Our industrial market in Southern California is rapidly morphing into a buyer’s/tenant’s market. By that I mean, a supply of available buildings which exceeds demand and a softening of prices.
This is happening in the large logistics spaces constructed in the last building craze. At their peak, rents topped $2.10 per square foot (triple net) for these concrete caverns. On a 100,000-square-foot building, that’s $210,000 per month plus an additional $40,000 for operating expenses.
In context, these industrial rents for a seemingly lower and lesser use than, say, an office building, eclipsed the price paid for a suite of office space.
Before June 2022, these boxes were devoured by hungry occupants even before construction was completed. Now they sit. In some cases, for months. Those deals that have transacted are much less than the halcyon days of two years ago. Now a creditworthy tenant can expect to pay $1.75-$1.85 triple net for the same address that not too long ago commanded a 17% higher rent.
What about the sale market?
In north Orange County (Anaheim, Placentia, Brea, Orange, Yorba Linda, Fullerton and La Habra), we’ve also seen softening. However, not to the extent rents have decreased. The inland areas tell a different story.
What’s with the shift?
1. Increased supply: The recent building boom has resulted in an oversupply of large logistics spaces. These buildings, once in high demand, are now struggling to find tenants. This surplus is driving down rental rates as owners compete for a shrinking pool of occupants.
2. Economic uncertainty: Economic factors, including inflation and rising operational costs, have made businesses more cautious about expanding their industrial footprints. Companies are reevaluating their space needs and, in many cases, opting for smaller or more flexible leasing arrangements.
3. Changes in consumer behavior: The rapid shift toward e-commerce during the pandemic has now stabilized. As consumer behavior normalizes, the frantic demand for massive warehouse spaces to accommodate inventory surges has waned.
4. Financing challenges: Higher interest rates and tighter lending conditions have made financing new acquisitions and developments more challenging. This has tempered the pace of new investments and developments in the industrial sector.
Tenant and buyer opportunities
1. Bargaining power: With a glut of available spaces, tenants have greater bargaining power. They can negotiate more favorable lease terms, including lower rents, longer rent-free periods, and tenant improvement allowances.
2. Strategic acquisitions: For buyers, especially those with readily available capital, this market presents opportunities to acquire properties at more reasonable prices. Investors can capitalize on distressed assets or properties that have been sitting vacant.
3. Long-term planning: Businesses can take advantage of the current market conditions to secure space for future growth at attractive rates. Locking in long-term leases now can provide stability and cost savings in the years to come.
Challenges ahead
1. Vacancy rates: High vacancy rates can strain property owners who rely on rental income to meet their financial obligations. This could lead to increased property turnover and potential distress sales.
2. Maintenance costs: Maintaining large, vacant industrial properties can be costly. Owners must continue to invest in upkeep to attract potential tenants, even as rental income declines.
3. Market uncertainty: Continued economic uncertainty and potential regulatory changes could further impact the industrial real estate market. Stakeholders need to stay informed and adaptable to navigate these challenges.
Southern California’s industrial real estate market is undergoing a significant transition into a buyer’s/tenant’s market. While this shift presents challenges for property owners, it also offers opportunities for tenants and buyers to secure favorable terms and strategic investments. By understanding the factors driving this change and staying adaptable, stakeholders can navigate the evolving landscape and capitalize on new opportunities.
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104. His website is allencbuchanan.blogspot.com.
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