Industrial Strength?

Los Angeles Business Journal

July 21, 2014

L.A.’s expansive industrial real estate market sweeps inland from the coast for more than 50 miles, from San Pedro and Long Beach to Pomona and beyond. Fueled by some of the busiest seaports, airports and rail yards in the nation, finding tenants for its acres upon acres of warehouses, manufacturing plants and distribution centers has never been a problem; at more than three-quarters of a billion square feet, the market has been exceedingly light.

Now, as the economy has rebounded, demand for industrial space has increased, constricting the market further. The countrywide industrial vacancy rate fell to 4 percent in the second quarter, a significant drop from the already tight 4.5 percent in the prior period and its lowest point since the dawn of the recession in early 2008, according to date provided by Jones Lang LaSalle Inc.

But greater demand has not been met with an increase in supply, as little vacant land remains in a mature market and much of it disappears to other expanding real estate sectors.

“Like it or not, for years industrial real estate parcels have at some point in time gone vacant, then been converted to other uses,” said Robert Kleinhenz, chief economist at the Los Angeles County Economic Development Corp. “We’ve seen industrial real estate have very low vacancy rates in part because we haven’t been very good about preserving our stock. We’ve allowed many parcels to convert to their uses over time.”

And it’s not being replaced. In a market of more than 750 million square feet, just 3.1 million square feet of industrial development is under way – enough to boost the market by less than one-tenth of a percent. And there’s little reason to believe developers will pick up the pace in coming quarters, either, though not for lack of trying.

In Los Angeles, where industrial construction boomed in the ‘50s and ‘60s, there’s little developable land to be had and lots of competition for what’s left. As a result, rents have risen on average to 59 cents a foot, up 11 percent from the year-earlier period, and only a tiny fraction of the massive market is making any moves. Though sales and lease activity increased more than 30 percent year over year in the second quarter to 13.3 million square feet, that represents less than 2 percent of the market.

“There isn’t a lot of activity because there isn’t enough product for tenants to move into,” said Mark Payne, a partner at Newport Beach’s Panattoni Development Co., which recently completed construction of a 330,000 square foot building in Santa Fe Springs. “It’s like Nordstrom without shirts.”

Strained supply

Supply is so low that in some areas companies that want to move or grow are often forced to stay put for lack of space or settle for a building that doesn’t meet all their needs.

Jack Cline, a senior vice president for industrial real estate brokerage Lee & Associates, said a dearth of opportunity for tenants is stifling what would otherwise be considered a healthy, surging market.

“Earlier this month, a tenant was planning to move out of a building a client of mine bought, but they found they had absolutely no options, so they signed a new lease,” he said. “There’s just an absence of quality real estate available.”

Exacerbating the situation is that a majority of the county’s industrial building stock was built 50 or more years ago, and much of it is now inefficient and outright obsolete.

But the desire to be in Los Angeles, an important gateway to the western United States, is strong enough that many are willing to overlook the problem of aging buildings, said Randy Kendrick, founder and chief executive of Seal Beach industrial real estate firm Xebec Realty Partners.

“Los Angeles has buildings that in other parts of the county would never be occupied because of their age and functional obsolescence,” he said. “But here, those buildings are still leased.”

Though about one-quarter of buildings in industrial Los Angeles are considered Class A properties the standard for that ranking tends to be lower than in other markets. In most places, Class A buildings generally have ceiling heights of at least 30 feet clear, state-of-the-art Early Suppression Fast Response sprinkler systems and an 80-foot truck court, among other features. In Los Angeles, buildings with ceiling heights of just 24 feet clear with 130-foot truck courts often pass for Class A.

“By no way, shape or form would that be considered Class A anywhere else,” Kendrick said.

Lucrative land

While the absence of space can be problematic for tenants, it has proved beneficial to investors and developers – assuming they can get their hands on some property. What few undeveloped parcels of land are left are small infill sites, rarely big enough to build a substantial industrial facility.

“Both industrial land prices and asking rents are set to increase here,” Larry Kosmont, president and chief executive of real estate consultancy Kosmont Cos. In downtown Los Angeles. “There’s still a little bit of play in the market, in some places, but we’re going to see some land prices rise.”

That’s why redevelopment – or, more accurately, demolition and ground-up reconstruction – has become the most effective ay to bring new stock to market.

One of the largest, most significant industrial redevelopment projects under way in the county is in Pomona, on the site of a former facility for aerospace defense company General Dynamics Corp. The $110 million project, called Mission 71 Business Park, will upon completion consist of more than 2 million square feet in 19 buildings ranging in size from 17,0000 square feet to 250,000 square feet. Long Beach developer Seventh Street Development Inc. began acquiring the land – about 60 acres – in 2006 and has since been slowly bringing state-of-the-art Class A industrial buildings to market on the site.

Craig Furniss, president and co-founder of Seventh Street, said the company is putting finishing touches on the third phase of the project, four buildings totaling about 463,000 square feet. He expects to break ground on the final phase – four more buildings totaling about 500,000 square feet – next month.

