MARKET HIGHLIGHT, DECEMBER 2005

INLAND EMPIRE: THE “IN” THING IN REAL ESTATE
John Ewart, Ron Washle, Skip Crane and John Kalmikov

The Inland Empire's office and industrial sectors continue to see decreasing vacancies despite robust new construction. High-end retail is flourishing in the area while the market's multifamily rent growth has been impressive.

Office

New office construction activity is at record levels in the Inland Empire despite some concern that there was too much product being introduced too soon. Clearly that doesn't appear to be the case based on the fact that the market closed out the third quarter with a vacancy rate of 7.2 percent, the second lowest in the nation and down two full percentage points from a year ago.

Meanwhile, absorption, totaling 483,845 square feet, more than doubled compared to the same quarter last year. Year to date, more than 1.55 million square feet of office space have been absorbed in the Inland Empire, triple the amount posted during the same period a year ago.

Strong demand and declining vacancies have pushed monthly asking rental rates up 10 cents to $1.96 for Class A space and up 18 cents to $1.69 for Class B.

Fifty percent of the 401,752 square feet of new office space that came online in the third quarter was absorbed, and there is an additional 1.5 million square feet of office space currently under construction.  

The airport and south county submarkets led the Inland Empire in absorption due to active pre-leasing. In south county, construction was completed on Phase I of Crossroads Corporate Centre, a Class A, 78,000-square-foot building that is 100 percent leased. In an early pre-lease, The University of Phoenix committed to 26,000 square feet. Also in south county, two Class A projects — Garret Corporate Centre and the first building of Vail Ranch Towne Square — debuted nearly 75 percent leased.

Strong pre-leasing trends in the airport submarket have been driving future absorption levels. And fourth quarter promises the same, thanks in part to Indy Mac Bank signing a 74-month contract for 40,000 square feet at the Airport Corporate Centre, set to deliver by fourth quarter. Indy Mac's expansion follows a trend of Orange County-based firms establishing more prominent office locations in the Inland Empire, rather than using smaller satellite locations to relay accounts outside of the region.

Existing inventory in areas of transition is also receiving healthy tenant interest. In north San Bernardino, Mountain Business Park, an 87,000-square-foot office park that was vacated when the administrative headquarters for the Campus Crusade for Christ moved in 1991, is signing tenants thanks to new construction along Hospitality Way. Currently 50 percent leased, the park inked two new tenants — Tactical Survey Group, a software company and Guy F. Atkinson Construction, a full-service contractor —contributing 20,000 square feet to absorption.

Nearly half of Carousel Mall's 317,000 square feet has been converted to office space and is partly occupied by two San Bernardino County departments. The asking rents are competitively lower than newer office buildings.

Institutional transactions included the $61 million purchase of Empire Towers, a three-building, 323,000-square-foot campus in Ontario, by Irvine-based CIP Real Estate, in a joint venture with an affiliate of Guggenheim Real Estate. The tenant list included names such as Merrill Lynch, Wells Fargo Bank and Sedgwick Insurance. Private investors were also active, capitalizing on low interest rates and rapid building appreciation values.

Office condominiums will be the next hot item for private investors. The south county submarket currently has five scheduled developments with prices ranging from $270 to $310 per square foot.

— John Ewart is a senior vice president for Grubb & Ellis Company in Ontario, California.

Industrial

The Inland Empire industrial vacancy rate remains low, while construction activity is picking up to meet demand. The vacancy rate in the third quarter was 2.8 percent down from 4.2 percent a year ago. Meanwhile, construction activity registered 19.1 million square feet, a 26 percent increase from last year. High demand levels remain in place. Year to date, 74 percent of the 12.9 million square feet completed since January has been absorbed.

Sale and leasing activity in the third quarter totaled 9.8 million square feet, up from 7.9 million square feet the previous quarter and a boost from 7 million square feet a year ago. New buildings, the destination for companies with larger size requirements, are quickly becoming absorbed. In the quarter's largest transaction, Mohawk Industries pre-leased an 849,000-square-foot warehouse in Fontana at Prologis' Transpark. The site is close to major freeways and offers direct access to a rail facility being developed by BNSF. On the sales side, MGA Entertainment of Van Nuys acquired a 435,000-square-foot distribution center for $23 million at Sares-Regis's new Rialto Commerce Center. MGA follows on the heels of Solo Cup, which leased 882,230 square feet earlier in the year.

Signed leases, while surpassing user sales, were not as prolific as previous quarters. During the 3-month period, 164 leases were signed for a total of 6.6 million square feet while user sales logged 100 transactions.

Buildings less than 50,000 square feet are in high demand. Buyers are taking advantage of historically low interest rates, SBA financing and prices that are competitive with neighboring markets.

Net absorption totaled 6.7 million square feet for the quarter versus 6.9 million square feet last quarter and 4 million square feet for the same period a year ago. However, year-to-date levels were down 26 percent compared to the same period a year ago.

The low vacancy rate is holding back absorption. One should expect active pre-leasing to drive future activity once new product comes online.

