By Mark McAdams, Vice President, JLL
While the Inland Empire is more well-known for its industrial real estate, the region’s office market has continued with its own success and stability pre- and post-COVID. As employees of office buildings seek refuge from high home prices in neighboring Los Angeles and Orange counties, occupiers equally appreciate the accommodating office rental rates while supporting their employee’s draw to the region.
The current office market is in nearly the same place it was at the end of the first quarter of 2020 when COVID appeared on the scene. The overall market vacancy rate stands at 7.8 percent. Some of the submarkets have lower vacancies today than in the first quarter of 2020. Some smaller submarkets have seen even lower vacancy rates down to unprecedented levels at 3 percent to 5 percent. Only one submarket, San Bernardino, has a double-digit vacancy rate at 12.6 percent, and that is still considered healthy. Anything sub-10 percent is generally considered a landlord’s market. These are historically low vacancy rates that have rarely been seen since the area started developing the bulk of its office inventory in the mid-1980s.
The pandemic put a hold on rental rate increases that had just started to occur in late 2019. The uncertainty caused many office occupiers to simply renew in place for short-term intervals until there was more clarity. Class A rental rates today range from $2.65 per square foot, per month to $2.95 on a full-service gross basis. Downtown Riverside has a few outliers that are even high with paid parking.
Markets like Upland, Corona/Norco and Temecula/Murrieta have led the way with the largest shares of net absorption as a percentage of their total inventories at 3.1 percent, 2.1 percent and 1.6 percent, respectively.
Many of the occupiers are in the area to serve the burgeoning population and industrial base. These would include financial institutions, real estate brokerages and insurance services.
One group that has long been absent is the distribution and manufacturing sector. That’s because they have always been able to put their office facilities within their distribution centers. However, even these sectors have recently started to lease additional office space. As industrial land prices increase some underutilized properties with excess land are being sold to developers, with the office components moving to office locations. Other groups are realizing they should conserve their high bay distribution space and are moving office facilities off-site.
With demand for Inland Empire industrial space skyrocketing, many flex buildings with a high percentage of office area have been converted back to pure industrial with a low percentage of office. This has further reduced the market’s office supply.
The work from home environment also caused many employees to rethink their living situations. This has created a flight to the suburbs and exurbs as residents seek larger homes to accommodate family and home offices. Environment is also at issue. Communities known for a high percentage of weekend and vacation homes, such as the Coachella Valley desert communities and the mountain resort communities of Arrowhead and Big Bear, are reporting a spike in full-time resident populations. This will fuel occupiers’ needs to have regional offices or, at a minimum, a satellite office in the area.
Hindering some of the recent office leasing activity has been the rise in construction costs. This includes labor and construction supplies, as well as delays caused by supply chain issues. Building office from shell condition once cost $50 to $60 per square foot for average density space. Today these numbers have risen to $70 to $80 per square foot and higher in some cases.
With the vacancy rates down, landlords want to reduce concessions being offered. However, with costs up, tenants are reticent to sign new leases due to concerns surrounding build outs being completed on time and on budget. Landlords should not forget that corporate occupiers still require their space built out per their needs.
Limited city resources have also continued to hamper inspections and approvals, creating further delays in build-outs.
Skyrocketing building replacement costs have also caused office occupiers to look at acquiring buildings for their use. As an owner-user, companies realize the benefit of creating their own environment and culture, both of which are key to attracting and retaining employees.
The Inland Empire office market will continue to be the little brother to the behemoth industrial market…yet it is quickly maturing. Many companies are expected to look to the region’s office market as they return to the office. That’s due to the Inland Empire’s affordability, proximity to labor and overall economics.