Retail Drives Industrial Growth Through Much of the Western U.S.
“The market fundamentals for industrial properties are the best they have ever been,” says Bob O’Neill, senior vice president of acquisitions at CapRock Partners in Newport Beach, Calif. “Industrial absorption, lease rates and sales prices are at all-time highs, while market vacancies are at historic lows and construction in the Western United States remains in check.”
Michael Collins, vice chairman of DAUM Commercial Real Estate Services in Los Angeles, has witnessed a similar trend in his market. He notes industrial assets in LA typically sell for $140 per square foot to $200 per square foot, with a vacancy rate of less than 2 percent in Southern California.
“Developable land is becoming more scarce and the Los Angeles County industrial marketplace remains very vibrant,” he notes. “Lease rates throughout Southern California have reached an all-time high and sales values are at unprecedented highs, with actual prices based on building age, location, functionality and amenities.”
Those looking to cash in on industrial should pause for a moment, however. Collins goes onto note that investors trying to enter the market are challenged by low cap rates in the 4.5 percent to 5.5 percent range. Some are also being converted into higher-use assets, such as office and that ever-popular multifamily.
Industrial Needs Retail
Areas like Los Angeles might be losing a portion of their industrial supplies to higher uses, but other regions are actually expanding their industrial segment through the conversion of vacant big box retail spaces.
“We are currently talking to a lot more groups that would like to do conversions — particularly with retail properties,” says Jeremy Ballenger, senior vice president of industrial and logistics in CBRE’s Denver office.
Red & Jerry’s, a sports betting lounge and family entertainment center, operated for 22 years at 1840 West Oxford Ave. in Sheridan, Colo., just south of Denver, before closing for good in March 2017.
“After the property sat vacant for over a year as retail, Cadence Capital got the property under contract, and as soon as it was marketed as industrial they signed a long-term lease with Ferguson Enterprises during their due diligence period,” Ballenger notes.
The space underwent a complete renovation, transforming into a distribution and showroom space. Cadence gutted the property, added two small showrooms, four new dock doors and a new drive-in door. The conversion also received LED lighting, new sprinklers and upgrades to the parking lot to create a Class A size truck court. The property also offers 240-foot bay depth and 24-foot clear heights.
Cadence Capital purchased the asset in 2017 and sold it to LBA Realty for $14.8 million this past April. The South Central submarket boasts a 3.4 percent industrial vacancy rate, making this submarket one of the lowest rates in metro Denver, according to Ballenger. This, combined with compressing cap rates, is driving up the area’s infill property values, paving the way for industrial sales and leases of this caliber.
“We were drawn to the real estate because the site featured a unique blend of industrial and retail characteristics that created the opportunity for us to deliver increased value to our tenants,” says Lucy Dinneen, managing director of Colorado and the Northwest for Cadence. “The site created a brand-building opportunity for our clients — even industrial clients — because of the great visibility on a high-trafficked corridor within the metro market. Our clients were able to get the industrial utility and pricing of an industrial space, but with added brand-building benefits of retail, and our buyers have a fantastic asset with future potential as infill mixed-use, industrial or retail as the future dictates.“
John R. DeGrinis, senior executive vice president in Colliers International’s North Los Angeles office, believes we may see additional industrial opportunities emerge from the retail sector as shop space requirements continue to evolve.
“We are witnessing significant change to our brick-and-mortar retail locations,” he says. “We believe this potential overbuilding in the retail arena will also provide opportunities for redevelopment as it appears the retail world may be changing.”
The costs, lack of land and timeframe associated with ground-up new construction can also be prohibitive to many industrial investors and users.
“We believe that redevelopment of functionally obsolete properties will be an opportunity for developers to build needed product,” DeGrinis continues. “In today’s hyper-charged market, it is difficult to conceive scraping buildings in favor of new ones. Values today prohibit this.”
Industrial Property Trust (IPT) executed this strategy when it purchased a 104,000-square-foot industrial asset on Susana Road in the Compton, Calif., submarket of Rancho Dominguez for $12 million in January 2017. The REIT spent $2.5 million modernizing the facility, portions of which were built in the 1950s. Specific areas of the building were demolished to expand the truck court, offices and old glazing were removed, dock-high loading doors were added and the outdated office component was replaced by a 10,000-square-foot, two-story office space.
The newly renovated facility was then leased to global supply chain solutions provider Apex International for a total consideration of $10.5 million. The 10-year lease commenced May 1.
“The lease to Apex International continues to prove the strength of this investment for our client,” says Collins, who, along with Jordan Lara, represented IPT in the lease transaction.
Collins notes the asset is currently valued at about $20 million.
“The initial rent for the Susana Road transaction was $0.735 triple-net, with annual 3 percent increases,” he continues. “Functional, 20-year-old buildings, or upgraded buildings in the larger size ranges are achieving rents near $0.75 triple-net. These larger buildings are leasing at rates near $0.85 triple-net when in new, state-of-the-art condition.”
CapRock Partners is taking on similar projects in equally supply constrained San Diego. The company purchased nearly 250,000 square feet of industrial space in the area through multiple transactions earlier this year. One of the assets was a vacant 91,183-square-foot industrial building in the Scripps Ranch submarket that had become surplus real estate for the corporate seller.
“While this property had ‘good bones,’ it was constructed in 1982 and the building exterior and landscaping reflected that time period,” O’Neill notes. “Additionally, the interior office improvements were last renovated in the late 1990s and were in need of modernization. Upon close of escrow, we obtained city approvals for significant renovations and work is currently underway.”
Though the asset may be older, CapRock engaged a 3D graphics technology company to provide prospective tenants with a virtual reality (VR) tour of the finished product.
