MARKET HIGHLIGHT , AUGUST 2005

REAL ESTATE DESIRE: THE INLAND EMPIRE
Kevin Assef, Scott Ostlund, Mary Piper and Neil Wachsberger

Expansion is the name of the game in the Inland Empire. Population and new job numbers are increasing while vacancies and cap rates are decreasing. Real estate players across all property types are eager to stake their claim in a market that offers not only growth, but relatively cheap real estate and accessibility.

Multifamily

Driven by robust economic expansion and lagging new supply relative to population growth, the Inland Empire apartment market will continue to outperform many other sectors around the nation. Housing demand is rising, yet soaring home prices are limiting many new residents to the rental market. As a result, the market will post record-high absorption rates despite increased construction. Investors will be hard pressed to find a market with better fundamentals, but will have to contend with premium prices to obtain an apartment investment in the area.

Developers are responding to the area’s strong economy and are expected to deliver 3,600 units this year, up from 2,500 units in 2004. Luxury apartments meet the needs of many new residents priced out of single-family homes, and areas such as Rancho Cucamonga and Moreno Valley are prime locations for many high-end projects. Three complexes totaling 1,200 units will be completed later this year in Rancho Cucamonga. The total includes the first phase of Homecoming at Terra Vista and 470 units that will be part of a large mixed-use center on 4th Street. Seven projects, totaling 1,475 units, are under way in Moreno Valley, the majority of which will be completed this summer.

Despite increasing development, owners can anticipate both a decline in vacancy and rising asking rents. Vacancy is expected to drop by 10 basis points in 2005 to 4 percent. Vacancy for Class A apartments has improved by 10 basis points in the last year to 5.6 percent. Such properties are performing well in Rancho Cucamonga and south Ontario/Chino, where average vacancy has declined to 3.8 percent and 5.7 percent, respectively, over the last year. These favorable market conditions will allow owners to raise asking rents 7 percent regionwide during 2005 to $991 per month. Fontana’s asking rents are currently up 9.5 percent to $896 per month, and Victorville rents, as of first quarter 2005, are up by 7.8 percent to $689 per month. Owners in the well-located south Ontario/Chino submarket have been able to raise rents 7.5 percent during the last year to $1,150 per month.

Investors are clamoring for a position in this high-growth market, and bidding is aggressive due to the imbalance of buyers to sellers. As a result, the median apartment price during the first part of 2005 was up 17 percent on a year-over-year basis to $97,000 per unit. Private investors have dominated sales activity as properties with fewer than 20 units account for two-thirds of all transactions. The median price of these smaller properties ended the first quarter up 10 percent to $96,000 per unit. Recent larger deals include the Morning Ridge Apartments in Temecula selling at $29 million and the Cambridge I Apartments in Fontana selling at $26.5 million. San Bernardino’s Mountainside Village Apartments recently sold for $21.8 million.

— Kevin Assef is a managing director of Marcus & Millichap and serves as regional manager of the firm’s Ontario, California, office.

Industrial

The Inland Empire continues to be ranked as one of the hottest industrial markets, if not the top one, in the country. What once started as an industrial outpost for the Los Angeles and San Gabriel Valley markets has blossomed into a sector that not only leads Los Angeles in absorption, but all other industrial markets in the United States.

Additionally, it also leads the country in square footage under construction for 2005 with nearly double the amount of square footage under construction compared to the second most prolific market in the country: Chicago. This has led to a dearth of available land, as the west end of the market is quickly becoming an infill market, which is pushing larger project activity eastward. The remaining smaller parcels in the west are quickly being developed into mostly for-sale product as more than 100 buildings are planned or under construction in that area. Will this result in oversupply? Not by a long shot. Most of the buildings under construction in the west are being placed into escrow well before completion with no standing inventory of new for-sale product available.

Firms continue to be attracted to the area due to its modern facilities and lower lease rates, as well as its proximity to freeways and to the Ontario International Airport. All this has led to a decline in overall vacancy to 6 percent. In addition, the decline in cap rates has reached the low 7-percent range with cap rates for high-quality real estate dipping below 6 percent for the first time in 20 years.

All of this activity is good news for landlords who, for many years, suffered through relatively flat rents due to buildings being reproduced on the great deal of available land. As the vacant land has reduced, the rents have increased. The real question for the western Inland Empire is “Where will the amount of square footage be absorbed?” This absorption seems to be in the east end of the valley. The east end, which for many years was the ugly sister to the west, is picking up the slack with the high desert area first on deck.

— Scott Ostlund is a principal in Lee & Associates’ Ontario, California, office.

Office

The office market in the southwest part of the Inland Empire (Murrieta-Temecula Valley area) continues to remain strong, and due to the low interest rates, office, medical and industrial condos have increased in popularity. In the last year, land costs have increased by approximately 30 to 40 percent due to supply and demand. The Temecula Valley — encompassing primarily Temecula and Murrieta, in addition to the unincorporated areas of Menifee, Wildomar and Lake Elsinore — has grown in residential population and is now considered one of the fastest growing areas in the United States. Murrieta-Temecula has become an extension of San Diego and Orange counties with the increased population in the area stemming from companies and families relocating from these two areas because of affordable housing, better school systems, etc.

