SoCal Industrial Summit & State of the Ports
“There is nothing more difficult to take in hand, more perilous to conduct, or more uncertain in its success, than to take the lead in the introduction of a new order of things.”
— Niccolo Machiavelli | The Prince (1532)
PART 1: INDUSTRIAL LANDSCAPE | FEARS AND OPPORTUNITIES IN THE NEW ORDER (OF THINGS)
With 1.85B SF of industrial space the SoCal marketplace is the largest in the nation and at 2.4% vacancy Los Angeles County has the highest occupancy rates in the nation. We wanted to catch up with the experts at the BisNow hosted SoCal Industrial Summit and State of the Ports Panel and see how the greater LA area has fared the economic fallout, where the market is headed and what the local players are up to. If you are looking at the marketplace and considering signing a new lease, expanding, purchasing a new facility or making an investment and want to know what is going on read on to see what we learned at the event.
According to Kurt Strassman, Senior Managing Director at CBRE there are three main factors driving the marketplace: limited Class A supply, anemic job growth and restrictive government regulations. The word of the day was undeniably “ecommerce” and was discussed in detail as it relates to these factors.
Class A space comprises only 15% of the total market and with increasing demand from fortune 500 companies for ecommerce distribution centers near major transportation hubs we find Class A rents having increased 5.8% year over year with similar forecast for 2013 according to Mr. Strassman.
According to November reporting from the EDD with job growth hovering around 1.5% we have pushed our unemployment rate down to 10.5% in October from 12.2% 12 months ago. Professional and business services, leisure and hospitality, trade, transportation and utilities and educational and health services are driving job growth and account for over 95% of net gains in employment while government and manufacturing sectors contracted.
David Nazaryk, Managing Director of Trammell Crow Company, points out that “increasing government regulation pushed down from Sacramento has been and continues to be a thorn in the side of business growth and investment into our economy. With new environmental regulations come new found organized challenges against Environmental Information Regulations (EIR’s). Additionally it is becoming more difficult to complete the entitlement process, especially where many communities see industrial warehouses as a net user of resources.”
These factors are not without their upside, for where there are finite resources and disparity in the marketplace opportunity abounds for those who are patient and diligent in their pursuits and perhaps have a long term view of the horizon. Two distinct business models surrounding class A and Class B/C space shed light on current opportunities where investors are taking on greater risk in an effort to push returns while historically low interest rates and increasing land constraints continue to challenge cap rate appreciation.
Trammell Crow’s industrial focus is being exercised in the Inland Empire (IE) where at the market low in 2011 sixty five acres of east IE land was acquired for less than $3/SF that by comparison has seen land trades today in the +/- $10/SF range. Trammell has been pushing through more difficult entitlement processes while at the same time learning how to work with increased organization brought about by non-profits who mount challenges to EIR’s. Mr Nazaryk is looking for a balanced approach to addressing these environmental conditions however he explains that “where it takes 50 acres of land to build 1MM SF of industrial space a bigger problem becomes actually finding the land in the first place.” When they are gaining land and entitlements Trammell is catering to the ecommerce market with the construction of Class A fulfillment centers for primarily larger corporations with better credit who bring sales tax and increased employment opportunities to the community.
Howard Schwimmer, Co-Founder and Senior Managing Partner of Rexford Industrial and Jon Pharris, Principal of Caprock Partners are competing on a much larger field comprised of B product under 200,000 SF in size. Rexford has aligned itself with a long term investment horizon while Caprock has a 2 – 3 year disposition period with an owner-user sale exist strategy. Both fields see entrepreneurial companies as their client base, either as tenants or buyers of real estate taking advantage of all time low rates and 90% SBA financing, both forces acting together are driving both rents and valuations higher.
Howard notes that “while rents fell 20 – 30% during the market downturn, vacancy did not rise and that while long term rents have not yet recovered continued market uncertainty has presented buying opportunities.” Having acquired 10 – 13 business parks in the last couple of years at low 80% occupancy and at 6 CAP rates of return with financing below 3%, Rexford is now seeing a return on their investment as occupancy has climbed to the mid 90% range. With the expectation of rent growth he sees cap rate compression coming for B/C assets which will further drive returns on the backend of their current portfolio.
Jon is seeing upwards of 65 – 75% of business owners wanting to take advantage of current low interest rates and acquire industrial space as it has, for those who qualify for the best rates, become cheaper to buy than to rent. Therein lies Caprock’s business opportunity where purchases made based on the actual versus replacement cost basis can be sold to owner users 2 – 3 years out who will also be looking at properties in the same manner.