Spec projects

Most of the buildings were constructed speculatively, without a commitment from a prospective owner-user, and Seventh Street had no trouble selling them. All of the 15 completed buildings have been sold, including those in phase three and even one in phase four. Household goods manufacturer Kittrich Corp. bought a 250,000-square-foot building, online retailer eToolsCity.com bought a 51,000-square foot building, dinnerware manufacturer Vertex China bought a 42,000-square-foot building and freight-forwarding and logistics company Unipac Shipping Inc. will close escrow on a 120,000-squre-foot building next month.

Taking off: Craig Furniss, center, at Seventh Street Development's Mission 71 Business Park redevelopment in Pomona.

Taking off: Craig Furniss, center, at Seventh Street Development’s Mission 71 Business Park redevelopment in Pomona.

 

 

 

 

 

 

 

 

 

Furniss said the four buildings together sold for about $48 million, or more than $103 a square foot.

“The market has come back,” he said. “We’ve seen a pretty dramatic climb over the last year – our sale prices have gone up 20 percent. It appears values are starting to climb to where they were back at the peak of the last cycle.”

Furniss said Seventh Street is selling its Mission 71 buildings because, unlike many industrial markets across the country, Los Angeles has a strong contingent of companies that prefer to own their buildings rather than lease.

“These entrepreneurial companies – many with Asian ownership – have a bias toward ownership,” he said. “Because we were able to offer the ownership opportunity, that really ignited a lot of demand.”

Selling brand-new buildings to companies has long seemed a fail-safe business in Los Angeles. But Paul Sablock, an executive vice president at JLL, said more developers are entertaining long-term investments in the area through leasing.

“In the 34 years I’ve been in this market, development deals in the central market never made sense to building, hold and lease. Out of 100 developments, 90 of them were built to sell in order to make the deal make sense, based on high land prices,” he said. “Now all of a sudden, there are two major developments – one in the city of Bell and another in Commerce – being built to hold and lease.”

The developer of the Bell property, Pacific Industrial of Long beach, is building a 40-acre industrial park there. The firm is building three facilities totaling about 425,000 square feet on one of the last remaining large parcels of undeveloped land in the county. It bought the land from the financially strapped city for $44 million late last year.

Dan Floriani, a principal and co-founder of Pacific Industrial, said the firm won’t even consider selling any of the buildings.

“It’s so difficult to find 40 acres in the central market, it just made sense to structure the project as a long-term hold,” he said. “It’s an irreplaceable asset in a great location.”

Construction on all three buildings is well underway and expected to be done later this year. One building, about 135,000 square feet, has been preleased to FedEx Ground, which will use it as a logistics facility for shipping e-commerce orders. The other two buildings are still up for grabs, but Neil Mishurda, another principal and co-founder, said the company will be able to find tenants.

This will be one of very few Class A industrial buildings that can be leased,” he said. “There’s maybe only one other building we compete with in the submarket.”

Designed to last

Because the company envisions a long-term hold, the $85 million industrial park was designed with the future in mind: All three buildings are on track to be certified a Leaser in Energy and Environmental Design (LEED) at the Gold level, complete with LED lighting and electric-vehicle charging stations

Also bullish on the long-range industrial future of Los Angeles is Real Estate Development Associates. The Newport Beach developer entered the L.A. market last year when it acquired 5.3 acres in Commerce, where it plans to build a for-lease facility on spec.

Bill Goltermann and Jason Krotts, principals of REDA, said the firm wants to build a 141,000-square foot distribution warehouse with 32-foot storage clearance.

“The manufacturing buildings we bought were 50-plus years old, and they were past their useful life,” Krotts said. “We decided to tear them down and build one larger, functional building that has state-of-the-art features that we think will be a long-term benefit for their community.”

The developer completed demolition this month and then began grading the site. No one has yet signed a lease for the space, but brokers said it’s not uncommon for tenants to wait to commit to a building after construction is well under way.

Capital gains

In the same spirit, a deep-pocketed New York investor last month negotiated perhaps the largest industrial infill lease ever signed in Los Angeles. KTR Partners leased the entire 615,000-square-foot Garfield Corporate Center in Commerce for 15 years to deep-discount retailer 99 Cents Only Stores Inc. The private equity firm backed the spec development of the project early last year and is on schedule to complete construction of the state-of-the-art distribution center by the end of the month.

JLL’s Sablock led the owner’s brokerage team on the deal. He said KTR and other institutional investors are more willing to hold and lease their properties because they see potential for rents to keep rising in Los Angeles.

“It makes sense now, because there’s such a shortage of inventory and now this big institutional money is trying to get into Los Angeles,” he said. “They’re starting to see that if you have the balance sheet, it makes sense to build own and lease a building.”

Prologis Inc., one of the largest industrial real estate companies in the world, with more than $27 billion in assets under management, is another institutional investor active in Los Angeles, The San Francisco company recently leased half of a 273,000-square foot building it constructed on the site of former steel plant in Torrance to Swiss logistics company Keuhne + Nagel International.

Kim Snyder, president of the southwestern region of the United States for Prologis, said he is optimistic about the L.A. industrial market in general, particularly for leases.

“I feel very good about the local conditions,” he said. “There’s limited supply, high barriers to entry and demand is good. All that means there are great prospects for a landlord to secure a little bit of rent growth.”

By: Betheny Firnhaber

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Posted July 21, 2014 by jcowan in News