Approximately 12.4 million square feet of industrial space was absorbed into the Inland Empire in 2010 and 12.4 million SF were absorbed in the first 9 months of 2011. This bodes well for the High Desert, which also absorbed 430,000 square feet of space during the first three quarters of this year. In addition United Furniture Industries, a furniture manufacturer, signed a lease for 505,192 square feet at SCLA that will be reflected in the High Desert’s Net Absorption and Vacancy levels in the fourth quarter of 2011.
The demand for industrial, office, and retail space as well as residential units in the High Desert will be greatly influenced by changes in the occupancy of industrial space in the Inland Empire. The recent absorption of industrial space in Los Angeles Basin is expected to lead to more construction and a reduction in the limited supply of industrial land that could accommodate industrial facilities. A study by John Husing dated August 2008 determined there was only 4,860 acres of land in the Los Angeles Basin portion of the Inland Empire that could be developed for industrial use. This number could be significantly reduced over the next few years thereby reducing number of sites that are rail served or can accommodate the development of large industrial buildings. It will not be belong before the very large industrial tenants or firms that require rail will have to locate in the High Desert or in the area along the I-10 Freeway in Banning, California. This is expected to create more base employment in the High Desert, which could generate additional secondary employment and lower unemployment rates.
Also, the increase in demand for the housing, and commercial space in the High Desert correlates with the growth in base and secondary employment in the Inland Empire. An estimated 60,000 residents of the High Desert still commute to the Los Angeles Basin to work. These commuters represent the equivalent of base employment for the High Desert. The increase in the demand for industrial space in the Los Angeles Basin would lead to an expansion of secondary and total employment in the Inland Empire, which in turn would generate an increase in the demand for housing in the High Desert and retail sales. That would lead to more construction activity; and an increase in demand for small tenant industrial space.
All the inventory, absorption, and construction information contained in this article was obtained from reports we generated from Costar. These numbers are deemed to be accurate by real estate industry standards; but they are not exact.
There is 496 million square feet (SF) of industrial space in the Inland Empire. This is equivalent to half the inventory of industrial space in the Greater Chicago area. Costar defines 478 million SF as Warehousing/Industrial space. The remaining 18 million SF is in smaller industrial flex space. The High Desert currently accounts for slightly over 4% of the total inventory; but in the intermediate term and beyond it is expected to be the primary future expansion area for industrial development in the region. Southern California is home to almost 2.0 billion SF of industrial space. Much of the increase demand for industrial space in the Inland Empire is attributed to firms relocating out of Los Angeles County in search of industrial sites on which to build larger, more efficient facilities.
The vacancy rate for warehousing/industrial space in the Inland Empire has increased from 5.2% at the end of 2004 to 12.2% by the end of 2009. The increase in vacancy was the result of overbuilding rather than a decline in industrial demand. The vacancy rate at the end of the Third Quarter 2011 declined to 7.9%. Very little inventory was added in 2010 and 2011; but there was a substantial absorption of large box industrial space during that two year period.
In calendar year 2007 the net absorption of industrial space peaked at almost 27 million SF. In 2008 industrial demand increase by 4.6 million SF; but in 2009 the net absorption was a negative 700,000 SF. Net absorption in the Inland Empire was a positive 12.4 million SF in 2010 and 12.4 million SF through the first nine months of this year. A portion of the increase in net absorption was caused by the acceleration of demand due to relatively low rents compared to prior years. According to Costar, quoted rents for warehousing space peaked in 2007 at $6.13 per SF per year. By 2011 the Quoted Rents declined to $4.65.
From 2005 through 2008 an average of 26.1 million SF of warehousing/industrial space was delivered annually in the Inland Empire. Deliveries declined to 7.0 million SF in 2009 and only 1.3 million SF has been delivered from January 2010 through September 2011. This limited level of construction coupled with the unanticipated increase in absorption has resulted in the elimination of half of the excess vacancy in the market place.
The vacancy level was 21.9 million at the end of 2005. It peaked at 57.9 million SF by the end of 2009. As of the end of the 3rd quarter 2011 it had declined to 35.7 million SF. There is still an estimated 10 to 15 million SF of excess vacant space in the Inland Empire; but the industrial agents in the Los Angeles Basin are now reporting excess demand (no vacancy) for buildings of 500,000 SF and larger. Most of the vacancy is in the medium and smaller size buildings often occupied by small businesses that have not experienced much growth since the Great Recession.
