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FEATURE ARTICLE, MAY 2005
INDUSTRIAL ACTIVITY
As supply trails demand in the West, industrial players look for new opportunities as well as new markets.
Barry Hibbard, Michael De Lew, Kyle Roberts, Jeanette Ferguson and Steve Barragar
In charting industrial activity in the West, the following industry insiders speak of emerging markets as well as emerging trends. Overall, absorption is increasing as developers and tenants search for available parcels and product.
California’s Southern Central Valley
During the past 5 years, California’s Central Valley has emerged as the next logical choice for the expansion of major logistics operations in Southern California and throughout the state. In an era where the three Ls are now logistics, labor and location, the major forces in the warehouse industry are eyeing the stretch of Interstate 5 — the West Coast’s major north-south arterial — between northern Los Angeles County and Bakersfield, California, as the strategic position for the next wave of modern warehouse facilities.
Target, Wal-Mart, Sears and IKEA have already chosen the area to build large facilities to house California and western region distribution facilities. The presence of these major players in the market should be evidence enough that the southern Central Valley — mainly Kern County — has come of age and will certainly gain more and more interest from developers, logistics operators and companies seeking a cost effective alternative to the congested and overbuilt industrial markets of the Los Angeles Basin.
The Central Valley’s industrial appeal once was not as evident as it is today. Ontario and other communities in the western Inland Empire were the most viable alternative for the expanding demand for modern warehouse facilities in Southern California, leveraging their straight-line links to the ports of Los Angeles. But as land in these established industrial corridors continues to dwindle and new development is pushed even further east into the desert communities, the perceived benefits are lost due to increased travel times, congestion on local freeways and the growth of residential development in the region. Moving north from Los Angeles to the Central Valley has become an option now every bit as attractive as the eastern Inland Empire for viable, logistics-driven site selection.
Improved land in Kern County costs approximately 50 to 60 percent less than the Inland Empire and the greater San Fernando Valley. Master-planned industrial parks at the I-5/Highway 99 junction and in the greater Bakersfield area offer entitled sites fully prepared for immediate development, many of which are improved for big box accommodation.
With rents in the western Inland Empire hovering between 30 and 36 cents per square foot, big-box space in the southern Central Valley cannot be overlooked at approximately 30 percent less. With big box vacancy rates shrinking to 5 percent or less in the western Inland Empire submarkets, large industrial users in Southern California will be compelled to pursue build-to-suit development opportunities in the Central Valley based on real estate fundamentals alone.
Approximately 96 percent of California’s population can be reached within 4 hours’ drive of the Central Valley. For many logistics operations servicing the state, the Central Valley has become appealing for its ability to service either Northern or Southern California in a round trip. (Also, Highway 58 provides direct access to I-15, a second crucial trucking arterial connecting Southern California to Las Vegas and beyond.) With the new federal trucking laws restricting trucks to a maximum of 11 hours on the road in a 24-hour period, professional drivers have been unsuccessful reaching the Northern California markets from the Inland Empire in a single day. From the Central Valley, the state’s major urban clusters in Los Angeles, Orange County, San Diego and the Bay Area (San Francisco, Oakland and Sacramento) are easily reached within 11 hours.
Central Valley locations are within 2.5 hours by truck from the ports of Los Angeles and 4 hours from Oakland’s port. The continued growth of inbound traffic at the port of Los Angeles and associated delivery delays are making this dual-port delivery option a critical safety valve for companies engaging in Pacific Rim trade. A joint venture between the city of Shafter, just outside of Bakersfield, and The Port of Oakland is proposing a direct rail link connecting Kern County and the Bay Area. Current rail capacity in the city of Bakersfield is capable of handling the eastbound needs of importers passing product through to their Midwest and Northeast operations.
Finally, the southern Central Valley marketplace draws its employment base from the greater Bakersfield area as well as north Los Angeles County, giving employers an estimated 800,000 people living within commuting distance. With an unemployment rate of 12.04 percent, the labor pool is deep for those companies taking advantage of the location and the cost savings in the Central Valley.
— Barry Hibbard is vice president of commercial and industrial marketing with Tejon Ranch Company.
Las Vegas
Dating back to 2001 and 2002, industrial-zoned property in Las Vegas has been under great pressure from homebuilders that can pay more for sites than industrial developers. Much of the industrial land base, particularly larger parcels, is being acquired and rezoned for traditional residential uses. With the new high-rise residential development craze, this pressure has increased two- or threefold. High-rise residential developers can not only acquire land for five times the amount that industrial developers can pay, they can also buy existing projects at effectively a 2 percent cap rate, with plans to demolish the industrial projects and go vertical with their residential projects. As much as 1 million square feet of industrial space will likely fall in the next year or two as a result of these redevelopment efforts. This pressure on industrial-zoned land is leaving industrial real estate developers scrambling to find available parcels.
