Boom in industrial space begins to go bust

By Roger Vincent

Feb. 3, 2009 12 AM PT

As the regional economy continues to sputter, vacancy rates are beginning to climb at warehouses and distribution centers for industrial goods, putting the already hard-hit Inland Empire at further risk of decline and threatening facilities in Los Angeles and Orange counties as well.

After years of high occupancy and rapid construction of cargo hubs, immense spaces are now standing empty. Some fell victim to the collapse of retailers such as Mervyns and Wickes Furniture; others are vacant because the huge national falloff in demand for consumer goods has meant fewer imports and less need for storing and shipping them.

Nearly all of these warehouses and shipping hubs are located in San Bernardino and Riverside counties, where a long-running industrial real estate boom is finally starting to go bust.

“We were the hottest market in the country,” industrial real estate broker Kevin McKenna said. “Imports were going crazy and the ports of L.A. and Long Beach were booming.”

Then, of course, the world economy changed.

Industrial vacancy in the Inland Empire doubled in the last year, from 6.2% in the fourth quarter of 2007 to 12.4% at the end of 2008, according to figures just released by brokerage Cushman & Wakefield. Hardest hit was the eastern side of the region including the cities of San Bernardino and Redlands, where vacancy has surpassed 22%.

More centrally located industrial properties in Los Angeles and Orange counties are also beginning to feel the pinch, although the modest increases in vacancy rates are still considered healthy by industry standards. Many of those properties are rented to small entrepreneurs who are hunkered down but so far toughing out the economic downturn, industry observers say. Small businesses that do fail are easier for landlords to replace than the large corporate tenants that favor the Inland Empire.

Vacancy in Los Angeles County is 3.3%, up only 1 percentage point from a year ago. Orange County’s vacancy is 5.1%, up from 3.2% last year at this time.

Industrial real estate is a lagging indicator of the economy, however, and the full effect of the recession may not be felt for months. Many industrial- property owners in the healthy markets are concerned about the radical change in fortune on the east side of the Inland Empire.

“The big question everybody is trying to figure out the answer to is whether that contagion is going to ripple all the way in” to the rest of Southern California, said John McMillan, a broker at Cushman & Wakefield.

So far the pain is largely confined to Inland Empire distribution centers that serve many of the world’s largest companies, said economist Esmael Adibi, director of Chapman University’s Anderson Center for Economic Research. Goods shipped in bulk into the ports of Los Angeles and Long Beach are often repacked in smaller units and shipped across the United States.

In recent boom times, developers built warehouses as large as several football fields where goods were moved around inside by robots and fleets of full-sized trucks could dock for loading. Most buildings quickly found tenants.

“All of the building taking place prior to the recession was expansion of distribution centers for nationwide firms,” Adibi said.

“Now you don’t need as many products to be produced and distributed.”

For much of the 2000s, though, it seemed like the needs were endless. Three years ago, there was a net addition of 20 million occupied square feet in the Inland Empire, said broker McKenna, an executive vice president at CB Richard Ellis.

So builders enthusiastically kept building. It takes years to get big warehouses designed, approved and built, however, which meant many structures were still coming up when the market began to cool.

“The recession hit so quickly in most sectors that we were caught off guard,” McKenna said. “There was an awful lot of new space in the pipeline.” Now almost no buildings are being started in the Inland Empire.

Industrial property construction is always rare in Los Angeles County, where it’s hard to find land to build on. A 400,000-square-foot building under construction in Commerce is the only one of its size being built in a market with 700 million square feet of existing space, said Cushman & Wakefield’s McMillan.

With the market softening, many Los Angeles landlords are sweetening their offers to tenants by paying more for their interior improvements and giving them a few months’ free rent if they sign a lease.

In the Inland Empire, tenants are more aggressive, McMillan said, demanding lower rents.

Competition among investors to buy industrial properties has dropped dramatically because investment financing is hard to come by, said investor and landlord Michael Frankel, a partner at Rexford Industrial. Prices are down at least 15% from a year and a half ago and will probably drop more.

Brentwood-based Rexford specializes in buying well-worn properties in urban markets and improving them so they can garner higher rents. For tenants, Rexford prefers smaller entrepreneurs to large corporations. “Smaller is more reliable. They are resilient,” Frankel said, and rely on their rented space to survive.

Fortune 1000 companies these days treat real estate more like a just-in-time commodity that they acquire and shed to suit economic times, Frankel said. “They don’t want to be tied longer than the business cycle.”

For all the current hardships, boosters say the Inland Empire industrial market is well positioned for a comeback when the economy improves, perhaps by 2010, because of its low-priced housing, ample workforce and desirable location for international shipping.

In Perris, all of the existing industrial buildings are occupied and about 30 properties with a combined 18 million square feet are approved or going through the city’s approval process, said Michael McDermott, the city’s economic development manager.

With property prices and rents coming down in the Inland Empire, some shippers will find opportunity, said Mike Fox, chief executive of Rancho Cucamonga trucking company Fox Transportation. His business is down about 5%, but he’s philosophical about changes in the economy.

“The Inland Empire is going to continue to explode and they will need these warehouses,” Fox said. “I think it’s just a matter of time.”

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Property pinch

Total industrial space

* Greater Los Angeles: 1.064 billion square feet

* Orange County: 270.4 million square feet

* Inland Empire: 394.4 million square feet

Industrial space completed in 2008

* Greater Los Angeles: 2.7 million square feet

* Orange County: 812,000 square feet

* Inland Empire: 24.7 million square feet