Industrial real estate agents are now suggesting there will be a new wave of construction for buildings larger than 500,000 Square Feet. When this is coupled with the fact there are only 4 sites in the Los Angeles Basin that can accommodate a building greater than 800,000 SF it is logical to conclude it will not be long before the High Desert will be able to successfully compete for the larger warehousing and distribution tenants. A higher level of industrial development will happen in the High Desert; though the timing is uncertain and unfortunately very much a function of public policy that will be determined in Washington and in Sacramento, California.
To some extent the industrial markets in the High Desert have tracked the industrial activity in the Los Angeles Basin. As of the end of 2006 there was 17.0 million SF of industrial space in the five city area of Adelanto, Apple Valley, Barstow, Hesperia, and Victorville. Over the following 3-1/2 years the inventory of industrial space increased by 3.6 million SF. By the end of the 2nd quarter 2010 there was 20.7 million SF of industrial space in the High Desert. A substantial portions of the additions occurred at SCLA, though most of the cities participated in expansion. From the 3rd quarter of 2010 through the end of the 3rd quarter 2011 the few additions to inventory that were offset by the demolitions of older buildings. By the end of the 3rd quarter 2011 the inventory of industrial space was virtually unchanged at 20.7 million SF.
At the end of 2007 the vacancy rate was 4.1%. It climbed to 12.3% by the summer of 2009 due to delivery of the industrial space substantially in excess of absorption. Thereafter the vacancy rate fluctuated between 10.4% and 11.4%, peaking in the 1st quarter 2011. Recent leasing activity reduced the vacancy rate to 8.4% and it will be reduced even further due to a recently executed lease that will be reflected in this year’s 4th quarter’s absorption.
The following graph summaries net absorption, amount of space delivered and the vacancy levels for the industrial market in the High Desert in half year periods from the beginning of 2007 through the September 2011. From the beginning of 2007 through the 4th quarter 2008 the net absorption of the High Desert was slightly less than 1.3 million SF. During the second half of 2009 the High Desert experienced a decline in industrial demand of 107,200 SF. The net absorption in the 4th quarter 2009 and the 1st quarter of 2010 exceeded 1,100,000 SF. Dr. Pepper moved into their new facility at SCLA and the company that supplies containers to Dr. Pepper leased almost 300,000 SF of space in a nearby existing building. The net absorption in 3rd quarter 2011 was 632,000 SF; and another 506,000 SF was leased in September and will be occupied by the tenant in December of this year. A confectionary company took delivery of 495,000 SF of space in the western portion of the existing 1 million SF building at SCLA. Church & Dwight has taken over the 200,000 SF of industrial space the confectionary company vacated in the City of Victorville for the production of cat litter material. In September, United Furniture Industries leased the remaining 505,000 SF in the eastern portion of the existing building at SCLA. Joseph W. Brady of The Bradco Companies, publisher of this Bradco High Desert Report, represented the tenant. Jay Dick, Darla Longo and Mark Latimer of CBRE represented Sterling Capital Investments. This was the largest square footage lease ever brokered in the High Desert.
The graph depicts the distribution of 2.7 million SF that was delivered in 2007 and 2008. Another 860,000 SF was delivered and occupied in the first half of 2010. Only a limited amount of space was delivered since June 2010.
The vacancy level increased from 739,000 SF at the end of 2007 to 2,446,000 SF at the end of June 2009. As of the end of the 3rd quarter 2011, the vacancy level had declined to 1,755,000 SF; of which 505,000 SF had already been leased.
There are two different classes of industrial tenants and users in the High Desert. One class consists of the large box users. They typically are warehousing and distribution firms such as Wal-Mart in the Town of Apple Valley or large manufacturing operations, such as Northwest Pipe in Adelanto. Such companies usually occupy buildings in excess of 50,000 SF. The other class consists of smaller manufacturing or distribution firms that for the most part cater to the local population and businesses or are niche manufacturing players in the regional market. They are typically small space users that occupy single or multi-tenant buildings of 50,000 SF or less. A significant number of such tenants were involved with the construction industry.
