From SoCal Real Estate’s July 2018 issue
Office, retail, and multifamily are also reaping the benefits of economic growth in this market.
By Carrie Rossenfeld
Touted by many in the commercial real estate industry as the hottest industrial market in the country, the Inland Empire wasn't always the burgeoning economic region it is today, says John Ewart, senior managing director of Newmark Knight Frank in Ontario, California. Ewart, a third-generation Inland Empire resident, says, "I come from a long line and deep roots in the IE." His grandfather settled in Pomona, California, in 1862, and Ewart himself grew up in Rancho Cucamonga, California, a place that used to be referred to as "the valley of the dirt people."
Despite the pejorative names, this area of Southern California has what most markets on the coast can't offer and what occupiers desperately need: land, and lots of it. That land is satisfying demand from industrial developers, who have been busily building million-square-foot warehouse and distribution facilities in the market to serve the growing e-commerce industry. But industrial isn't the only sector that's benefiting from this abundance.
Ewart says that the availability of land has drawn people to the IE for generations. Being very rural, the market has always had an abundant surplus of land, and with the huge development curve the industry experienced after the recession, there's been a continual push for affordable acreage — for industrial as well as other uses. "Although industrial is the Inland Empire's powerhouse, the office, retail, and multifamily sector fundamentals have gradually improved in recent years," Ewart says.
The numbers bear out. According to NAI Capital, the IE had the lowest office-vacancy rate in Southern California during Q1 2018, clocking in at 7.9 percent, down 100 basis points over Q1 2017. Meanwhile, the office-market vacancy rate across Southern California was 10.2 percent in Q1, up 20 basis points over Q1 2017. Orange County, Los Angeles, and Ventura County all saw rising vacancies year after year: Orange County was up 80 basis points to 9.7 percent, Los Angeles was up 30 basis points to 11.3 percent, and Ventura County was up 80 basis points to 11.6 percent.
"The reason we're so low on office space is that we came out of a horrible downturn where there was no development, and net absorption has been positive for the last six years running," Ewart explains. "Our office vacancy is the lowest it's been since 2007 — that was the beginning of the downturn. Unemployment is hovering near a record low of 4.4 percent, and we've added 130,000 or so new jobs, but there are only a handful of development projects that have broken ground or will break ground. There are a couple of owner/user developments being developed and a couple proposed, but with absorption at such a high rate, by the time they are completed, at the current rate of absorption we will probably be hurting at 3 to 4 percent vacancy."
Ewart adds that few northeastern Orange County office tenants have also migrated inland to access competitive office rents and, in a few cases, take advantage of low interest rates to own rather than lease.
Medical-office absorption may also be increasing in this market. According to CoStar Market Analytics, the number of 55- to 69-year-olds has more than doubled since 2000, which benefits healthcare employment and favors demand for medical-office space in the IE, although Ewart points out that this market is not tracked by NKF.
Also, as retail giants continue to move their warehouse business to the IE, their corporate presence may follow, which could put the IE's office market on the map as an attractor of big-league corporate users. "With the Walmarts, QVCs, and Amazons bringing their industrial business out here, we may start to see corporate types in the office sector. We're hopeful this will happen."
Ewart says affordable housing is drawing SoCal residents inland, which is also helping to grow office demand. The number of residents living in Los Angeles, Orange, Riverside, and San Bernardino counties increased by 82,000 from 2016 to 2017, according to recent data from the U.S. Census Bureau. Most of the growth came from the Inland Empire's two counties, with Riverside adding nearly 37,000 residents and San Bernardino growing by another 20,000 new residents.
The median home price was $710,000 in Orange County and $580,000 in Los Angeles County in February, according to CoreLogic, compared to $375,000 in Riverside County and $336,500 in San Bernardino County. Inland Empire apartment rents are also 34 percent lower on average. "An influx of new residents benefits office sectors that serve the local population, such as banks, insurers, law firms, and government agencies," Ewart says. "This in turn leads to greater demand for office space."
Population growth, paired with a healthy labor market, is also favoring the IE's retail segment. Ewart says new construction is following housing rooftops, with the market becoming a focal point for discount retailers such as ALDI, Dollar General, and Daiso. "Vacancy of 7.1 percent is on par with late 2008, while rents are flat. Lifestyle centers with a healthy mix of dining and entertainment options continue to net foot traffic. Home prices are increasing, and inline retail tenants, especially those in neighborhood centers, are not very active, since many use home equity to finance their business."
Like in most parts of the country, many enclosed malls in the IE are struggling. Plans to renovate Montclair Plaza fell short in 2015, for instance, and according to Ewart, the mall's owner now wants to focus less on shopping and more on eating and entertainment and even housing and offices. "This does not apply to Ontario Mills, which sees about 28 million visitors a year, 10 million more than Disneyland. The center manages to achieve a balance between discount shopping and dining and entertainment options."
Since the other food groups are doing well, it stands to reason that multifamily is also on the rise in this region. Strong employment growth and a steadily improving economy are driving demand, and deliveries over the last few years have enjoyed solid lease-up phases. "As was the case before the recession, rising home prices and rents in neighboring metros L.A. and Orange County help to drive in-migration to pockets of the Inland Empire, specifically to Ontario, Rancho Cucamonga, Corona, and Riverside," Ewart says. He adds that multifamily occupancy was at 95.7 percent as of late April, with approximately 3,267 units under construction at that time, and rent growth of 4.8 percent is expected this year.
