“The warehouse/distribution sector is no longer a tenant’s market,” declares Cushman & Wakefield in its second-quarter report on Orange County industrial. “[T]enants in the market—especially those seeking Class-A product—have few choices,” a local industry veteran informed GlobeSt.com in August. Indeed, there may be no surer sign of a recovery in progress than a shift in control from tenant to landlord. Other positive signs are apparent as well. Reis, tracking a warehouse/distribution market of 99.5 million square feet, cites a strong, if somewhat uneven, positive absorption trend, low vacancy, and a return of rent growth. Speculative development remains, for the most part, on the sidelines.
Given its large high-tech business base, Orange County claims a substantial inventory of Flex/R&D space—59.6 million square feet by Reis’ latest count—much of which is concentrated in high-end business parks in the Irvine area and South County. This market also shows marked signs of recovery, including low vacancy and the return of positive rent growth.
With no new space delivered and demand running positive over the past year and a half, a decisive downward trend in warehouse/ distribution sector vacancy became established. The rate for second quarter 2012 was 9.6%, down 20 basis points from the quarter before, down 260 from the cyclical peak recorded for the third quarter of 2010. The local rate, moreover, was fully 310 basis points lower than the 12.7% second-quarter national rate for this property type. The local market, accordingly, strikes a different posture than do most other markets nationwide. Occupancy in the Flex/R&D sector has behaved similarly. At 6.4%, vacancy in this sector was down 20 basis points from a quarter earlier and was down 230 from the second quarter 2010 peak. Moreover, vacancy in this sector also breaks with the national trend. Indeed, its rate was less than half of the 14.7% reported for the national Flex/R&D market for the period. For the 275.7 million square feet of industrial space tracked by Cushman & Wakefield, mid-year vacancy was 5.6%, down 40 basis points from the first quarter, down 50 year-over-year.
SUPPLY AND DEMAND
The Orange county warehouse/ distribution market has some unusual characteristics. With development opportunity difficult to come by, the market tends to enjoy low vacancy rates; given local cost structures (land, construction, and other factors), rents run high. Development, meanwhile, tends to feature relatively small projects; large state-of-the-art logistics space development gravitates eastward to the Inland Empire. Thus, the local market does not take advantage of port traffic and related distribution to the extent seen elsewhere in the region. Indeed, even the distribution market in western Phoenix has captured a portion of Southern California’s port-related business.
“In terms of touring activity and the amount of active tenant requirements,” reports Jones Lang LaSalle, “Orange County is enjoying a solid recovery that is outpacing many markets around the nation.” However, the scarcity of development, according to this source, presents the county market with one of its biggest challenges, the ongoing “lack of quality Class A property.” “Demand for this property is growing faster than [for] any other class, but there are very few existing options for tenants.” (As noted in Special Real Estate Factors, a kind of “flight to quality” in reverse has emerged as a result of the limited availability of Class A space.) On the other hand, adds Jones Lang LaSalle, “Landlords with Class C product continue to find difficulty in attracting new tenants to fill vacancies, and with several new Class A developments slated to deliver over the next couple of years, the struggle is expected to be sustained for months to come.”
Net absorption of warehouse/distribution space as counted by Reis has slowed but remains positive. The total for the first half of 2012, at 272,000 square feet (including second quarter’s 203,000), comes on the heels of 1.9 million square feet in 2011. As suggested by the “Lansner on Real Estate” column in a June issue of the Orange County Register, the slowdown in net absorption could be an effect of the shortage of desirable supply. More of the same could follow. Indeed, no new space of this type has delivered since a small volume came online in 2010. Only 210,500 square feet of warehouse/distribution space was under construction per report date—in three projects, at least two of which are single-tenant endeavors. Of this sum, only 26,000 square feet for a locally based retailer will complete by the end of the year. The other two projects are due online in the latter part of 2013 (see Submarkets). Net absorption in the Flex/R&D market has been strong—and also slowed during the first half of 2012. Including second quarter’s net absorption of 103,000 square feet, the total to mid-year was 157,000 square feet. No product of this type was under construction per report date. While improving market conditions may again make speculative projects appropriate, few starts of this type appear imminent at present (one in the Anaheim/Orange submarket is cited in the Submarkets section).
If Orange County industrial is no longer a tenant’s market, landlords have yet to reap a large harvest from lease rate growth. Losses, however, have ceased; stability has taken their place. At $6.17 psf and $5.73 psf, mean second-quarter asking and effective warehouse/distribution space rents were up 0.5% and 0.7% for the quarter and were up 0.7%
each since year-end in the wake of an anemic performance in 2011. Even weaker last year, mean rents for the Flex/R&D sector also have stabilized. At $10.08 psf and $9.32 psf, second-quarter asking and effective averages in this sector were up 0.1% and 0.5% for the period and were up 0.2% and 0.9% year-to-date following losses in the vicinity of 2.0% in 2011. Continuing modest growth is expected for both markets over the remainder of the year. Higher rates of increase should follow for both in 2013.
According to Jones Lang LaSalle, tenants can still take advantage of rental rates, which remain low by Orange County norms (if higher than in the inland markets). As reported by Cushman & Wakefield in its second-quarter report on county industrial real estate, the $7.92 psf overall asking average was up fully 4.8% year-over-year. “Demand for newer Class A warehouse space exceeds Orange County’s available inventory and landlords are no longer offering the generous concessions that were available in previous years,” adds this source. According to the “Lansner on Real Estate” column in the June 22 issue of the Orange County Register, “many building owners are holding firm on asking rents or even going a step further by reducing concessions and implementing modest rent increases in higher-quality Class A and B properties.”