Warehouse development, widespread in Rialto and Fontana, will push east along Interstate 10 and south along Interstate 215 in the near future due to available land and DHL. DHL recently opened a 262,000-square-foot cargo center at March ARB that will receive 10 cargo flights a day. Meanwhile, older submarkets will be revitalized by infill developments. In Colton, Hager Pacific Properties acquired Stater Bros' former corporate headquarters for $30 million and plans to redevelop the campus after the grocery company moves to SBIA. The site covers 50 acres and has six buildings.

— Ron Washle is a senior vice president for Grubb & Ellis Company in Ontario, California.

Retail

High-end retail is selling in the Inland Empire despite the region's predominantly blue-collar demographic. In Rancho Cucamonga, Victoria Gardens, a 1.3 million-square-foot development that mixes aspects of a traditional mall (big anchors and large parking lots) with an outdoor lifestyle center (fountains and diverse architecture in a miniature cityscape) opened in late 2004 and is exceeding expectations. In the final quarter of 2004, sales taxes for general consumer goods purchased in Rancho Cucamonga increased by more than 72 percent over the 2003 holiday season. To regain lost market share, older malls will be renovated in an effort to rejuvenate consumer interest and remain competitive. In Montclair, Montclair Plaza will add to its west end an outdoor shopping area dedicated exclusively to specialty stores. The new 600,000-square-foot center will emulate the architectural heart of Victoria Gardens. In Riverside, the Galleria at Tyler will adopt a similar strategy, creating a 150,000-square-foot open-air center with higher end restaurants and upscale retail additions.

Lifestyle retailing, which creates ambience and convenience with what are thought to be high-quality products, is becoming increasingly more relevant in an age where competition from other retailers and the Internet has magnified the need for the aesthetic. The model is universally effective — from high-end retail to grocers. By the end of 2005, Vons will convert a quarter of its locations to lifestyle stores that will include wood floors, an array of water fountains, comfortable seating and organic food.

High gasoline prices, high living costs, a still volatile job market and higher interest rates are directly altering shopping habits of consumers with limited discretionary income. In turn, this is beginning to cut into the profits of discount retailers. In 2005, sales at Wal-Mart stores open a minimum of 1 year averaged a 3-percent gain while Target recorded a 7-percent boost, prompting a change in strategy for the world's largest retailer. In an effort to bait more affluent customers that tend to shop just for groceries at the store, Wal-Mart will begin to sell higher-priced, trendier merchandise. At the same time, the company vows not to ignore its core customers who shop for staples on a budget.

The Inland Empire retail market has 15 to 20 million square feet of space currently under construction or in the entitlement process. Driven by a strong local economy, low interest rates, land and, above all, substantial residential growth, the retail sector's expansion will outpace the national average in 2006. The current 6.4 percent vacancy rate will remain under 8 percent in the next 6 months as developers pace the introduction of new product to remain balanced with current supply/demand levels. Asking lease rates, meanwhile, will rise across most markets — particularly in the west end and south county — as residents clamor for high-profile developments. Realizing the potential of another Victoria Gardens, developers will break ground on two noteworthy developments — Shoppes at Chino Hills and Piemonte at Ontario Center. Shoppes will be a 1 million-square-foot outdoor mall, set to resemble a downtown shopping district; Piemonte, a 90-acre mixed-use project blending retail, office and residential space, will integrate northern Italian design motifs.

— Skip Crane is a senior vice president for Grubb & Ellis Company in Ontario, California.

Multifamily

The overall performance of the U.S. apartment markets was sluggish in 2004, where only four markets had rent increases of more than 4 percent. Topping the list was the Inland Empire where rents grew 6.6 percent as renters sought cheaper rents in relation to Orange and Los Angeles counties. However, the price gap is narrowing. As rising home prices and mortgage interest rates push ownership beyond the means of more families, the pool of renters will expand, elevating rents. Developers, faced with higher land and construction material costs in the presence of a low vacancy rate, will pass costs on to tenants. Additionally, condominium developers are aggressively competing for available land — in some cases, paying upwards of 65 percent more than apartment builders. Overall, Inland Empire rents are forecasted to increase by 6 percent in 2005 in an area experiencing burgeoning population growth.

Demand continues to outpace supply levels, pressing the total vacancy rate below 5 percent. Due in part to longer entitlement processes and higher construction costs, developers are expected to complete 2,600 units in 2005, 400 fewer units than last year. Dwindling home affordability — only 18 percent of Riverside County's residents can afford the median-priced single-family home –– makes the Inland Empire a lucrative option for institutional and private multifamily investors. Driven by upscale housing and the need for less expensive entry-level housing (priced below $300,000), Condominium development will provide an opportunity for first-time buyers, while investors will capture apartments for conversion. There are currently 7,000 Inland Empire apartments mapped for speedy condo conversions, and more than 1,000 of these are in the midst of being converted — a new dynamic in a maturing market.

The local population reached 3.7 million people in 2004, an increase of 408,000 since 2000. And according to recent BLS statistics, Riverside was the fastest growing county in the state from July 2003 to July 2004 with San Bernardino third. But does the area's much-publicized affordability remain? In March, median home prices were $379,000 and $298,000 in Riverside and San Bernardino counties, respectively — a 26.3 percent and 34.8 percent jump from the previous year. While these increases were dramatic, the two-county region was still attractive when compared to Orange County and Los Angeles where median home prices were $565,000 and $440,000, respectively.

— John Kalmikov is a senior vice president for Grubb & Ellis Company in Ontario, California.

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