So while Caprock relies on tenants exiting leases and becoming owners Rexford depends on tenants absorbing higher rents to meet their return expectations. With current restrictions on lending there should be room for both players in this tight marketplace. Those established and qualified business owners can see the writing on the walls, inventory is disappearing, there is no more land to build, fortune 500 companies are moving in and rents are rising. These four pillars will be holding up the industrial market for the foreseeable future.
“Whosoever desires constant success must change his conduct with the times.”
— Niccolo Machiavelli
PART 2: STATE OF THE PORTS: A CHANGE OF CONDUCT
With over $6B in new investment, the leading gateway for trade to and from Asia, Los Angeles and Long Beach Ports pass $1B of goods over their docs each day of operation. John DeCesare, President of World Class Logistics Consulting brings to scale the significance of the investment when compared to the same $6B invested recently into upgrades to the Panama Canal and $12B invested into the Burlington Northern rail network upgrades. That being said he points out that “2006 was the peak year for the ports and with the offshoring of manufacturing mostly completed we will no longer see double digit growth but more likely 2 – 3% increases in the future driven by cost, transit time and reliability.” We look at what the port is doing to reduce costs, decrease transit time and increase reliability to stay competitive and how those efforts are affecting industrial real estate in the region.
John outlined three main initiatives that the ports are undertaking as related to industrial real estate: Pier Pass, Clean Transit Program and the Ocean Carrier Chassis Program. In an effort to relieve congestion the ports have incentivized night shipping to the point that 50% of all shipping occurs after hours. This places a further premium on warehouses located in exclusively industrial zoned parks as opposed to many areas in SoCal where we see residential development on top of industrial warehousing. “The clean trucking program has increased costs from $20K to $100K per vehicle and has limited supply and in turn added further benefit to proximity of warehousing to the ports.” Lastly the United States is the only large market where ocean carriers own and provide chassis to truckers to move cargo however this is a dying program and truckers are being required to provide their own chassis for transportation. This has resulted in several pools of chassis under operation at the LA / Long Beach Ports from which chassis may be utilized. This increases the amount of space required for storage, and in turn may increase overall costs to transport goods through the ports. According to John all of this means that the velocity of goods through the ports will need to increase to remain competitive. In turn receivers must be able to operate 24/7 and with higher levels of efficiency which means that their fulfillment and distribution centers need to be both located and engineered to maximize ROI.
Kim Snyder of Prologis looks to deliver that product to his tenants by building Leed Certified buildings however with the added cost he notes that it is important to get tenant clients involved in the process of certification from the beginning. The program is built into the lease rates with the goal of providing a lower cost of operation under a high quality, sustainable approach that can be pushed through to clients’ customers through green marketing. Prologis is looking for class B space in class A market locations with 20 – 24’ clear height and ready access to the freeway system, rail and or ports to fulfill their business plan. They are seeing consolidation (of facilities) over growth as businesses look to improve operating efficiencies and reconfigure supply chains to reduce costs. It is clear to see why Kim sees the ports as the “biggest driver of business in SoCal,” and the biggest threat to their success a potential diversion of traffic elsewhere, should it be made more difficult to operate from them.
Conversely, Mark Payne of Panattoni Development Company does not see things the same way. “Leed Certification is not a priority because Class A space is so difficult to find; (users) are not willing to pay more for it.” He adds that “building standards (for new construction) are close to Leed Standards in SoCal already.” Although he counters that the “cost to certify is coming down and it is becoming common place to certify buildings. Panattoni is looking to differentiate its product and is seeking D & F buildings to raze and build small buildings with truck courts and trailer storage for the owner user marketplace. Concerns moving the market forward include “rising land prices and increasing difficulty gaining entitlements that pushes prices up.”
Barbara Emmons, Vice Chairman of CBRE talks about the ecommerce affect, saying that “port growth equals demand for distribution centers.” Clients are looking for “proximity to UPS / FedEx distribution for next day delivery. They want to be near end customers.” Barbara sees the “port as a driver, adding that investors want to be here, and for those reason there is relative safety of the market. She agrees with Kim Snyder and sees many (larger) clients looking to consolidate operations to save money and she is looking for growth in the small business market. Her biggest concern, one that we hear from many business owners, is keeping the state business friendly.
Technology continues to be an enabler of change, forever driven by the human spirit to always move forward. Technology is here to meet new environmental regulations, receive and move goods faster, build more efficient buildings and push costs lower (over the long term). We are always at the forefront of innovation when the moment is now, the question is where will we be twenty years from now; how will you position yourself to be there before there becomes now.