Negative Net Absorption Despite Completions

The Mid-Counties remains one of the tightest industrial market in Southern California, with a vacancy rate of 1.6%. This has left very few options for firms looking to expand in that market. As new construction slows, tenants who need to be located in this marketplace will pay a premium as quality space remains scarce.

The vacancy rate rose over the quarter to 1.6%. Under construction buildings totaled 255,700 square feet, which will not have a significant impact on the vacancy rate in future quarters. Net absorption reached negative 245,300 square feet this quarter, the first quarter of negative net absorption since 2010. Sales and leasing activity totaled 1,350,700 square feet. Tight market conditions for quality buildings continue to limit options for tenants looking to expand. Rents increased to $0.75 PSF NNN, which is the highest average rental rate ever for this market. Significant barriers to creating new supply coupled with increased demand by tenants are putting continued upward pressure on rents. This will continue to make the Mid-Counties one of the more expensive markets in Southern California.

New construction deliveries totaled 542,000 square feet this quarter, while 255,700 square feet of additional space remains under construction. Development opportunities continue to be scarce, and land prices for even marginal industrial parcels are seeing new highs. Capitalization rates increased 140 basis point this quarter in Los Angeles County averaging 5.8% in the second quarter of 2018. Average sale prices rose over the quarter to $188 PSF.

Key Takeaways:

  • This quarter, 542,000 square feet of industrial space finished construction, all of which was pre-leased. 
  • Industrial absorption was negative 245,300 square feet, the first quarter of space givebacks since 2010.
  • Average asking rents increased $0.01 over the prior quarter to $0.75 per square foot (PSF) triple-net (NNN).
  • The overall vacancy rate was 1.6%, up 80 basis points from the previous quarter. This was due to a handful of large space givebacks.
  • Sales and leasing activity totaled 1,350,700 square feet for the quarter, including three sales (47,000 square feet) and 28 leases (1,303,700 square feet).
  • Only 255,700 square feet remains under construction, most of which is pre-leased.

Outlook:

The Mid-Counties market remains a tight infill market, despite rising vacancy rates this quarter. Industrial demand remains at record levels for Southern California with the Mid-Counties being one of the most sought after areas for distribution and last-mile industrial uses. High industrial demand and low inventory continues to put upward pressure on asking rates, which have hit a new peak every quarter for the last two years. As rents continue to rise, industrial users continue to purchase real estate, which is further driving up sale prices.

Despite space givebacks this quarter, vacancy remains tight and is expected to decrease in future quarters. Tenants are advised to start their building search well in advance of lease termination. Absorption will likely be positive next quarter as fully leased buildings are brought to the market. Rents will continue to rise in future quarters and tenants can expect to pay a premium for all types of industrial space. Tenants who signed leases five years ago can expect their rents to increase significantly upon renewal. Increasing rental rates and sales prices, along with continued low vacancy rates, may lead to older buildings being redeveloped into new projects. Industrial real estate will remain in high demand, especially densely-populated infill markets.