with our longstanding commitment to be a good partner to our customers and an exemplary citizen, minimize our environmental impacts, and maximize returns for our stakeholders. LEED certifications and sustainable features like drainage management, efficient lighting, cool roofs, rooftop solar, and alternative fueling options are gaining ground in Southern California in an effort to make users’ operating costs as low as possible.Pertaining to the movement of goods, we’ve only scratched the surface on home delivery for groceries. The perishable products associated with this kind of delivery will drive the development or reconfiguration of more industrial building to include refrigeration and freezer space.
Beyond just groceries, last-mile delivery will continue to increase demand for nearby warehouse and distribution facilities as consumers’ desire for instant gratification becomes the new normal. We may see traditional mid- to large-box retailers incorporate more warehousing in their retail stores to help facilitate delivery, especially due to the proximity of these existing stores to their customer base. For the same reason, we may also see vacated big-box space getting converted to last-mile distribution facilities.
Additionally, pure manufacturing operations are moving out of state due to the high cost of doing business in California, and many of these vacated blocs are being backfilled by third-party logistics users.
Pertaining to development, with the escalation of land and construction costs, developers and users will start considering multi-story industrial developments. The movement of goods at a vertical facility is a new dimension for the logistics industry. Owners and users will need to determine how to utilize elevators, scissor ramps and/or trailer lifts within a multi-story building. Building engineering will change as well, as structural requirements impact clear-span and clear-height ratios, as well as a variety of other components. In the meantime, San Diego and Orange County are seeing a lot of traditional renovation or repositioning of older industrial buildings, while Inland Empire and Riverside County have more ground-up development.
Lacking a crystal ball, it’s difficult to say where we are in the market cycle, but market fundamentals suggest ecommerce will continue to evolve and grow and that consumer demand is far from sated. The supply of infill industrial space in Los Angeles, for example, has a vacancy rate of less than a half percent.
Pertaining to technology, while technological innovation has had minimal impact on the construction or renovation of industrial space, we are seeing internal systems transform with the use of robotics. Technology utilized inside the buildings is changing rapidly as retailers incorporate automation to increase efficiency.As e-commerce consumes more market share, so will the logistical demands of the industrial sector — and even more so for the densely populated SoCal region. Last-mile delivery will be one of the major change agents for Southern California’s industrial sector over the coming years. In order to accommodate consumers and streamline operations for logistics providers, it will be necessary to have smaller industrial spaces spread throughout the area. We are just beginning to see more creative space options for these providers. One important strategy is to reposition non-performing retail for industrial or flex use. This can often involve a lengthy re-zoning effort for industrial and is not always an easy task, especially in this region’s densely populated areas. However, as the demand increases for e-commerce, it is inevitable that we will need a shift in sectors that will favor industrial uses.
I believe that even sooner, we will be seeing an increasing number of retailers utilizing their stores as more of a hybrid distribution hub. Target is a good example. Recently, the retailer said that half of its online orders during the past holiday season were filled by its stores as its last-mile strategy. The retail giant is leveraging its retail locations to make deliveries quickly to nearby customers. This strategy is also more cost efficient. Amazon Prime Now is another example: Amazon has started to offer two-hour delivery of Whole Foods products to nearby customers straight from its brick-and-mortar locations.
As new technology, connectivity, and megatrends like online shopping fuel the growth of logistics needs, this increasing demand for faster delivery of more products will create jobs to serve increasing distribution needs. Ultimately, the volume and value of goods handled by distribution centers will increase the tax base for regions like Southern California. What the Wall Street Journal has called “a new eco-system of tech and services” is already transforming traditional logistics operations.
You’re not imagining it: it’s getting more crowded. So, if you ask me how logistics will continue to change the industrial sector in Southern California, my mind moves directly to traffic. Traffic will be the number-one challenge for logistics with our growing population and the limitations on growing the infrastructure. Bounded by ocean on one side and mountains on the other, we have a finite amount of land area to build roads, railways and airports — juxtaposed to, say, Arizona, where you just move farther south or north or east and you find more flat land available to expand infrastructure.
I think as the population grows, and with it the economy, and traffic moves slower and slower in Southern California, we will see the supply chain organized around smaller and smaller operations closer and closer to the dense population bases they serve. And similar to seeing convenience stores and Starbucks at every neighborhood corner, we will see “convenience industrial” at many corners close by to warehouses that distribute the products we are buying for delivery closer to where we live. What started with the 1-million-square-foot-plus distribution centers that house all the products for a region is now culminating with smaller warehouses, even within blocks, that can warehouse and distribute the products most in demand in that particular area of town. Gone are the days of ordering a pair of shoes on line in Southern California and having them shipped from a single distribution center in the Inland Empire or farther East. Today, if you are in Newport Beach, they will come from a small industrial building in the Airport Area of Irvine, Costa Mesa or Santa Ana.
The densification of Southern California and all of its counties, cities and towns, demand the densification of the industrial buildings in order to deliver the logistics and supply-chain solutions that will in turn deliver the in-demand products for those communities — in shorter and shorter amounts of time. How short a time and how close those industrial buildings will be depends on how much you really want it, need it, and are willing to pay to satisfy your immediate gratification.