From SoCal Real Estate’s August 2018 issue
It’s not just the baby boomers here who are aging — our buildings are, too.
CBRE recently reported that momentum for additional construction of U.S. warehouses is not likely to wane because the vast majority of the country’s warehouse stock is decades old and ill-suited for the needs of e-commerce. This is a national problem, but the issue is especially painful in Southern California because of the already-low industrial vacancy rates and many users’ need to be close to the ports.
When it comes to age, industrial inventory in Southern California is largely bifurcated. Because the Inland Empire is a relatively new industrial market — particularly when it comes to large warehouse and distribution facilities — many of the buildings are newer, state-of-the-art facilities. On the other hand, many industrial properties in other regions of SoCal were built decades ago, making them obsolete for today’s users and adding to the already-troubling dearth of available space.
Take San Diego, for instance. According to a recent report (complete with infographic) from Cushman & Wakefield (C&W), only 3 percent of San Diego’s current existing inventory was built after 2009. Since the 1970s, San Diego’s existing inventory grew on average 39 million square feet each decade, but since 2010, inventory grew by less than 4.5 million square feet. “At this level, there is not enough new supply to satisfy demand for new and functional industrial space,” says C&W.
With the countywide industrial vacancy rate at a 15-year low, the demand for modern and specialized space in San Diego is rising, the firm reports, and one solution is redevelopment. In response to the low vacancy and increasing demand, C&W reports, “We are not only seeing asking rental rates increase but also an increasing trend of renovations of older product to make them more appealing to tenants.” The report cites an opportunity for redevelopment in the 82 percent of industrial inventory that was built prior to 2000.
Demand for this type of redevelopment will only continue to grow. According to a report from Avison Young (AY), industrial vacancy in San Diego fell 50 bps year-over-year to 4.4 percent in the first quarter of 2018. Vacancy has remained below 5.5 percent for the past three years, and there was minimal construction activity during that time.
As of the first quarter of 2018, construction projects have gained momentum in San Diego, AY says. More than 2.1 million square feet of new industrial inventory was under construction in eight separate projects around the county, with the bulk located in the North County and South Bay submarkets. The largest project is the Carlsbad Oaks North business park located in East Carlsbad. Three separate buildings located in Carlsbad and Oceanside completed construction during the first quarter, adding 328,500 square feet of new inventory. As developers become emboldened to take on new projects where limited opportunities are available, AY expects vacancy to edge upward.
The Orange County industrial market also remained tight in the first quarter of 2018 as record-low vacancy persisted, pushing rents to record highs, according to the AY report. Even with a modest spike in the construction of speculative inventory, supply is trailing demand in this market as well.
The industrial vacancy rate for the first quarter of 2018 remained extremely low at 2.2 percent in Orange County after a modest increase of 20 bps year-over-year, the firm reports. Industrial tenants seeking new space can expect a challenge as the number of options decline. As of early June, the only industrial property currently under construction in the market was Beckman Business Center, a seven-building industrial park located in Fullerton, California, that was slated to bring a total of 934,800 square feet of speculative space to the market by mid-year 2018. Meanwhile, a 143,930-square-foot build-to-suit for Rosendin Electric at 1730 South Anaheim Way in Anaheim — which, as SoCal Real Estate reported in May, was sold to American Realty Advisors — completed construction during the first quarter of the year. There is approximately 800,000 square feet of proposed development, spread among five projects, waiting to commence in the market, according to AY.
As demand for industrial space increases in Orange County, larger tenants increasingly look to options in the neighboring Inland Empire. However, last-mile warehousing is a necessity within Orange County as consumer expectations grow along with the population in this affluent county, AY says. In addition, as SoCal Real Estate reported in April, industrial vacancy is also low in the IE market, falling to just above 3 percent at the end of Q1.
CBRE also reports bifurcation in SoCal’s industrial sector, saying that the Inland Empire is flush with new state-of-the-art facilities ideal for e-commerce distribution, yet the Los Angeles area as well as some parts of Orange County are dominated by old warehouses that were originally designed for a manufacturing economy. Kurt Strasmann, CBRE’s executive managing director of Orange County and Inland Empire operations and Southern California functional industrial & logistics-market leader, CBRE, said in a recent statement, “There is opportunity, but it’s a challenging one. E-commerce and distribution companies require different functional needs than that of a manufacturer.”
