A Sector In Flux

A Sector In Flux
Industrial: A Dedeaux Properties asset at 3450 Palm Ave. in San Bernardino.

Declining port volume, increasing interest rates, a move by some companies further inland and high lease rates have all put pressure on L.A.’s industrial market.

As of June 1, the vacancy rate in the market stood at 3.8%, up from 2.3% the previous year and 1.7% in 2021. It is the highest vacancy rate of any recent year, according to data from Avison Young Inc. The brokerage also found that leasing activity in the first few months of the year totaled nearly 8.5 million square feet, also far below recent years – for comparison, 2022 saw nearly 21 million square feet leased, while more than 34 million square feet of industrial product was leased the year before that.

Steve Bohannon, an executive director at Cushman & Wakefield, called current sales and leasing “well off its pace.”

“Activity has slowed, and the sale market and investment arena has slowed down rather dramatically,” he said.

“It’s definitely not as robust as it was a year ago,” said Rob Antrobius, senior vice president and market officer in Los Angeles for Prologis. He oversees the company’s 40-million-square-foot Los Angeles and Orange County portfolio.

“Industrial outperformed the other asset classes and in a way benefited when we came out of Covid. E-commerce and other companies were looking to build up inventory and have it on hand, and it led to really positive industrial warehouse leasing,” he said. “The first half of the year we have seen healthy statistics in terms of occupancy, leasing, rent, but compared to last year it’s not as robust.”

He added that things were “normalizing” now.

Ted Evans, director of asset management at Santa Monica-based industrial real estate developer and owner Dedeaux Properties, also called current lease rates a “return to normalcy.”

Danny Williams, an executive managing director at Newmark Group Inc., echoed the sentiment.

“Transaction volume is off from prior years, but I would add the caveat that 2020 through 2022 were incredible, somewhat abnormal years for us,” he said. “This is coming back down to earth and a return to normalcy. It’s a good thing. It’s healthy.”

Slowdown at the ports

Complex: A Dedeaux Properties industrial facility at 3450 Palm Ave. in San Bernardino. It sits on 21.3 acres and has 600 trailer parking stalls.

One of the major factors contributing to changes in the industrial market is a slowdown at the local ports.

The Port of Long Beach and Port of Los Angeles handle nearly 40% of U.S. cargo imports from Asia and are among the busiest ports in the nation. In April, however, the port of Los Angeles processed 22% fewer twenty-foot equivalent units than the previous year. The Port of Long Beach, meanwhile, processed 20.1% fewer twenty-foot equivalent units than the previous year.

The ports have also seen issues as contract talks turned tense. Earlier this month, contract disputes shut down two terminals in Long Beach and one in Los Angeles.

In addition, dockworkers forced a daylong shutdown at the ports in April. Workers have been without a contract since July 1 but a tentative agreement was reached last week.

“Some of the issues we’ve experienced in the last couple of years coupled with IWU contract negotiation has made some carriers divert cargo to other ports,” Williams said, referring to backlogs at the ports.

Evans added that there are other issues at play as well.

“The decrease in port activity, it’s a variety of reasons,” Evans said. “One, you have the labor dispute going on at the port, and at the same time your inbound traffic and volume is just lighter because tenants have tremendous inventory in the space already.”

Antrobius said that delays at the ports during Covid led some to increase the amount of product they have on site, which is now causing a lot of inventory in some spaces, and in other cases tenants are now finding themselves with too much space if they no longer are storing larger-than-usual amounts of inventory.

“Last year there was a backup at the ports. As that worked itself out, one of the benefits for industrial warehousing space was that that product needed a home, so we saw a ramp up last year of companies taking up space,” he said, adding that some no longer need the same amount of space.

He added that while many customers want to continue to have a presence in infill Los Angeles near the ports, some are “diversifying their supply chain routes for products through other ports. They are not abandoning the ports of Los Angeles and Long Beach, but we are seeing some go through routes they previously did not to make sure that if there is some disruption in the supply chain the issues do not happen again like they did when we ran into the situation with all the ports waiting to unload.”

Bohannon agreed, adding that some “shippers have diverted from the Ports of L.A. and Long Beach to other ports.”

Moving further out

Complex: A Dedeaux Properties industrial facility at 3450 Palm Ave. in San Bernardino. It sits on 21.3 acres and has 600 trailer parking stalls.

The slowdown at the ports and high prices of nearby assets have led some tenants to consider spaces outside of infill L.A., rather than be near other ports or in secondary markets.

“Some tenants are saying ‘OK, I can potentially continue to operate my business. I thought I needed to be in proximity to the ports, but I can move up to Central Valley or Las Vegas or Phoenix. I can continue to operate my business and pay the additional drayage expense and it still works for me because my rent costs are a third of what they were in L.A.,’” Evans said.

Lease rates have still been strong this year. The asking rent for industrial properties so far this year is $1.87 a square foot on a triple-net basis, up from $1.73 the year prior and $1.22 the year before that, according to data from Avison Young.

In the Inland Empire, rents are currently $1.25 on a triple-net basis, according to Avison Young data. Rents are much lower in other markets, experts agree.

Bohannon said that the Inland Empire doesn’t represent the same value it once did.