Another contributing factor to the pressure has been the rapid growth in material costs related to construction. An industrial project that would have cost $40 per square foot to build (just the shell and onsite work) 2 years ago will now cost more than $55 per square foot to build. Las Vegas industrial businesses are beginning to feel the strains of the steadily declining vacancy and increasing costs with greatly increased purchase prices and rental rates.
Just a couple years ago, tenants or buyers — whether new to the market or a local expansion — that had a requirement for industrial space would typically have had at least eight or more viable options to consider. Today tenants and buyers are fortunate to find more than a few opportunities, many of which are older, somewhat functionally obsolete properties. A buyer seeking a smaller industrial building will most likely have to line up to put a bid in for a building in a new development while the ink is still drying on the approved plans. Although this creates a favorable demand scenario for future industrial development, increasing land prices and construction costs have created difficulties in bringing new developments to the market that actually pencil without assuming a large forward movement in lease and sales pricing. It is one thing to underwrite a development on today’s rates, but to have to bank on a 20 percent increase in rates to make it work is entirely another.
In the southwest submarket, there is dim light at the end of the tunnel for tenants since Clark County Aviation (the airport authority) entered into land leases for more than 700 acres of prime industrial land with developers such as EJM Development, Majestic Realty and Juliet Companies. These land leases enable these developers to keep the lease rates lower than what would typically be required due to the lack of any land basis. That is not to say these developers are keeping falsely low rates; they will chase the market up with other properties in order to maximize the opportunity for themselves and the airport. Additionally, these developers are finding higher and better uses than industrial and much of their land will be developed into R&D and/or office parks.
With the vacancy rate decreasing by more than 2 percentage points in 2004 to 7.8 percent, it is pretty clear the Las Vegas Valley industrial market is in a tightening trend. The following major leases in North Las Vegas support that movement: Artesian Spas for 100,100 square feet from Panattoni Development Company; Metl-Span for 126,700 square feet from Operating Engineers Pension Fund; Kichler Lighting for 180,000 square feet from Panattoni Development; and CDW Corp. for 513,240 square feet from DP Partners.
— Michael De Lew is a senior vice president at Colliers International in Las Vegas.
Salt Lake City
Year-end 2004 marked the first view of blue sky for the Salt Lake City industrial market since fourth quarter 2000. The long hangover — caused by the national recession, exodus of manufacturing to Asia, consolidation of regional distribution centers and vacancy resulting from the completion of the 2002 Winter Olympics — finally relented as market vacancy shrunk from a two-decade high of 13.7 percent in 2003 to 8.33 percent at year-end 2004. This decrease and corresponding increase in demand caused the first positive pressure on lease rates since year-end 2000. At the close of last year, bulk distribution product — long the indicator of market health in Salt Lake City — saw an average increase of 17.8 percent in lease rates over the previous year. Sales prices for vacant buildings increased by a whopping average of 28.7 percent. Cap rates for institutional-grade investment product remained fairly stable, if not decreasing slightly, as the demand for quality industrial investment property solidified. The simultaneous evaporation of lease incentives, like free rent and moving costs, contributes to the bullish view of the market’s health.
Despite the firming of the market, lease rates have not returned to the historical high levels of the year 2000 and are below the lease rates that warranted speculative development in the mid- to late 1990s. With this, the first speculative development in 3 years is underway. This is somewhat enigmatic as construction costs, fueled by tremendous increases in structural steel and concrete prices, have soared during the past 2 years, though lease rates have yet to achieve historical levels warranting speculative development.
Among the planned or under construction bulk distribution projects for 2005 are a 122,000-square-foot building by Sortech LLC; the first of two 140,000-square-foot buildings developed by Hamilton Partners; a 192,000-square-foot building developed by ProLogis Trust; a 350,000-square-foot building developed by Buzz Oates Enterprises; and a 365,000-square-foot building developed by Natomas Meadows. Given the Salt Lake City industrial market base size of approximately 98.03 million square feet, the increase of about 1.17 million square feet in speculative bulk industrial product listed above represents an increase of 1.19 percent. This excludes user development and flex product, which both have a strong presence in Salt Lake City.
While all this development may appear to be throwing caution to the wind, there are strong market factors in favor of developing speculative inventory. As entitled industrial land becomes scarcer, land values will continue to rise, adding a deterrent to development and further tightening of vacancy over time. In addition, the current and projected increase in market demand for space will cause a natural and fairly rapid escalation of lease rates as space absorbs. First quarter 2005 saw construction commence on the new Salt Lake City regional intermodal facility. Union Pacific’s 350-acre state-of-the-art “inland port” facility will reaffirm Salt Lake City as a pre-eminent distribution market. The facility will be one of five developed in the United States in the next 15 years. In addition to the new intermodal facility, Salt Lake City boasts the crossroads of the West in the intersection of Interstate 80, which spans the continental United States from East to West, and I-15, which spans the country from Canada to Mexico. These factors, coupled with Utah’s status as a right-to-work state and the perennial top 10 ranking of Salt Lake for quality of life, bode well for the future of the industrial market.