Ewart cites many economic drivers for this market. Proximity to Southern California's consumer base (23 million residents) and the nation's busiest port system, a predominately blue-collar workforce, modern space for consolidation/expansion, and competitive rental rates are driving the industrial market, while affordable housing relative to Los Angeles and Orange County affects the region's office, retail, and multifamily markets.
Investors are also looking favorably upon this market. "Industrial aside, institutional investors generally view the Inland Empire as a bedroom community that attracts residents from pricier markets," says Ewart. "Escalating housing and business costs in Los Angeles, Orange County, and San Diego bode well for household relocations and local population growth."
He adds that investors view the IE a lot more favorably than they used to. "A handful of years ago, you wouldn't get a company like Hines to come out here and consider buying. You get the feeling from those sectors that we're a bunch of hicks. You would hear us referred to as ‘the valley of the dirt people,' a lot of negative, like Mad Max, fighting each other for gasoline. But investment groups like Greenlaw followed Hines, and we're starting to get a lot more, even though five years ago you couldn't get them to return your call."
And the lender view goes hand in hand with investors. In the past, the only property type lenders were willing to lend on was industrial — they wouldn't touch an office building as an investment unless the buyer was committing at least 50 percent equity to the deal, Ewart explains. "Now, that's starting to change," he adds. "I get deluged by smaller SBA lenders all the time. Our market attracts a lot of mom-and-pop, local-type tenants, so they look for mom-and-pop banking to finance their buildings." Some of the popular commercial real estate lenders in this market include Citizens Bank, Arrowhead Credit Union, Wells Fargo, California Security, Banner Bank, Bank of the West, Pacific Western, and East-West Bank.
Perhaps because of its mom-and-pop, rural persona, the IE still has a hometown feel no matter how much it grows, says Ewart. "Personally speaking, and you may not get this from people in the 949 or 714 area codes, but there's a quality of life here that is truly special. I know my neighbors, and my neighbors know me. The other day, we inadvertently left our garage door open, and our neighbor went in and closed it. You may not find that in Newport Beach. I'm not trying to point fingers, but this area is still that way."
Ewart points out that the growth in this region, in addition to his deep knowledge of the market, has created a huge infill business for him. "Because I've been here so long, know it so well, and know a vast majority of landowners, I've turned into an infill guy. I can dig up sites no one thinks about and sell them without listing."
To illustrate his point, he tells the story of a property in Montclair, California, that had been a drive-in movie theater for 60 years. When the senior member of the family — who had been good friends with Ewart's father (Ewart and the owner's son grew up together) — recently passed away, "You wouldn't believe the line to the table to buy the land. I've had two unsolicited proposals, and I probably will get 10 more, from industrial to multifamily — the gamut. That kind of site will easily sell for over $1 million an acre, which, 10 years ago would have been unheard of."
But even though pricing has gotten out of hand, the market still has lots of available land. "Brokers are doubling what they did the previous year and say they are on track for their best year yet," Ewart says. Some of the submarkets that have attracted attention include the eastern part of northern San Diego County, Perris, and the Moreno Valley, which he calls "the new bastion." Before the last downturn, the IE was the last place for development momentum to stop; when the upturn started, it was the first place it picked back up again.
Over the next five to 10 years, this market will continue to change and grow. Ewart says he expects to see California's minimum wage reach $15 per hour by 2022, warehouse and manufacturing occupiers embrace automation (where applicable) to reduce their employee counts, and many retail concepts become smaller. He also believes larger land sites will be scarcer in the core basin, which will push industrial development to the High Desert and further to the east, such as Victorville, Apple Valley, and Barstow.
Additionally, Ewart forecasts more regional trade schools, especially those geared toward the industrial segment of the market. "Only 19.5 percent of Inland Empire residents have a bachelor's degree or higher, and there is an opportunity to groom this base." He also expects to see more hospitals there, which he says is likely in a market where many SoCal residents will retire, such as the Canyon Springs Healthcare Campus, which was approved last November for Riverside. Industry sources report that the project is set to include a 280-bed, five-story hospital with a penthouse; five medical-office buildings ranging from 40,000 to 100,000 square feet; a 234-unit, three-story senior-housing facility; a 290-bed, three-story independent living/memory care, assisted living, and skilled nursing facility; and two four-level parking structures.
Ewart also expects daily needs and experiential retail — such as Victoria Gardens, a 147-acre open-air shopping mall that was built in Rancho Cucamonga 13 years ago — to continue to take off in the IE, driven by the area's large employment base and Hispanic population, which he says has the highest disposable income of any demographic group. "I can't tell you the number of retail projects that are popping up — not just corner retail, but the likes of Stater Bros. and Sprouts-anchored centers — in Rancho Cucamonga like crazy. San Bernardino is a little different; it's not the same as Rancho Cucamonga or Ontario, and Riverside is so built out it doesn't have infill sites. But a lot of retail owners are going in and rehabbing and upgrading."