Long lines of tractor-trailers filled with electronics, apparel and home-improvement goods crowd Interstate 10 through Southern California’s Inland Empire. The trucks are headed for a growing number of warehouses that are displacing the citrus groves that once dominated the area.
HauteLook, an online discount retailer owned by Nordstrom Inc. (JWN:US), will move its fulfillment center to a new 604,000-square- foot (56,000-square-meter) facility in San Bernardino next month, data from brokerage Jones Lang LaSalle Inc. show. Amazon.com Inc., the world’s largest online retailer, moved into a 950,000-square-foot warehouse late last year.
Demand for industrial space in the Inland Empire, a 27,000- square-mile (70,000-square-kilometer) area east of Los Angeles, is spurring a surge in building as developers start projects even without lease commitments. Warehouse construction in the region rose 81 percent in the fourth quarter from a year earlier, resulting in the most industrial square footage being built in any U.S. metropolitan area, CBRE Group Inc. said.
“The Inland Empire is the most dynamic industrial market in the entire country today,” said Darla Longo, a vice chairman at the brokerage’s institutional group. “It is one of the first markets to come back from an industrial perspective, and has bounced back more than any other market.”
About 7.8 million square feet of industrial space is under construction in the area, up from 4.3 million at the end of 2011, according to a report by CBRE. Tenants are currently on the hunt for about 20 million square feet, which has resulted in a 60 percent pre-lease rate for speculative construction, according to Bo Mills, managing director and head of industrial markets for the western U.S. at Chicago-based Jones Lang.
The area is the closest large-scale industrial market to the ports of Los Angeles and Long Beach, the biggest seaport complex in the U.S. About 75 percent of all international goods coming into the ports pass through the Inland Empire by truck and rail, said Steve Adams, a councilman for Riverside, one of the largest cities in the region.
Other major cities include San Bernardino and Fontana. The region, about an hour’s drive from downtown Los Angeles and home to more than 4 million people, was known mostly for its citrus groves and dairy farms until the 1970s, when population growth and rising home prices began spurring buyers to seek properties farther from Los Angeles.
During the recession and housing crisis, the Inland Empire became one of the nation’s foreclosure capitals following years of overbuilding, with about one out of 10 homes receiving a notice of default or repossession in 2009, according to San Diego-based research firm DataQuick. The industrial vacancy rate jumped to a record 12 percent in the third quarter of that year after the housing boom was accompanied by a record amount of speculative construction.
A recovering economy and rising demand for consumer goods helped push the industrial vacancy rate down to 6.2 percent as of the first quarter, a post-recession low, CBRE said. The median home price has climbed 40 percent from its low to $229,000, while remaining 43 percent below peak levels.
Prologis Inc. (PLD:US), the world’s biggest owner of industrial properties, is building 327,000 square feet for Bayerische Motoren Werke AG (BMW) in the Inland Empire city of Redlands -- space the luxury-car maker will use for parts distribution.
The landlord also has an 800,000-square-foot project in the same city under development without a tenant, and is planning as many as three additional speculative properties with a total of 1.7 million square feet within the next 18 months in the region, according to Tyson Chave, a Prologis vice president.
The San Francisco-based company (PLD:US) is close to completing its most recent speculative warehouse, which it said probably will be leased by such tenants as a large retailer or fulfillment center. The site is in a Redlands neighborhood with wide, newly paved roads and symmetrically planted trees, making the area reminiscent of a planned residential community.
“Everything is new, clean and safe here,” Kim Snyder, Prologis’s president for the U.S. southwest, said during a drive through the area last month. “State of the art -- that’s what tenants look for more than ever.”
Prologis’s Inland Empire properties were fully occupied last month, Snyder said. The company’s entire portfolio had an occupancy rate of 93.7 percent as of March 31, Prologis said today in a statement announcing its first-quarter financial results.
BMW considers the Inland Empire’s biggest draws to be its extensive infrastructure, which speeds up delivery times, and its proximity to Los Angeles. The city is one of the automaker’s three biggest U.S. markets, along with New York and Miami, said Kenn Sparks, spokesman for BMW of North America LLC.
“Southern California is very important to us, especially as the economy is recovering here,” he said. “The Inland Empire is ground zero for us in terms of its importance and its logistics.”