Jerry Holdner, a Southern California Region Lead for Avison Young, said he was seeing tenants migrate out of L.A. “if it makes sense, but it doesn’t for every company.”

“Some stay and are moving into smaller buildings. A lot of companies are rightsizing,” he added.

Experts agree that some tenants are interested in the Inland Empire not for the price discount, but because there are bigger spaces available than in L.A.

“In the infill Los Angeles area, there aren’t many facilities over a half million feet available,” Antrobius said. “We see companies that need more than half a million square feet migrate to the Inland Empire because they have more choices. And we are seeing some companies start to look at Phoenix, Las Vegas and Texas.”

Still, Evans said many tenants want to be in L.A., as it’s near both the ports and a population hub.

He added that many tenants were being “more methodical” about their leases.

“During Covid and immediately post-Covid, there was such a strong demand not knowing about supply chain issues and (if there would be) enough inventory. Tenants were very reactive in that this is the only space available, I need to stay here, or I’ve ordered as much inventory as I can get my hands on and will pay whatever it takes to store it so I can continue to operate my business. Now, it just makes sense for tenants to slow down and wait a minute. There are some indicators that the economy may be slowing down, and I’ve got all of this inventory from Covid that I’m still trying to go through and let me be a little more methodical on the next steps.”

Sublease space

Another complication is the amount of sublease space on the market.

So far this year, roughly 6.6 million square feet of sublease space has become available, up nearly 70% from the total amount seen in the market last year, which was up nearly 64% from the year prior, according to data from Avison Young.

Holdner said a lot of the sublease space on the market today is a result of companies taking more space than they needed during the pandemic and now giving some of that space back to the market.

Antrobius agreed.

“A lot of the sublease space comes as no surprise, because when you look at many of those spaces, they were the result of customers acknowledging they might be taking on a little more than they need long term but wanted to assure they had the appropriate amount of space to hold their products,” he said. “Now that things are normalizing, a number of industrial users out there are placing their excess space on the market for sublease, and it does create some competition for the direct availability space.”

Holdner said there was enough sublease space on the market now to compete with direct rentals and expects it to “put upward pressure on the vacancy rate.”

The sublease space has, he added, created some opportunities for tenants in the marketplace. When there is a large amount of sublease space on the market, it can affect rents and concessions offered by direct spaces, or spaces leased directly by landlords.

Whether sublease space is in competition with these spaces depends largely on the amount of space, but also how long is left on leases for the spaces.

Companies that need short-term overflow, especially if it will just be stacking goods on the floor, may find sublease space appealing. Tenants with complicated logistics operations, forklifts, rack storage, conveyer systems and more, however, often do not want to make the financial investment necessary to get their operations up and running for only a short time.

Industrial sales

Industrial sales have taken a nosedive this year. As of June 1, only 22 industrial properties had sold in L.A., putting the market on pace for roughly 53 sales this year. Last year, 139 industrial properties were sold in L.A., and 145 were sold the year before, according to Avison Young.

And experts agree one of the main reasons for this is clear: interest rates have risen dramatically in the past year.

“Interest rates going up started a lot of this. You’ve got these buildings that are coming up and need to be refinanced. Owners are finding their debt services doubled,” Holdner said.

“While interest rates spiked early on, the leasing activity remained strong and we were still getting record rates with regard to leasing rates, but that tide has turned and we have noticed a precipitous drop in velocity,” Bohannon added.

Despite there being fewer sales, the sales that did happen fetched a pretty penny.

The average sale price per square foot so far this year has been roughly $411, compared with $291the previous year and $241 in 2021.

And Antrobius added that the rising interest rates aren’t impacting some of the biggest players in the sector the way they are other companies.

“It’s not having the effect that some might have thought it would,” he said. “Industrial, especially the largest facilities, the ownership landscape is now made up of large institutions like Prologis. You don’t see as many highly leveraged ownership structures, so you have not seen a lot of fire sales or product coming to the market for sale for the reason of interest rate increases. Right now there’s not a lot of large or quality industrial real estate on the market for sale.”

The outlook

Complex: A Dedeaux Properties industrial facility at 3450 Palm Ave. in San Bernardino. It sits on 21.3 acres and has 600 trailer parking stalls.

Experts and owners alike predict the rest of the year will be slow.

“We are projecting a slow remainder of 2023, and it’s probably going to limp around,” Bohannon said.

He added that he expected the next 12 months to be “rather flat” as far as sales go. His business used to be 80% leasing and 20% sales but has lately moved to 90% leasing and 10% sales.

Bohannon said there was not a lot of product on the market now, and many industrial investors were “on the sidelines waiting for better deals to come along.”

Holdner said that while there are some “aggressive” industrial owners out there, many “have put their pencils down.”

He expects things to pick up again next year.

Dedeaux’s Evans said his company was taking a cautious approach.

“We’re being more conservative in today’s environment to make sure we are executing and achieving the best results for us and our investors,” he said. “We have a strong belief in this market, in the greater Los Angeles market, and we think that there is continued value for investors looking to partake in industrial real estate.”

The company is focused on the IOS space, meaning yards and terminals, but is still working on more traditional industrial sites as well.

He added that construction costs and the price of debt increasing were a concern, but the company was still interested in building and owning properties in the market.

“We’re here for the long haul,” Evans said.

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