Owners of industrial properties have been singing a sweet tune for some time.
But, like with the housing market, a few observers are beginning to wonder about a possible industrial bubble.
Investors, meanwhile, are debating how low expected rates of return will go amid skyrocketing sale prices, while some tenants are looking outside the county for expansion space.
The local conditions are spectacular by any measure.
Low vacancy rates, a limited supply of land for new development and strong absorption all favor Orange County landlords.
This means upward pressure on lease rates should continue through the year. South County should again see the highest rents.
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Redhill Business Center: 19 industrial condos developed by BKM |
“We’re entering an unprecedented time for the industrial market,” said Bob Sattler, an agent for the Anaheim office of Lee & Associates Commercial Real Estate Services Inc.
Sattler said the market is being propelled by record sales prices for existing properties and the conversion of industrial sites to retail, residential and other more profitable uses.
But could the market be set up for a reversal?
“Like the housing market, everyone is wondering, ‘Where’s the bubble?’ for the industrial market,” Sattler said. “We don’t know where the top is.”
Asking rental rates for manufacturing and distribution space in the fourth quarter increased 2 cents to 62 cents per square foot, compared to a year earlier, according to CB Richard Ellis Group Inc.
South County recorded the highest rates in the county, at 83 cents per square foot.
Market trackers expect industrial rents to rise between 4% and 7% in 2006.
Meanwhile, there’s not a lot of industrial space under development.
About 750,000 square feet of industrial space was under construction in the fourth quarter. That’s up about 5% from a year earlier but still well below levels posted from 1996 to 2003.
Many smaller tenants have gravitated toward for-sale industrial condo units. The units have sold briskly in OC, particularly in Anaheim and South County.
But larger tenants are finding themselves scrambling for space here, with few construction projects under way that target tenants who need more than 100,000 square feet.
Extreme Measures
Some companies are taking extreme measures. Huntington Beach-based surfwear maker Quiksilver Inc. recently said it was moving some distribution operations outside OC. The relocation trend is likely to continue.
“For a lot of other companies, that fork in the road is going to come soon,” said Jeff Cannon, corporate managing director for the Irvine office of Studley Inc., a tenant representation company.
After several years where the local industrial market added more new space than it lost to absorption, the tables began turning in 2004.
About 5 million square feet of industrial space was absorbed in 2005, led by demand in North County, according to economists at the University of Southern California. More than 9 million square feet of positive absorption took place in the past three years.
For 2005, the biggest news surrounding the industrial market was the conversion of land toward more profitable uses, particularly for housing around Anaheim’s Platinum Triangle.
The Platinum Triangle has about 5.8 million square feet of industrial space, comprising 11% of all industrial property in Anaheim.
Demolishing Space
About 500,000 square feet of that space will be demolished in 2006, with another 500,000 square feet taken down in 2007.
Replacing the industrial space will be numerous high-rise condominium towers from the likes of Lennar Corp. and others.
With space at premium, industrial vacancy rates fell to a record low of 3.3% in the fourth quarter, down 20% from a year earlier, according to Voit Commercial Brokerage LP.
There’s been no shortage of investors willing to buy new and existing space. That’s been positive for local sellers. The average asking sales price is up to $160 per square foot,a staggering level for the industrial sector,according to Grubb & Ellis Co.
Industrial properties in OC typically have traded hands at capitalization rates,the expected return from rents and fees,that are higher than 8%. Now brokers are seeing deals made just above 5%, a rate closer to what is seen for top office buildings.
“The biggest change here has been the cap rate compression,” said Steve Beck, senior vice president for Irvine-based GMAC Commercial Mortgage Corp. “Rates are at a 25-year low.”
These rates are providing a challenge to Beck, who makes loans to industrial developers.
“When we look at (local) deals now, we have to ensure from five to 10 years out, that we haven’t over-loaned,” Beck said.
The market has left some local investors scratching their heads.
“It is a unique situation,” said Rob Neal, executive vice president for Newport Beach-based Hager Pacific Properties. “Are we at the top of a curve, or are we now on an entirely new curve? Is it a brand new paradigm?”
Either way, “we appear to be on top of a ferocious pricing cycle,” Neal said.
The cap rate compression has left many to speculate that new industrial landlords will have to set rent increases even beyond the 4% to 7% projected for 2006 in order to recoup their investments.
For now, the high prices for land are causing some local investors to vote with their feet.
Hager Pacific recently went outside the region for a major buy,a 1.2 million-square-foot facility in Detroit. Of the roughly $300 million in assets it plans to buy this year, all will likely be outside OC, Neal said.
Tenants Look Wayward
Some tenants are finding more affordable industrial space outside the county.
Quiksilver announced plans earlier this month to move a large part of its distribution operations from its Surf City hometown to the Inland Empire. The apparel maker signed a long-term lease on a 683,000-square-foot distribution building in Mira Loma.
“We found a part of our distribution operation could be conducted off-site at a substantial cost savings,” said John Shipe, Quiksilver’s vice president of facilities, in a release.
Industrial developers have to go outside OC for larger warehouse and distribution projects to make financial sense, and tenants increasingly are following, said Chris Migliori, executive vice president for commercial brokerage firm GVA Daum.
“People are becoming more willing to move east, especially for 30% to 40% discounts in prices,” Migliori said. “Five or seven years ago, people were saying there was no way they would go as far out as Corona. Now Corona is seen as a viable alternative, even though prices have increased heavily there, too.”
Rents for industrial space in the Inland Empire are 35 cents to 45 cents per square foot,in some places half the rate that tenants would pay in OC, said Jeff Manley, chief executive of Newport Beach-based tenant representation firm Cresa Partners LLC.
Companies that are planning growth, or have leases expiring in the next two years, need to start dealing with their space issues now, Studley’s Cannon said.
“If you wait too long, your options are going to be limited,” he said. “If you have strategies in place, you don’t have to be held hostage.”
Some Large Projects
Most local developers have been focusing on residential and retail projects in OC. But despite the land cost challenges, some developers are placing bets that industrial construction still is feasible for larger projects.
Gardena-based developer Overton Moore Properties is set to move ahead with plans for a 50.3-acre Seal Beach site formerly owned by Irvine-based Boeing Realty Corp.
Plans call for 830,000 square feet of industrial space spread among 10 buildings ranging from 45,000 square feet to 184,000 square feet.
Among developers geared toward smaller industrial tenants, Costa Mesa-based BKM Development Co. has a number of projects in the works.
At North Anaheim Industrial Park, BKM is putting up 37 free-standing for-sale buildings, totaling 287,316 square feet. The project is expected to be finished by early next year.
In Costa Mesa, BKM is building 19 industrial condo buildings at Redhill Business Park. The project will total about 171,000 square feet when completed later this quarter.