“We believe there will continue to be opportunities to reposition and renovate existing industrial buildings with functional utility in infill markets,” O’Neill says. “In general, we have seen increased appetite by quality tenants for more immersive insight into prospective property offerings. With VR tours and other technology, we are pleased to continue to partner with cutting-edge providers to stay ahead of the market. The next decade will be an interesting period of change and resilient investors will adapt to meet the demands of tomorrow’s industrial occupiers.”
Retail Needs Industrial
Not all needs can be met through conversion and redevelopment, however. While it’s not possible to conjure up open space in tight markets like Los Angeles simply by scrunching one’s nose, there are other options along well-traveled corridors that can accommodate last-mile demands.
“Distribution users over the past 20 years have utilized logistics technology to continue to realize efficiencies in delivering product from the manufacturer to the consumer,” says Joseph N. Rentfro, executive vice president of real estate for Tejon Ranch Co. “Larger fulfillment operations such as Amazon continue to hone the logistics models to be as efficient as possible, but each user’s needs are a bit different.”
That’s why Rentfro and his company set out to be a bit different. Rather than compete with port-side owners, Tejon Ranch Co. developed the 20-million-square-foot Tejon Ranch Commerce Center less than 40 miles south of Bakersfield and about 80 miles north of Downtown Los Angeles. This area offered what many others didn’t — lots of open space — about 1,450 acres, to be exact. Tejon Ranch Commerce Center is now home to IKEA, Famous Footwear and Caterpillar, among others. Tejon Ranch Co. also has separate joint ventures with the Rockefeller Group and Majestic Realty Co.
The center’s newest building is a 480,000-square-foot facility that was completed in 2017. Dollar General has leased 240,000 square feet of this space to expand its area operations.
“This building is addressing the needs of the fastest-growing segment of the industrial sector, which is distribution,” Rentfro says. “With such scarcity of product and land to the south, the Tejon Ranch Commerce Center is the alternative for the user looking to expand in a business-friendly environment at a great value compared to alternatives to the south.”
DeGrinis, who handles Tejon Ranch Commerce Center’s leasing along with a larger Colliers team, believes we will continue to see companies seek out alternative locations as it’s becoming infeasible to absorb large chunks of industrial space near city cores.
“User appetite for additional space in North Los Angeles is very strong, however, a lack of available inventory for users is very problematic,” he says. “Add the fact that there is virtually no available land for development, which is creating stress on many San Fernando Valley users interested in expanding or relocation. There just are not enough buildings to satisfy tenant demand, and this is manifesting in much higher lease and sale pricing. Given the scarcity of land to develop in North LA, the Tejon opportunity offers users the ability to expand in a business-friendly environment with tremendous labor capacity.”
Wonderful Real Estate took a similar approach, targeting 1,625 acres northwest of Bakersfield where it built Wonderful Industrial Park (WIP). The park, located in Shafter, is now home to FedEx, Target, Ross, American Tire Distributors and Formica. The latest tenant to take advantage of WIP’s vast square footage options is Essendant Co. The business product wholesale distributor signed a built-to-suit lease for 405,299 square feet, which it plans to use for its local and regional fulfilment, ecommerce and distribution needs.
“Essendant was looking to implement a new distribution strategy and sought out a facility that would allow them to distribute from North Los Angeles to the Bay Area,” says Joe Vargas, president of Wonderful Real Estate Development. “The newly implemented strategy allowed Essendant to consolidate several smaller facilities into one large regional center.”
Wonderful also recently completed a new 1-million-square-foot speculative facility at its park. This space is one of only a handful of U.S. spec industrial buildings to offer 1 million square feet with 40-foot clear height, oversized, large truck courts and access to four major U.S. ports. Vargas believes these types of spec projects are a good bet as the substantial size needs of industrial users is likely to increase in the future, thanks to ecommerce.
“The need for mega-box facilities doesn’t look like it’s going anywhere, thus, developers and users will look at previously ignored locations where there are large tracts of available land for development at a price that makes sense for both owner returns and user rents,” he asserts. “Spec is important to the user as the majority of users around the country are still formulating their supply chain strategy. Once these decisions are made, they need to execute quickly to become operational. An existing building enables users to act now as opposed to waiting 12 months for a new building.”
WIP is further luring ecommerce users to its facility through its amenities and convenient location — regardless of whether you’ve heard of their town or not. The park is situated within a one-day truck turn to 35 million customers and a two-day turn to more than 70 million, providing it with the shortest average distance to major populations centers within the Western U.S. WIP also features an on-site rail yard with more than 17,000 feet of track and direct access to Burlington Northern Santa Fe (BNSF) Railway’s mainline.
The City of Shafter has invested in the further development of an existing rail terminal with 18,000 linear feet of track next to the BNSF mainline. The adjacent inland depot allows importers to arrange for inbound containers, while terminating their empty containers all on one site. Tenants at the park further benefit from an on-site FedEx Ground hub, which boasts a 9 p.m. deadline for FedEx shipments, allowing extended time for orders and deliveries in Mountain and Central time zones.
As delivery times, technological advances and automation become more and more sophisticated, Vargas — along with many other industrial developers — knows where his strategy lies, now and in the future. That’s continuing to do what he and his business partners do best.
“We want to continue to be a premier location for servicing 70 million people in a two-day truck turnaround and for establishing a loyal employee base that results in minimal turnover,” he says. “The growth of ecommerce and two-day or less fulfilment to consumers will continue to dominate the needs of industrial tenants and the response of industrial developers as they design facilities to fit these needs. Growth has been spurred over the past several years by the rise of the omnichannel and ecommerce fulfillment, as well as new mega-box distribution centers. Ecommerce, in particular, will continue to change the face of industrial real estate.”
— Nellie Day