Strasmann tells SoCal Real Estate, “The IE is a newer market, so the bulk of the buildings there are pretty good, and that’s evolving. That market has had about 500 million square feet of warehouse space, and 100 million of that has come on line in the last five years only. There are good buildings there, for the most part. Designs are evolving as business models have evolved. We’ve gone from a manufacturing-based inventory stock to a business model where the demand is for warehousing.”
The infill areas, on the other hand, are different from the Inland Empire, Strasmann says. “Many of these buildings were built 40 or 50 years ago, and what was in vogue then was different than what is now.”
There are many challenges that industrial owners and developers face in both new development and redeveloping old inventory to bring it up to current standards, including rezoning of industrial to higher and best uses such as multifamily and residential and the sheer lack of land available on which to develop this product type.
“It’s not like land is available in these different areas that you can develop — this is few and far between,” Strasmann says. “Most of it is already developed, and to reposition — or more adequately said, to tear down and rebuild — is challenging. First, something has to be available for sale; then, you can tear it down and rebuild. But then, you are dealing with a lot of regulation in California. This is all exacerbated by low vacancy. For the size of the market, there are very few new developments.”
Increased clear height is the number-one criteria for modern industrial distribution and warehouse users, but this is not always easy to achieve in a redevelopment. Users “would love to have increased ceiling clearance to have warehouses as high as they can,” Strasmann says. “You need maximum clear height to maximize cubic square footage, but there are regulations controlling this.” He adds that adequate truck-turning distances are another requirement — many warehouses need 185 feet, but and sometimes the property doesn’t lay out that way.
There are also other demands from today’s industrial users. For example, sometimes sprinkler systems need to be upgraded for modern buildings. “There’s a calculation of how much water spreads over a certain square footage in a certain time frame, and that often needs to be updated,” Strasmann says. “The higher up you go, the higher calculated the sprinkler system needs to be.”
Cost is a major challenge for many to satisfying these demands and requirements. “Raising the roof on buildings is very expensive, and there are structural concerns that can be cost prohibitive,” says Strasmann. “It’s more efficient just to tear down and rebuild — this has been proven by all the developers.”
Will the SoCal market ever embrace multistory industrial, as some markets like Seattle have begun to do? “I think we eventually will, but it’s still cost prohibitive,” Strasmann says. “There are height limitations on buildings, depending on where they’re located. Prologis is the first developer in the west doing multistory, and this is in Seattle and the Bay Area.”
In adapting to the lack of state-of-the-art warehouses in this market, many users are expanding the radius of their search. “Typically, you would want to locate close to where you’re at, but due to lack of inventory, particularly in Orange County and L.A., they are looking in a much larger geographical set to find the right facility,” Strasmann says. “We’re in a very unique time period, with the vacancy rate where it’s at and the economy where it’s at. There’s a finite amount of land and buildings, and when sites come up, often the industrial sector competes with residential, which exacerbates the problem. So, lease and sale prices have gone up. We’re all experiencing this same issue in many markets, so we’re making do with what’s available.”
The IE is a little different story since this market is adding more than 20 million square feet of industrial a year — that’s why there’s been such tremendous growth in the IE, Strasmann points out. But that market is also averaging over 20 million square feet in net absorption annually, so demand has kept up with the supply being delivered. “Certainly, the e-commerce factor has contributed greatly to what’s going on. There’s the double whammy of e-commerce and the fact that the general economy is diverse and broad.”
There are still solutions available. In the infill areas of San Diego, L.A. and Orange County, raising the roof is ideal, but the next best thing is working on the aesthetics: exterior curb appeal, hardscape, and landscaping to make a property look nice.
“Modernizing the interior office space is also very important,” Strasmann says. “Then, from an efficiency standpoint, improving the efficiency of loading to increase capacity or run a logistics model with more truck doors that allows more inventory flow in the building can be done. Lastly, the sprinkler calculation is the big one. It’s important to allow the storage of different types of products in warehouses. It’s a really hard and challenging problem, but the best solution is if something comes up for sale, tearing down and rebuilding.”