Rents expected to rise as demand remains strong in 2004 By Chris Tolles The Los Angeles industrial market has some sexy fundamentals. According to the CB Richard Ellis Los Angeles Industrial Market Index for fourth quarter 2003, the vacancy rate stood at an attractive 2.4 percent, a 10 basis point decrease from the previous quarter. Including Ventura County, the vacancy rate stood at 2.7 percent. Rental rates, meanwhile, have increased 6.25 percent since the fourth quarter of 2002. The appeal of the 1-billion-square-foot market "illustrates the economic recovery under way from the recession that began in 2001," the report says. Generally, the outlook among Los Angeles industrial market players looks good this year. Kirk Johnson, senior vice president of real estate operations for Watson Land Co., said the strength in the market will lead to improving fundamentals this year. "We expect an increase in rates and a decrease in concessions in new lease deals," Johnson said. Some observers saw problems in the marketplace below the surface glamour, however. The 2004 Casden Real Estate Economics Forecast by USC's Lusk Center for Real Estate found both strength and weakness in the 2003 Los Angeles industrial market. While low vacancy rates play tribute to its success, "[the market] has shown some softness associated with the lack of sustained economic growth," the report said. The market's main problem, according to the report, was that in 2003 average rents declined in core industrial areas due in large part to the weak economy in the beginning of last year. Average Los Angeles industrial rents in 2003 measured 50 cents per square foot. Rents, according to the Casden forecast, will rise slightly in 2004 to 51 cents monthly per square foot. David Prior, president of the Klabin Co., said misunderstandings about the Los Angeles industrial market have been floating around for several years. "Some people think we've suffered," Prior said, "but it's always been the strongest industrial market in the country. This is the place to be in this business. I like where we stand, where the market stands." Demand Factors Los Angeles County industrial vacancy may be at its lowest point in five quarters, according to the CB Richard Ellis report, but availability increased 4.6 percent from the third quarter due to decreased leasing and sales activity. At the top of the submarket list, according to the report, Vernon and the city of Los Angeles saw the lowest vacancy rates, of 0.58 percent and 0.52 percent respectively. Those submarkets benefited from their proximity to the Alameda Corridor, which transfers goods from the ports. Some Los Angeles submarkets are a bit contradictory. The San Fernando Valley submarket, for example, posted the highest vacancy in the county at 4.56 percent. Yet it also boasted the largest net absorption last quarter, at 757,627 square feet, and one of the highest asking lease rates in the region at 62 cents per square foot, according to the CB Richard Ellis report. The Tri-Cities/Glendale and Ventura submarkets shared the highest asking lease rates, at 64 cents per square foot each. Vernon, meanwhile, was at the bottom at 40 cents per square foot, the report stated. Vernon was also one of two submarkets with negative net absorption last year, but it was a paltry 28 square feet. The Mid-Counties submarket experienced negative net absorption of 150,525 square feet last quarter, which, coupled with 451,913 square feet under construction, added up to a 3.7 percent vacancy rate, the report stated. The South Bay submarket, the region's largest at 219 million square feet, held relatively steady over the past year with the availability rate hovering at 8.1 percent and absorption of 530,794 square feet in the fourth quarter. The South Bay also has the most space under construction, 2.6 million square feet. Total new industrial construction in Los Angeles is down 12.9 percent from the third quarter at 7.7 million square feet under construction last quarter. About 11.8 million square feet is slated for construction this year, according to the report. "With a scarcity of land available for development in L.A. County, this substantial construction activity illustrates the attractiveness of industrial product to investors," the CB Richard Ellis report stated. Taken as a whole, Johnson predicted a strong year for Los Angeles industrial space demand. "We are projecting that gross and net absorption will increase in Los Angeles County," he said. Johnson said newer industrial spaces, such as the Dominguez Tech Center in the South Bay, will be readily absorbed by the market. Watson Land Co. and the Carson Cos. are co-developers of the 4-million-square-foot industrial center. James Flynn, president of the Carson Cos., said the Los Angeles industrial market demands new, high-quality space. "If you want to be in the market, you've got to look for the new product," Flynn said. His industry outlook for this year, however, was guarded compared with other industry experts. Driven by the proximity to the ports of Los Angeles and Long Beach - the two busiest ports in the nation - vacancy rates in warehousing and distribution centers will stay low, Flynn said. Vacancy is increasing in manufacturing and research-and-development spaces, however. Market researchers often misrepresent the industrial outlook because the two subdivisions of manufacturing and research and development are significantly weaker than the warehousing portion. "[The market is] not OK when you break it down," he said. Many of the region's manufacturing facilities built in the 1960s and 1970s and are outdated, he said. The age factor results in a vacancy rate for manufacturing in the low teens percentagewise. For research and development, Flynn said the vacancy level hovers near that of manufacturing properties. However, he said, defense spending and the improving computer demand may lead to a brighter future for these properties. On the sales side, Mike Tingus, senior vice president of Charles Dunn's industrial properties group, said low interest rates will play just as significant a role in the market this year as they did last year. Investment deals will continue until rates eventually reach 8 percent or 8.5 percent, he said. Then, Tingus said, activity would slow to a lull, followed by an increase in leasing activity. But, he said, the market always provides opportunity for deals. "[There are] always good buys," he said. Manufacturing Comeback Regardless of market fundamentals, the flight of American manufacturing to nations such as China has been the center of attention of many in recent years. Low production and labor costs there have lead to more American companies sending their manufacturing to China. But industry experts are not changing their dollars to yuans. Overall, Tingus said, the nature of industrial properties is changing because of the economic situation. With economic growth comes new small business formation, which will require space. "The landscape in the next 10 years is going to be driven by R&D prototype and small-scale development of goods, which will be manufactured overseas," he said Jack Kyser, chief economist for the Los Angeles Economic Development Corp., said Los Angeles became the nation's top manufacturing market in 2002, a year in which Chicago lost a large portion of its manufacturing. He said traditional means of moving goods might not satisfy the market because of its often-sluggish means of travel. "I [wouldn't] want my stuff somewhere out in the middle of the ocean," he said. Other industry experts suggested that the shift toward overseas' production will lead to significant changes in the United States. Johnson said the loss of manufacturing will improve the quality of Los Angeles' industrial facilities. "It will force functionally challenged or obsolete industrial buildings to be rehabilitated or demolished to meet today's generic demands for industrial users," Johnson said. And in a market with such low vacancy and high demand for quality product, he said, the change will benefit industrial users. Playing It Safe With an increase in foreign goods entering the country, safety and security will continue to play a major role in shaping the demand for Los Angeles' logistics properties this year, according to market observers. Since the Sept. 11 terrorist attacks, industrial owners and tenants have heightened security measures. The trend should continue, Tingus said, biomedical and defense-related industrial users taking the lead to make their properties safer in 2004. Flynn said security breaks down into two issues. First, he said the government cannot afford to inspect containers at each interval of international travel. It's far more efficient to check them at the start and keep them secure in foreign trade zones. Second, companies need to pay more attention to traditional security needs such as product safety, along with concerns of terrorism, he said. Flynn said the theft of a container at an industrial property could cost from $50,000 to $500,000 depending on its contents. "The control of that container is critical," he said. Even with concerns warranted by security issues and the loss of American manufacturing, experts maintain that 2004 will be a strong year for the Los Angeles industrial market. Prior especially remained confident. "I'm really bullish," he said. "There are always opportunities."
February 2, 2004