MARKET HIGHLIGHT, AUGUST 2006

THE IN(LAND) THING TO DO
Andrew Gordon, Kevin Assef and Kevin McCarthy

The fundamentals of population and job growth persist in Southern California’s Inland Empire market. Add to those factors the cheaper land costs and it’s little wonder many real estate players are looking inland.

Retail

The Inland Empire retail market is still on the rise amid a stabilizing housing market. Recently, the area has seen a short-term trend of cooling home prices that could signal an end to the cycle of steep appreciation. San Bernardino alone is the 11th most populous county in the nation with almost two million residents. Given that 50 percent of all jobs created in California in 2005 were in the Inland Empire, the area continues to draw people away from the more unaffordable coastal areas.

A strong retail environment persists as vacancy rates have dropped just below 6 percent, and there are more than 20 million square feet of planned retail space in Riverside and San Bernardino counties. Furthermore, the market is continuing to draw upscale regional tenants to lifestyle centers like The Shops at Dos Lagos in Corona, which features Pottery Barn, Williams Sonoma, P.F. Chang’s China Bistro and The Cheesecake Factory.

Rental rates have remained strong throughout the Inland Empire. Developers are achieving shop rents between $30 and $39 per square foot for new space, while existing grocery/drugstore-anchored shop rents fetch $21 to $27 per square foot. Rents for junior-anchored space in regional centers are anywhere from $14 to $18 per square foot in existing centers and more than $24 in newly constructed centers.

The High Desert and the Interstate 215 corridor remain two of the hottest submarkets for retail development in the Inland Empire. Lewis Retail is leading the way in the High Desert with Apple Valley Commons, a 658,000-square-foot center featuring Target and Lowe’s Home Improvement Warehouse as well as the High Desert Gateway, a 382,000-square-foot, Target-anchored center. Both are scheduled for delivery in first half 2007. Not to be overlooked are the upscale neighborhood centers also scheduled to break ground this year such as The Shops at Bear Valley, an 80,000-square-foot, Walgreens-anchored center in Victorville being built by Newport Beach-based developer, Treadwell Robertson.

The freeway adjacent developments along the I-215 corridor continue to thrive and attract top national tenants. San Diego-based Cahan Properties is breaking ground on its 500,000-square-foot Perris Crossing, anchored by The Home Depot and WinCo Foods. A few miles north at the I-215 and Freeway 60 intersection, Transcan Development recently completed Canyon Crossings, a 740,000-square-foot center with anchors Wal-Mart, Staples and LA Fitness.

With a nationwide cyclical change looming in the future, investors and developers still remain optimistic about the opportunities in the Inland Empire. According to Mark Sandoval, president of Mark Development Inc., “Higher lending and bond rates could push cap rates up and obviously slow down construction and buying power. But growth in the Inland Empire will continue to surpass that of the surrounding areas as land costs remain cheaper than the neighboring counties.”

As the Riverside-San Bernardino area continues to dominate in retail net absorption (1.3 million square feet in the past 6 months) and as it leads the nation with a 7.1 percent year-over-year growth in average effective rent, the bullish sentiment amongst the big players in the industry appears to be justified.

— Andrew Gordon is a retail specialist for RBI Retail Brokers in Riverside, California.

Multifamily

The Inland Empire’s economic and demographic profiles are among the most attractive in the country and continue to draw investors seeking entry into a growing market. Job growth and new housing are the attraction for waves of new residents, with the professional and business services sector, for one, expected to increase significantly in the near term. While job growth will generate even greater levels of demand for apartments, high single-family home prices in the area continue to support demand for rentals. Home price appreciation is expected to slow this year, but affordability in the metro area will remain a challenge for many residents, pushing new residents into the rental market. With demand generators expected to remain vigorous this year and for years to come, the current level of apartment construction should be absorbed by the influx of new residents to the area. Much of the apartment development in the metro area is occurring in outlying submarkets such as south Riverside County, the Coachella Valley and Victorville, which offer a great deal of growth potential.

Employment growth remains strong in the Inland Empire, as employers added 4,000 jobs in first quarter 2006, a deceleration from 13,800 jobs in first quarter 2005. Based on early second quarter estimates, however, it appears that growth has accelerated, fueled by the distribution industry. By year’s end, Inland Empire employment is expected to rise 2.6 percent in 2006, well above the 1.5 percent growth forecast nationwide. Overall, local employers are expected to add more than 34,000 jobs to the region by year’s end.

Multifamily developers will bring 3,200 units online this year, which will result in a 2.4 percent increase in local apartment inventory. The increase in stock is almost equivalent to household growth projections for the year. Vacancy will remain unchanged at 4.6 percent through year’s end. New construction is in line with household creation and job growth. Also, home prices remain relatively high, supporting demand for apartments. The median price of a single-family home in the metro area has climbed 15 percent in the past year to $396,000, pushing homeownership out of reach for many residents. The resulting strong rental demand will support a 5 percent gain in asking rents to $1,036 per month in 2006. Effective rents are forecast to rise 4.8 percent to $989 per month, as concessions will remain neutral during the year.

