Brentwood-based Rexford Industrial Realty Inc. has had to get creative when it comes to finding new opportunities in an increasingly competitive industrial real estate market.
One of its latest pushes? Office properties that can be redeveloped into industrial ones once vacated.
Earlier this year the company purchased the Chatsworth Business Park at 21415 – 21615 Plummer St. in Chatsworth for $42 million, which it plans to redevelop with two warehouse buildings.
Last year the company acquired the Torrance Technology Campus which it also plans to turn into an industrial property.
“We saw the opportunity very early on when we noticed that occupancy was declining at a lot of these suburban office buildings. People were getting nervous and demand is still weak and has not recovered yet for this product,” Rexford co-chief executive Howard Schwimmer said of the latest push. “We saw we were able to acquire some in industrial zoned land. We were able to buy it at higher office yields and get paid handsomely to wait for those leases to expire.”
Rexford isn’t the only company interested in redeveloping office sites into industrial properties.
“There’s this huge demand for product by tenants, as a result, there’s huge demand to own or build newer industrial product,” Bret Hardy, an executive managing director at Newmark Group Inc., said. “With a lack of land, developers are looking anywhere they can and one of the places that developers have been able to go to is suburban office locations where they’ve been able to (buy) underutilized existing office product to demolish them and convert them to industrial uses.”
Brookfield recently acquired a two-story creative office building known as The H near the ports for $36.1 million. It has plans to redevelop the site at 19701 Hamilton Ave.
In December, Hines purchased a property at 21041-21081 Western Ave. in Torrance for $42.2 million. CBRE Group Inc., which marketed the property, said it could be redeveloped into an industrial property.
Jeff Chiate, an executive managing director at Cushman & Wakefield Inc., said he had about five office to industrial conversion deals in the works now.
“Industrial land pricing in the greater L.A. area is in the $200 or even north of $200 a foot. A lot of these buildings that are either short-term leased or vacant are ripe for conversions,” he said.
“There are a lot of developers leaning in hard to discover these opportunities,” Chiate added.
Industrial on fire
In the first quarter of the year, the industrial vacancy rate was a mere 0.6%, down from 2.9% the previous year, according to data from Jones Lang LaSalle Inc.
During the quarter asking rents averaged $1.44 a square foot on a triple net basis, up 45 cents over the previous year.
“Clearly industrial has proven to be one of the most if not the most resilient of the asset classes,” Hardy said.
The office vacancy rate during the first quarter meanwhile, was 20.8%, up from 17.5% the previous year, according to JLL data.
Barbara Perrier, a vice chairman at CBRE who worked on the 21041-21081 Western Ave. and Chatsworth Business Park sale, among other potential office to industrial conversion deals, said this is driving the office to industrial trend being seen now.
“You have one asset type that’s accelerating and one that’s in a standstill,” she said. “As that has happened, people are looking for opportunities…we have record low vacancy rates (in industrial) and huge tenant demand and a lot of investors willing to pay a lot of money for land, especially because our rental rates have gone up exponentially. That’s why this trend has started. Industrial investors are looking at opportunities. At first, they were looking at retail…but I think they received a little more push back from municipalities in trying to make retail work because if you are in a retail location it’s probably better as mixed-use or multifamily. Office makes sense. A lot of suburban offices are near industrial.”
Michael Longo, an office specialist at CBRE who works with Perrier on office to industrial deals, called the trend a “confluence of both worlds intersecting.”
Longo said high-quality office spaces are continuing to do well but for older, obsolete product, a move to industrial makes sense.
One of the most important factors in whether an office property can be redeveloped into industrial is zoning.
“The key thing for us is we look for opportunities where the underlying land is already zoned for industrial use and we don’t have to take any entitlement risk,” Michael Frankel, a chief executive at Rexford, said.
Mike Fowler, a senior managing director at JLL, said there are “huge barriers to entry in Southern California” making it difficult to develop industrial product at locations that aren’t zoned for industrial.
Taxes from retail properties are a huge revenue generator for many cities, making cities unlikely to agree to rezone retail properties to industrial.
Some cities, experts agree, are willing to rezone some office properties to industrial but it can take months if not years leading many developers to look only at sites that already have industrial zoning.
“The cities that have got a significant pre-existing industrial footprint, it’s much easier to make the conversion from office to industrial,” Hardy added.
Beyond zoning, developers look for sites with lots of land in desirable areas.
Schwimmer said you also have to find a site that is “not tied up with leases that have options” to be renewed many times.
“We can’t buy those sites. Those don’t really work. We want to get to the site in a reasonable period of time,” he said.
Experts agree that continued demand for industrial product means there’s still a runway for more office to industrial redevelopment.
“We think this is going to be a trend that is going to continue,” Hardy said. “We don’t see industrial demand falling off a cliff…we are going to see industrial developers and their capital partners looking for every possible way to get their hands on new product and this is a trend that will sustain.”
Chiate agreed, adding that “as land prices continue to escalate it’s going to make more and more of these industrial conversions appealing.”
But some experts say the trend could be temporary.
“It’s a trend that’s going to ramp up but I don’t things it’s an endless trend. There’s a finite amount of opportunities,” Perrier said.
She added that it makes sense in markets like Southern California where land is valuable and hard to come by but makes less sense in other markets.
Frankel said that while Rexford was interested in more office to industrial plays the “universe of those opportunities is not that substantial.”
“It’s not really even a rounding error in terms of the size of the market…that being said, we will continue to be very opportunistic,” Frankel said.
He added that he expects 2022 to be a very busy year for the company which has already done $450 million worth of acquisitions this year.