Amazon.com (AMZN:US) in the fourth quarter opened its first Southern California fulfillment center in San Bernardino to receive goods from manufacturers and process orders for quick delivery to local customers, according to Hillwood Development Co. and Clarion Partners LLC, the warehouse’s owners. The retailer is adding 515,000 square feet this year at an Inland Empire facility also developed by Hillwood and Clarion, according to a person with knowledge of the agreement who asked not to be identified because the transaction is private.
Kelly Cheeseman, an Amazon spokeswoman, didn’t respond to a request for comment on the company’s expansion plans this year in the Inland Empire.
Karen Modlin, a spokeswoman for Dallas-based Hillwood, and David Confer, a Dallas-based director at Clarion, both declined to comment on the new Amazon site.
Clarion, a real estate investment manager based in New York, has 11.5 million square feet in the Inland Empire, including 3 million square feet under construction, Confer said. The firm has more space being built in the region than anywhere else in the U.S., he said.
Mandy Hjellming, a spokeswoman for Nordstrom’s HauteLook unit, declined to comment on the company’s Inland Empire facility.
There’s a risk that the increase in Inland Empire construction will lead to an industrial-property surplus in the area, potentially hurting occupancies and rents, according to John Stewart, senior analyst at Newport Beach, California-based research firm Green Street Advisors Inc.
“There’s a lot of land in the Inland Empire,” he said. “The meaningful increase in supply in such a short period of time could lead to oversupply and pose a long-term threat to the investment proposition in the area. We’ve certainly seen this in the last cycle, and it could happen again.”
Monthly rents in the area averaged 38 cents a square foot in the first quarter, up 5.6 percent from the previous three months, CBRE said. While that’s less than the 45-cent peak reached in the third quarter of 2007, Inland Empire industrial rents probably will rise 8.7 percent this year, outpacing a 3.4 percent gain nationwide, CBRE Econometric Advisors said.
As rents rise and vacancies drop, prices for industrial property in the Inland Empire have climbed, squeezing profits for landlords entering the market. Industrial-property sales totaled $471.6 million in the first quarter, the highest for a three-month period since the end of 2010, according to preliminary Jones Lang data. Warehouses and distribution centers of at least 100,000 square feet sold for an average of $68 a square foot, a 4.6 percent increase from a year earlier.
In the first quarter, capitalization rates, a measure of yield for real estate investors, were about 4.6 percent to 4.7 percent in the area, compared with 7.6 percent nationwide, according to Jones Lang. Cap rates fall as prices rise.
“You have an abundance of capital that looks to the Inland Empire as a choice location because you have brand-new buildings, and your tenants are Fortune 500 companies that have been recovering very well,” said Michael McCrary, an executive vice president at Jones Lang.
The drop in yield from the “mid-sevens about three years ago” is buoying construction because building is becoming cheaper than buying, said Philip Hawkins, chief executive officer of DCT Industrial Trust Inc. (DCT:US), a Denver-based real estate investment trust.
“After demand was dormant from 2008 to early 2010, it has been going through a resurgence,” he said. “Combined with very low vacancy rates in the region and growing rents, that makes this the strongest market in the country. It’s also made things more expensive. So now is a good time to build.”
Hawkins’s company, which focuses on industrial real estate, has made Southern California its biggest investment area, up from fifth place three years ago, he said. DCT, which has 13 percent of its holdings in Southern California, is building two structures with a total of 780,000 square feet in the Inland Empire cities of Fontana and Rancho Cucamonga, and is planning more in the area.
Demand is also increasing for so-called big-box warehouses -- structures of at least 250,000 square feet, said Snyder of Prologis. All 28 of the Inland Empire’s speculative projects since the end of 2011 are in that size category, with the smallest being a 300,300-square-foot building in Chino owned by Chicago-based First Industrial Realty Trust Inc. (FR:US), according to Jones Lang.
“Customers today demand very large buildings -- often between 600,000 and a million square feet,” said Jones Lang’s McCrary. Warehouses have grown in size because inventory- handling systems have become larger and the rise of Internet sales has resulted in goods being moved from retail stores to distribution centers. “Not many areas in the U.S. that are strategically located have 50-acre sites of dirt.”
More residents in Los Angeles also are fueling demand in the Inland Empire, said Snyder of Prologis. Los Angeles County’s population grew to 9.96 million by mid-2012, up 1.5 percent from two years earlier, according to the U.S. Census Bureau.
The area has “started to support itself -- it’s become its own market that feeds off of itself,” Snyder said. “Combine that with demands from outside the region and you’re looking at a true growth market.”
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