Vacancy Rises Due To Increased Move Outs

The South Bay remains the premier market for distribution companies and cargo-centered sea-and-air industrial users. It is nearly fully developed, making land incredibly scarce. Tight market conditions and a lack of larger modern space continue to be deterrents that drive tenants to neighboring markets, primarily to the east.

The vacancy rate rose 30 basis points to 1.5%. Despite this rise in the vacancy rate, they remain near historic lows. Vacancy was tightest in the LAX/El Segundo/Hawthorne submarket at 0.8% and remains highest in the Torrance submarket at 2.7%. Industrial demand reported negative 716,700 square feet of net absorption this quarter due to space givebacks across all markets and size ranges. Sales and leasing activity totaled 2,081,900 square feet this quarter. This was broken down into eight sales (248,700 square feet) and 47 leases (1,833,200 square feet). Average asking rents increased $0.01 to $0.84 PSF NNN. Asking rents reached their highest levels ever and are expected to rise in future quarters. Demand remains high for newer modern industrial space. These new buildings come with higher asking rates, which will drive up asking rates for the region once they are constructed.

There were no new projects that finished construction this quarter. Several new projects broke ground this quarter and construction activity totals 1,585,800 square feet of space currently under construction. Development is exceedingly difficult in the South Bay, where raw land, if available, sells for a premium. This quarter, ProLogis completed its acquisition of DCT Industrial in an 8.4 billion dollar stock-for-stock transaction. Many of the desirable Class A properties were located in Southern California, driving average sales prices for the quarter to $216 per square foot. Rising sales prices led to further compression of cap rates to 5.0%. No other property type has seen such continued compression in cap rates, especially at a time when 10 year treasury rates have increased over the past year by 70 bps.

 

Key Takeaways:

  • Space givebacks this quarter totaled -716,700 square feet as the vacancy rate rose 30 basis points to end at 1.5%. 

  • Industrial rents increased $0.01 over the quarter to $0.84 per square foot (PSF) triple net (NNN). Rents have increased 3.7% over the last 12 months and are at their highest recorded point.

  • Sales and leasing activity totaled 2,081,900 square feet, which breaks down into eight sales (248,700 square feet) and 47 leases (1,833,200 square feet). 

  • Industrial space under construction totaled 1,585,800 square feet as several new speculative projects have started construction this quarter.

Outlook:

Rents are at their highest levels ever, prompting many users to consider buying their real estate. This proves difficult however, as few owners are willing to sell and the available inventory of buildings for sale is insufficient to meet  demand. Land is incredibly scarce and many industrial users are having to get creative or face paying a premium to secure land for truck, car or trailer storage.

Future quarters are likely to see flat or slightly rising vacancy rates as high rents force tenants from marginal industrial spaces. Absorption is likely to be flat or negative in future quarters as the trend of space givebacks continue. Positive absorption may occur when the buildings currently under construction are built and leased. 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 roughly 45% upon renewal. 

Tight market conditions have led to a building boom for industrial product in the South Bay. Future developments will likely require greater scrutiny on the part of developers as the remaining obsolete and under-utilized parcels often come with environmental risks inherent in infill development. Developers must factor this environmental cleanup cost along with steeply rising land sales prices when considering new projects in the South Bay. Investors remain attracted to the industrial sector due to continued shifts in consumer behavior and a growing economy. Southern California remains the premier industrial investment market due to low vacancy rates and continued rising rental rates.