The graph below categorizes the industrial inventory in the High Desert by city as well as by whether or not the structures are greater than 50,000 SF. It also segregates the industrial space in the City of Victorville into the inventory at SCLA and the non-SCLA portion of the city. Of the 20.7 million SF of industrial inventory in the High Desert, 8.5 million SF is associated with buildings of 50,000 SF or less. The remaining 12.2 million SF is in buildings greater than 50,000 SF. The City of Victorville has almost 8.6 million SF of industrial space, of which 4.5 million SF is located at SCLA. The balance of 4.1 million SF is in the Foxborough Industrial Park, which the city developed and in several other industrial sub-markets throughout its incorporated area. The City of Hesperia is home to 4.5 million SF of industrial inventory, much of which is in the older industrial area north of Main Street between the railroad tracks and I Street. Adelanto accounts for 3.5 million SF while the Town of Apple Valley has 2.8 million SF. Barstow has almost 1.4 million SF of industrial space.
Approximately 58.9% of the industrial floor area of the High Desert is in structures greater than 50,000 SF. The remaining 41.1% is in buildings that have a Rentable Building Area (RBA) of 50,000 SF or less. The distribution of industrial space between smaller and larger buildings varies by city. In Adelanto, 39.5% of the inventory is in larger buildings. In the Town of Apple Valley 65.5% is in structures greater than 50,000 SF. The 1.25 million SF Wal-Mart Distribution Center accounts for most of the large building inventory in that city.
Only 45.4% of Barstow’s inventory is in larger buildings. Hesperia is the city of smaller industrial buildings, with only 61.7% in smaller structures. Just over 89% of the industrial buildings at SCLA is greater than 50,000 SF, while 65.0% of the rest of Victorville is in larger structures. Over 60% of Adelanto’s industrial Inventory is in smaller buildings, many of which are located in one of its five industrial parks; the city developed 25 years ago. It is anticipated that a substantially greater percentage of the growth will be in structures greater than 50,000 SF. Many of these structures are likely to be warehousing and distribution facilities.
As of the end of the 3rd Quarter 2011, there was 613,000 SF of vacant space in the smaller industrial buildings. The largest amount was in the City of Adelanto, followed by the non-SCLA area of the City of Victorville. There was no vacancy in the less than 50,000 SF buildings at SCLA. The small building vacancy levels in the Town of Apple Valley and the cities of Barstow and Hesperia ranged from 62,000 to 107,000 SF. The vacancy level in larger buildings in the High Desert as of September 30, 2011 was 1,124,000 SF. SCLA accounted for 625,000 SF of which 505,000 SF was in one building and it has already been leased. Barstow had over 255,000 SF in two industrial buildings on Lenwood Road. Adelanto accounted for 105,000 and Hesperia had approximately 201,000 SF of vacant space while the Town of Apple Valley and the non SCLA areas of Victorville did not have any vacant space in the larger facilities. When all buildings are considered the City of Adelanto has the highest vacancy level at 346,000 SF followed by Hesperia at 308,000 SF. SCLA only has 119,000 SF of available space after accounting for the recently executed lease.
As of September 30, 2011, the vacancy rate in the High Desert for buildings 50,000 SF or less was 7.2%, while for larger buildings it was 9.2%. The City of Barstow had the highest vacancy rate for buildings over 50,000 SF. It was 30.7%. The vacancy rate for the smaller buildings in Barstow was 8.2%. The non SCLA portion of Victorville had a 9.1% vacancy rate in the smaller buildings; but none in the larger structures. In the Town of Apple Valley there was no vacancy in the larger buildings but the rate for the smaller buildings was 7.4%. The smaller buildings in the City of Adelanto had a vacancy rate of 11.5% while the larger buildings reached 7.7%. The vacancy rate for smaller buildings in the City of Hesperia was 3.8% compared to 11.7% for larger buildings. For an area the size of the High Desert the stabilized vacancy rate is approximately 5% provided the demand for industrial space is expanding.
During the first 9 months of 2011, the High Desert experienced a net absorption of 430,000 SF. SCLA accounted for 536,000 SF, all of which was in the larger industrial buildings. The City of Adelanto lost 161,000 in industrial demand of which 105,000 SF of the negative absorption was associated with larger buildings. During the same period the Town of Apple Valley had a net absorption of 29,331 SF, almost evenly split between smaller and larger sized buildings. The City of Hesperia absorbed over 26,000 SF; but more than 22,000 SF were in smaller buildings. City of Barstow experienced approximately 10,000 SF of negative absorption, all in smaller buildings, while the non SCLA portion of the City of Victorville recorded 9,100 SF of positive absorption.