— Kyle Roberts is a founding partner of NAI Utah and an active industrial investment broker.
Seattle
The absorption velocity created in the Puget Sound industrial market in 2004 shows no sign of slowing down. The leasing demand established in first quarter 2005 has dropped the vacancy rate to 8.7 percent with absorption at 1.6 million square feet. All submarkets reported vacancy decreases and absorption gains with the exception of close-in Seattle. Kent Valley was the best performing submarket with 698,440 square feet of positive absorption. The positive absorption of the past five quarters eliminates the negative absorption from the previous 3 years. Lease rates are holding steady across the board and concessions are tightening.
The largest leases this quarter were generated by retail tenants seeking distribution centers. In the Kent Valley, Broder Brothers signed a 160,300-square-foot lease in the newly built 500 Milwaukee building, and Furniture Factory Direct is leasing the entire 113,760-square-foot Sternoff Building.
Sales activity continued to be strong in the Puget Sound’s industrial market, with 20 industrial transactions exceeding $3 million during the first quarter alone. The total sales volume was $180.6 million with an average price per square foot of $69.27. The largest sale was the 532,943-square-foot Aldarra Corporate Park in the Kent Valley for $33 million or $61.92 per square foot.
The improving market has given many industrial developers the go-ahead to break ground during the year. New buildings added 3.1 million square feet to the market in 2004 and currently there are 3.5 million square feet of industrial product under construction. The number of planned projects is growing, with an amazing 13.4 million square feet on the drawing board. This pipeline of product represents 2 to 3 years of supply if constructed. Opus Northwest and Panattoni Development both have significant square footage under construction and in the planning stages to keep them busy for a few years. Opus Northwest alone has more than 2.5 million square feet designed and another 433,000 square feet currently being built. The bulk of the new space will be south in the Kent Valley and Pierce County. Close-in Seattle’s building activity is concentrated on high-tech/R&D buildings for the growing life sciences industry. Minimal projects have begun in the Northend and Eastside markets as industrial growth pushes southward between the Port of Seattle and the Port of Tacoma.
— Jeanette Ferguson is manager of Colliers International’s Market Information Group in Seattle.
Portland
The Portland market saw a sharp decline in industrial development in the past year, with just 800,000 square feet delivered in 2004, compared to 2.6 million delivered the prior year. The development slowdown was good for the market overall, because industrial users are absorbing space faster than builders are producing it, pushing vacancy rates down, closer to market equilibrium.
Steve Barragar, vice president of Colliers International in Portland, says demand for industrial space in Portland is segmented. Small industrial users, those under 12,000 square feet, have dozens of options when they search for space. The market for these small spaces is solidly in the tenants’ favor, discouraging most developers from building for this segment.
Medium-sized industrial spaces, in the 20,000- to 50,000-square-foot range, seem to have moderate supply and demand, achieving balance and not prompting much development in this range. Landlords with the most modern facilities fare best of this group.
Large-scale industrial space, typically more than 70,000 to 100,000 square feet, is where development is most in demand in Portland. Warehousing and distribution users, for example, require clear heights in excess of 26 feet and truck yards as long as 130 to 150 feet.
Of the 478,650 square feet constructed across three buildings in northeast Portland — the city’s most active submarket for new development — 204,550 square feet were pre-leased. Overall, 35.7 percent of the nearly 1 million square feet of new construction in the last year was pre-leased. About half of the 580,000 square feet slated for delivery in first quarter 2005 was pre-leased, but just 10 percent of second quarter deliveries are leased so far. The last four quarters’ trends show construction starts outpacing deliveries.
Barragar forecasts industrial development growth in 2005, particularly in the large-user segment. But he points out that the demands of large users are tough to satisfy because finding available land is more and more challenging. A Portland Development Commission survey concluded that slightly more than a quarter of the region’s 3,900 acres of vacant land is ready for development, and only 142 of those acres have built-out infrastructure such as roads, sewer and water service.
That’s why some large users will look away from the Portland market, Barragar says, to locations such as Yakima, Washington. While Portland is a logical choice for the warehousing and distribution of goods from Asia or between California and the Puget Sound region, the Yakima Valley holds promise for shipping between the United States interior and the Pacific Northwest.
On the other hand, with the rising costs of fuel and shipping, Barragar said more industrial users are looking to expand their distribution hub network once again, perhaps to seven or eight markets. “They’ll be looking for a northwest regional hub and that puts Portland on the map,” says Barragar.
— Heidi Stout is the marketing and research director at Colliers International’s Portland office.
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