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The Inland Empire: A Premier Southern California Industrial Market

2163-Riverside-Drive-Colton-California

Demand for industrial space in The Inland Empire is precipitating more portfolio sales, such as Black Creek's purchase of this three-building property in Colton, Calif.

The Inland Empire continues to be one of the most dynamic industrial real estate markets in the country from both a user and investor perspective. Rent growth remains exceptionally strong, boasting a growth rate of more than 50 percent in the past five years, with a 10.1 percent increase in 2017.

Although current average asking rents are at record highs, they remain at a 40 percent discount when compared to the neighboring infill markets of Los Angeles and Orange County, indicating ample room for further growth. Vacancy remains unchanged at 3.7 percent, despite 20 million square feet of deliveries last year, a testament to the market’s unrivaled user demand. Leasing momentum continues to outpace supply, particularly for recently constructed distribution space.

Andrew Briner, HFF

This is demonstrated by the 46 percent pre-lease rate for deliveries greater than 1 million square feet last year. The Inland Empire’s proximity to world-class transportation infrastructure, combined with a relatively large supply of recently delivered distribution facilities, creates a highly optimistic future outlook when considering the projected exponential growth of e-commerce.

The Inland Empire’s e-commerce primacy of location as it relates to underlying market fundamentals are attracting best-in-class domestic and global capital. This is creating a hyper-competitive buyer landscape, where both new and historically active capital sources are aggressively pursuing opportunities across the risk spectrum.

Per the latest AFIRE survey, Los Angeles was the top-rated U.S. city for foreign commercial real estate investment.Industrial ranked as the most sought-after product type, which has brought in an additional tranche of competing investors. Sovereign wealth funds from the likes of Canada and Singapore are now aggressively pursuing transactions as low as $35 million, a significant drop from the previous minimum threshold of $100 million-plus. The abundance of dry powder from both new and old capital sources as compared to the number of opportunities is further contributing to cap rate compression, driving yields to historic lows.

These compressed yields, combined with the surging land-cost basis in the Inland Empire, have contributed to a fundamental shift in investor preferences and strategies to boost returns. On a risk-adjusted basis, investors are now heavily weighted toward value-add and opportunistic strategies, resulting in a significant shift to the pursuit of alternative investment avenues to deploy capital at scale and satisfy yield requirements.

This shift has resulted in a prominent increase in ground-up development, land acquisitions, forward sales, partial interest sales and recapitalizations. Most notably, we have seen tremendous interest from both operators and investors alike regarding joint venture partnerships, with a focus on not only development, but the recapitalization of projects that have been repositioned by best-in-class sponsors with a desire to stay in long term.

The influx of sophisticated e-commerce users to the Inland Empire has fundamentally altered the dynamic between capital providers and operators. Specific building attributes, such as higher clear heights, expanded truck courts, ESF sprinklers and shallow bay depths, are needed to facilitate efficient distribution and require skilled operators with experience.

The increased demand for skilled operators has contributed to a rapidly expanding number of investors wishing to engage in programmatic joint ventures with regional GPs. Capital sources are using these partnerships as a vehicle to invest at a granular level and overcome the most significant challenge in today’s environment, achieving portfolios of scale in primary infill markets like the Inland Empire.

Alternatively, we have seen an influx of skilled operators hoping to capitalize on the competition among capital by seeking new partners who share similar strategic visions and can compete long-term on a cost of capital basis in the Inland Empire’s highly dynamic capital markets environment.

Eight consecutive years of global expansion, combined with continued cap rate compression, historically high leasing rates and 47 percent year-over-year transaction growth in the Inland Empire have created a level of uncertainty among some capital sources.

However, investor fears are generally assuaged by the current spread between the 10-Year Treasury and market-leading cap rates, which is still generally wide of pre-recession spreads. Overall, the 2018 market outlook for the Inland Empire is positive.

We expect fundamentals to remain robust, with tenant demand and leasing activity outpacing new supply, given the differentiated position of this submarket and an evolving supply chain being built to support a 21st century “e-conomy.”

— By Andrew Briner, managing director, HFF. This article first appeared in the April 2018 issue of Western Real Estate Business magazine.

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