Only three industrial buildings totaling 25,372 SF were delivered in the High Desert during the first three quarters of 2011. As of September 30, 2011, there was only one industrial building under construction in the area. It is a 49,672 SF reinforced concrete building located in the City of Hesperia. The building is scheduled to be delivered to the Victor Valley Transit Authority in November 2011. With the exception of the 860,000 SF Dr. Pepper’s Building delivered in the 1st Quarter of 2010, there has been little new industrial space delivered in the High Desert since 2008. This has enabled the large box industrial market in the High Desert to trend towards equilibrium; but there does not appear a need to build any speculative large box space at the present time. The negative absorption in industrial buildings of 50,000 SF of less argues against any speculative development in this size range.
According to the latest Costar survey, quoted NNN monthly rents in the High Desert declined from $0.58 per SF as late as the 3rd quarter 2009 to $0.37 per SF in the 3rd quarter 2011. Effective rents are significantly less; and antidotal evidence suggests both could continue to decline. In the Inland Empire quoted yearly NNN rents for warehousing and industrial space declined from $6.13 per SF in 2007 to $4.59 in the 4th quarter 2010. They have rebounded slightly to $4.69 per SF in the 2nd quarter 2011. Some industrial agents in the Inland Empire have indicated the effective rents have increase more than the quoted rents since the end of 2010.
Short and medium term outlooks for the industrial markets in the High Desert are uncertain because the economic forecasts for the United States and California are greatly impacted by assumptions regarding political decisions made at the national and state level as well as in China and Europe. A majority of economists now believe that at best the U.S. economy will expand at an average of only 2% per year for the next few years. The economic forecasters are assigning a 30% chance that the economy will slide into a recession within the next year even if the level of deficit spending continues at current levels in the United States. Contributing factors may include: (1) a material decline in U.S. home prices that would adversely impact the equity reserves of U.S. banks and their ability to lend; (2) A sovereign default on Euro debt by Greece or other countries in Europe that would significantly reduce the equity reserves of European financial institutions, thereby impeding their ability to make loans; (3) the economic slowdown in China becomes greater than intended by its government so that China imports less goods from the U.S. and Europe; and (4) households and business in the U.S. increase their rate of savings and consume less or invest less in their business because they become more pessimistic regarding the economic outlook.
Between now and the elections of 2012, there is not likely to be any significant change in public policy at the federal level. Depending on which party gets their candidate elected president and which party controls the Congress and the Senate there could be a substantial increase in government spending, higher taxes, substantial increases in debt and more government regulation; or there could be less government, taxes, deficit spending, and regulation. The former would have a negative impact on economic growth while the latter could revive the U.S. economy especially if it allowed the private sector to aggressively drill for oil and gas throughout the United States. Within 10 years the nation could go from importing $400 billion of oil in a year to actually be a net exporter of gas and oil, while adopting conservation programs that reduced the consumption of fossil fuels. Of course, if one party controls the Senate or Congress and another controls the presidency then it will likely lead to more of the status quo; which would not result in much economic growth. Even if the Republican Party gained complete control of the U.S. government it is not certain that they would adopt the policies necessary to get the economy out of its doldrums. The State of California will not be able to significantly change any current public policies before November 2014 when a new governor could be elected.
In spite of all the political and economic uncertainty the big box industrial market in the High Desert is likely to add one or more users each year for the next few years before the increase in demand accelerates in the second half of this decade. This will probably be the case because large industrial users will continue to relocate from Los Angeles County to the Inland Empire in order to build larger, more efficient facilities. As the availability of large industrial sites in the Inland Empire diminishes those seeking larger sites will have no choice but to locate in the area of Banning, California or in the High Desert. Only an economic depression would defer this from happening.
We do not expect any substantial positive Net Absorption for smaller industrial buildings in the High Desert until small businesses in the United States and in California begin to participate more in the economic expansion. This is not likely to occur before 2013; and then only if the more business friendly public policies are adopted. When residential construction in the High Desert experiences a substantial rebound it will also add to demand for industrial space in buildings 50,000 SF or less. Before this can occur it will be necessary for household formation in the Inland Empire to eliminate the excess of vacant housing units in both the Inland Empire and the High Desert. This would necessitate the replacement of most of the 175,000 jobs that were lost in the Inland Empire during the last recession. To date approximately 15,000 jobs have be added in the Inland Empire; hence a high level of residential construction is not likely to occur much before 2015.