In the multi-tenant office sector, there is a vacancy rate of 3 percent, which has ranged over the last year from 2 to 4 percent. Asking rates for Class A buildings range from $2.20 to $2.75 per square foot based on a modified gross lease. Class B+ to C buildings range from $1.60 to $2.30 per square foot modified gross.

On the development front, TUMF (Transportation Uniform Mitigation Fees) has increased development costs and material costs, causing rental rates and purchase prices to increase for new construction. Last year, the county of Riverside had imposed the TUMF on new developments from residential to commercial. The purpose of these fees is to have developers participate in the construction of the transportation improvements needed to accommodate the impact of new construction in the Inland Empire. Phased in over a 3-year period starting July 2004 to July 2006, these fees are collected at the time the developers receive their building permits. For example, a July 2004 TUMF added $1.61 per square foot of gross floor area to a developer’s costs, in July 2005 $3.23 and $4.84 per square foot in July 2006. However, fees for industrial, retail and residential differ from office product.

Currently, there is only a handful of true Class A office developments in the Murrieta-Temecula Valley comparable to Orange and San Diego counties’ Class A office buildings. For example, Crossroads Corporate Center, located in Murrieta along the 215 freeway just north of Murrieta Hot Springs, recently completed the Phase I base-building construction. Developed by Whitaker Investment Corporation, Crossroads Corporate Center will consist of four buildings totaling 273,000 square feet after completion. Phase I of the center encompasses a 78,000-square-foot, four-story office building, which should be 100 percent leased by the end of this month. Phase II of the Crossroads Corporate Center will also include a four-story, 78,000-square-foot office building, which is scheduled to break ground soon.

Another development that was recently completed is the Garrett Corporate Center, a three-building, 55,010-square-foot office center located in Temecula at the base of the foothills. Developed by The Garrett Group, the property is approximately 60 percent leased.

— Mary Piper is vice president/ principal in Lee & Associates’ Temecula office.

Retail

The Inland Empire retail market is booming as major homebuilders continue to thrive in the area. In early 2005, the Inland Empire captured 52 percent of Southern California’s new home development. Affordable housing and available well-paying jobs distinguish this region from neighboring Los Angeles, Orange and San Diego counties, and are the main factors contributing to the growth of the region. From 2000 to 2004, the Inland Empire experienced a population increase of 15 percent, adding nearly 500,000 residents in that timeframe. The area is well on its way to the forecasted 1.8 million new residents by 2020. It is currently the fastest growing metropolitan area in the country and is quickly becoming one of the nation’s hottest retail markets.

The Inland Empire retail sector currently comprises approximately 85 million square feet of space. With almost 3 million square feet slated for completion during 2005, the demand for retail continues based on the expectations for job and population growth. Vacancy rates will remain fairly stable around 6.25 percent as retailers absorb this new construction. Although development activity is down slightly from 2004 (4.2 million), it continues to be strong as both retailers and developers take advantage of the favorable conditions.

In first half 2005, cap rates fell slightly with private investors still driving the Inland Empire market. “Cap rates in the Inland Empire have become very competitive with both the Los Angeles and Orange County marketplaces,” says Brian Ley of The Umansky Retail Team in Sperry Van Ness’ Ontario, California, office.

Retail rental rates, though competitive, are actually more affordable than in the adjacent major market counties of Orange, San Diego and Los Angeles. New construction high-profile shops are typically achieving rents in the $32 to $40 per square foot range. Grocery-anchored shop space ranges from $24 to $29 per square foot while community power centers lease for around $18 per square foot.

With the success of retail projects completed in the last few years, many out-of-state developers are taking measures to ensure they don’t miss the boat. Developers such as Global Retail Development Group of Scottsdale, Arizona, one of the most prominent and active neighborhood shopping center developers in that state, are actively developing in the Inland Empire due to its fresh regional draw and demographic similarity to Maricopa County (Phoenix).

Many freeway-oriented retail development projects are currently under construction throughout the market. The Interstate 15 freeway, a north/south arterial linking San Diego with Las Vegas, has numerous new large retail centers planned and/or under construction at almost every exit as it cuts through the Inland Empire. At the Bundy Canyon exit in Wildomar, California, Gatlin Development Company has proposed a 235,000-square-foot Wal-Mart Supercenter-anchored development, to be completed mid-2006. Further north along I-15, Victorville Pavilion, an $80 million, 254,000-square-foot lifestyle center in Victorville, will boast retail stores such as Linens ‘n Things, Michaels and Pier1 Imports. Slated to open in first quarter 2006, this Victorville Family Partnership development is expanding an area that not long ago was considered too far out and somewhat unsophisticated in its composition. California-based Transcan Development’s Canyon Crossings is to come online in late 2005 with 740,000 square feet of retail at the 215/60 interchange in Riverside, California.

A combination of the above factors is the reason that the Inland Empire is experiencing such dramatic growth, and although the summers tend to be somewhat hot, the general climate in the area is very conducive to the much sought after Southern California lifestyle.

— Neil Wachsberger is the regional director of Arizona-based RBI Retail Brokers’ Riverside, California, office.

©2005 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.