Strong fundamentals continue to attract investors to the Inland Empire. Owners have been realizing significant price appreciation over the past few years, and local properties consistently register low vacancy and solid rent growth. Rising interest rates and energy costs have caused some slowing in the investment market, and cap rates have begun to rise as buyers have become more focused on NOI growth when pursuing prospective deals. While prices have risen in the last few years, values are still reasonable when compared to property prices in nearby coastal markets. The Inland Empire will continue to draw multifamily investors because of the region’s strong demographics, rising interest rates and high single-family home prices.

— Kevin Assef is a senior vice president and managing director in the Ontario, California, office of Marcus & Millichap.

Industrial

Future economic expansion is very bright in Riverside and San Bernardino counties as the Inland Empire, one of the nation’s hottest industrial markets, continues to mature in Southern California. Boasting 320 million square feet of industrial product, the market benefits from its strategic location near the nation’s largest ports — Long Beach and Los Angeles — and the region’s growing population, which now exceeds 18 million, 3.9 million of which reside in the Inland Empire, according to statistics from the California Department of Finance, the U.S. Department of Commerce and the Census Bureau.

Large distribution centers will be developed eastward along major transportation corridors throughout the eastern Inland Empire as the region’s population approaches 4 million residents by year’s end. Developers in the market are keeping a close tab on rising land prices, rising interest rates and skyrocketing construction costs.

Despite some growth concerns, there’s no doubting what economists are predicting: the tripling in volume of international goods through Southern California’s ports in the next 20 years. The Inland Empire is the nation’s most active industrial market, accounting for nearly 30 percent of the new construction starts nationwide, according to CB Richard Ellis’ Chief Economist Steven Dunn. The market’s industrial vacancy rate is 2.8 percent, the second lowest in the nation, according to the Los Angeles County Economic Development Corp.

Once the base of industrial activity, the western Inland Empire cities such as Ontario and Rancho Cucamonga are now considered the financial center of the market. That’s where the new frontiers for the industrial sector come into play. The short supply of available land due to the office market’s growth and other factors has enabled the eastern Inland Empire to become the new red-hot industrial submarket, where users continue to seek new construction for state-of-the-art distribution space, according to John Husing, Ph.D., a leading Southern California economist who publishes the Inland Empire Quarterly Economic Report.

Because large blocks of land are becoming more difficult to find in the western part of the market, industrial developments are spreading eastward along Interstate 10 (San Bernardino freeway) between Fontana and Redlands, Interstate 60 (Moreno Valley freeway) between Riverside and Moreno Valley, and south along Interstate 215 (Escondido expressway) between Moreno Valley and Perris near March Air Reserve Base. 

Prime examples of this development trend include Hillwood’s Alliance California, a massive industrial development of nearly 6 million square feet located at the former Norton Air Force Base. Another noteworthy project is Meridian, a 1,000-acre, fully entitled, master-planned business park in Riverside that is being developed by Lennar Partners, an operating division of L&R Property Corp. Also, the Majestic Freeway Center in Riverside County, a 330-acre, master-planned industrial park, is slated for nearly 6.95 million square feet of warehouse distribution space and will boast more than two miles of I-215 expressway frontage.

As long as the demand exists for more industrial real estate space because of the import volume from Asia, experts agree the Inland Empire’s burgeoning economy will show no signs of slowing in the second half of 2006 and, for that matter, years to come.

— Kevin McCarthy is vice president, director of development and a board member at City of Industry, California-based Majestic Realty Co.

Office

While the commercial property market’s momentum appears to be moderating compared to last year’s fevered pace, both national and foreign investors will continue to place an ample amount of capital in Riverside/San Bernardino office properties.

Vacancies in the Inland Empire’s office market are at the lowest levels they have been in 10 years and the sector is an attractive alternative for many apartment and retail investors dealing with lower cap rates. Office properties also offer more of a recovery play as retail and apartment fundamentals have been strong for the past several years. As the economy continues to grow, more people are starting their own businesses, and existing firms are expanding aggressively after several years of lackluster growth. This is driving the need for more urban and suburban office space, particularly since companies will be facing higher rents in a tightening market. To access a larger workforce and reduce commute times, a growing number of companies are moving their operations further out geographically, which is benefiting the Inland Empire. Unlike most previous cycles when battles raged between the suburbs and downtown markets for companies, there is plenty of economic and demographic growth to go around.  Urban markets are benefiting from the growth in the “empty-nester” segment of the population and professional adults who choose the amenities of central cities. 

The Riverside/San Bernardino office market will continue to thrive due to another year of healthy job growth. Strong office-using employment gains culminated into record construction levels last year. Developers, responding to robust demand, have filled the planning pipeline with more than 4 million square feet of office space. Despite the increase in the construction pipeline, heightened demand from companies expanding inland to serve the growing population will keep vacancy rates low.

The outlook for investing in the Inland Empire’s office market remains strong for the remainder of the year, especially as more companies are pushed out of higher-priced urban areas near the coast and as healthy job growth continues.

— Kevin Assef is a senior vice president/managing director and regional manager of Marcus & Millichap’s Ontario, California, office.

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