WESTERN SNAPSHOT, MAY 2010

The Inland Empire Retail Market

Although job growth will resume in the Inland Empire in late 2010, the depth of the local housing correction and recent layoffs will delay a recovery in space demand. Economic strain will be pronounced in areas farthest from employment centers, especially where developers built ahead of demand to secure prime locations.

As a result, significant weakening is expected to continue in the Palm Desert and south Riverside County submarkets, particularly among newer, larger developments as additional stores shutter in 2010 and leasing efforts remain a challenge. Retail demand is anticipated to fare better west of Interstate 15 in Corona, Ontario, Upland and Montclair due to a proximity to major metro employment hubs. Nonetheless, softening will persist in these locations until meaningful job formation resumes.

In response to these issues, builders and retailers have delayed groundbreaking on some projects and ceased construction on a few partially built developments. Work on the 540,000-square foot Murrieta Marketplace, for instance, stopped in mid-2009 following Target’s decision to hold off indefinitely on building the anchor site.

Looking at fundamentals, minimal inventory expansion and resumed job growth caused the Inland Empire to advance three places in the National Retail Index. After eliminating 50,600 jobs in 2009, employers will add 6,800 positions this year, a 0.6 percent gain. Builders are forecast to complete 600,000 square feet of retail space in 2010, down from 1.2 million square feet last year. Weak retail sales will result in the metro’s second consecutive year of negative net absorption, causing vacancy to rise 80 basis points to 12.7 percent. In 2009, vacancy spiked 310 basis points. Asking rents will fall 2.4 percent to $20.40 per square foot in 2010, while effective rents will decline 5.4 percent to $16.90 per square foot.

Retail investment activity in the Inland Empire will remain subdued until an up-tick in bank-owned listings occurs, helping to set a market price point. While banks’ readiness to modify loans will limit the presence of REOs, current distress levels will cause some to emerge, further solidifying a price floor. The re-establishment of benchmark prices will assist in pulling sidelined capital back into the market and increase sales velocity modestly. Prospective buyers will target infill assets closer to the western edge of the two-county market, where tenant demand is expected to rebound first. Cap rates for single-tenant properties in the close-in cities will average in the mid-6 percent range this year, with a 100 basis point spread for assets in tertiary areas. Initial yields for well-located multi-tenant properties will average between 8.5 and 9 percent and could reach as high as 10 percent in outlying communities. First-year returns are projected to rise this year, though assets listed in excess of $2 million will post a sharper increase due to financing hurdles.

— Douglas McCauley is the regional manager in the Ontario, California, office of Marcus & Millichap Real Estate Investment Services.

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