MARKET INTEL: SoCal Industrial Insights – AIRCRE/CompStak Webinar

SKIP AHEAD TO:

• Industrial Market Outlook
• Industrial Rent Growth Shows No Sign of Slowdown
• Industrial Transaction Size Growing
• Industrial Lease Escalations on the Rise
• Tenants Face Steep Increases at Lease Renewal
• Effective Rent Growth Keeping Pace with Base Rent Growth

CompStak presented its latest data and insights on the industrial market in Southern California including the markets of Inland Empire, Los Angeles, Orange and Ventura Counties in AIR CRE’s Q3 2022 Research Insights webinar. This market has charted some of the fastest rent growth in the industrial sector nationwide; what are the market stats showing as we approach the end of 2022 amid mixed economic signals?

ICYMI, here are some of CompStak’s key findings on the industrial market in Inland Empire and Orange, Ventura, and Los Angeles counties.

Industrial Market Outlook

The industrial market has had a record growth over the last few years, driven in part by structural changes that happened during the pandemic. And while the U.S. did record a short recession during this period in 2020, the industrial market barreled ahead. It’s important to keep in mind that the industrial market was significantly different the last time we experienced a major recession (the Great Financial Crisis of 2008).  Most importantly, ecommerce accounted for about 3.5% to 4% of all retail sales from 2007-2009. Today, ecommerce is a larger share of the pie, averaging about 14.5% over the last four quarters, more than triple the levels seen in the last recession. This level is expected to remain elevated despite a shift back to normal levels of spending on services. At the same time, average annual rent growth for the industrial market was in the single digits preceding the last recession, instead of the double-digit growth we are seeing in many markets today including in Southern California. In 2007, the industrial vacancy rate was around 7-8%, and today it is less than 3% nationally and falling. What are some significant factors to pay attention to in regards to the industrial sector amid threats of a recession?

• Consumer sentiment improved slightly in recent months but remains close to its record low reached in June 2022;
• Retail spending (which is not adjusted for inflation) is flattening in recent months, especially on goods.
• Retail inventories are at record highs after retailers stockpiled goods to meet demand and counter supply chain issues. Now as consumer spending is falling, this is driving demand for industrial storage space to hold these goods. 
• The NAIOP CRE Sentiment Index is at its lowest level since September 2020, but respondents expect industrial to fare best over the next year. 
• After a sixth rate hike, the rising cost of capital will continue to weigh on CRE and industrial cap rate compression is expected to slow or reverse.
• Southern California’s particular challenges include rising development pressure at the same time as vacancy is at a record low. 
• Port volume at Long Beach and Los Angeles has fallen as shipments have shifted to East and Gulf Coast ports over the last few months, especially as import activity from China has slowed.

Industrial Rent Growth Shows No Sign of Slowdown

• Robust rent growth continues for the LA/VC/OC/Inland Empire market overall, no signs of slowdown yet, despite growing economic pressures. 
• The rate of growth in base rents for closed transactions – meaning the starting rent for industrial leases — has been posting double digit YOY growth for at least the past five quarters. 
• The spread between the average base rent in Inland Empire and in Los Angeles County is narrowing:
  • In 2020, the premium for LA County industrial space averaged about 34.4%.
  • In 2022 to date, this premium has narrowed to 18.3%.

Industrial Transaction Size Growing

• Industrial lease transaction sizes have increased dramatically in the Inland Empire, topping 100,000 square feet for the last four quarters, especially driven by leasing in newer construction. 

• Average starting rents are increasing fastest for deals over 100,000 square feet in the Inland Empire; Tenants below 100K are paying on average 8.7% more per square foot that tenants taking 100K+ spaces over the last four quarters.  By comparison, this same statistic was 41.6% in 2020.

Industrial Lease Escalations on the Rise

• The average annual escalation is now 3.91% in the Inland Empire/LA/OC/VC industrial market and increased for 9 consecutive quarters from 2Q 2020 to 2Q 2022.

• With strong year over year growth for the last several years in this market, landlords began to price in stronger rent increases for existing leases – pushing up the average lease escalation.

  This rise in industrial lease escalations is not unique to this market. While it reflects the highest average annual lease escalation among the markets CompStak evaluated, it has risen also across major markets across the United States up from the standard annual increase around 3%.

• As the share of leases with annual lease escalations above 3% has risen, the average term length has risen as well for leases inked with annual escalations above 3% in the Inland Empire/VC/OC/LA market.

• Meanwhile, the average term length has fallen for leases with annual escalations at or below 3%, suggesting that landlords are willing to complete longer term deals but are pricing in higher escalations. 

Tenants Face Steep Increases at Lease Renewal

• There is a significant spread between what tenants are currently paying today in active leases vs what deals are being executed at today in terms of starting rents.

• This difference is most stark in Inland Empire due to the robust growth there —the average rent being paid today (not including concessions, discounting or provided work values) is well below the average starting rent inked by industrial users in 2022 there — the 2022 average starting rent is more than 67% higher than rent being paid in place according to CompStak’s data.

• Rent growth for renewal transactions has kept pace with rent growth for new transactions in this market and YOY growth has slightly outpaced that of new transactions for two quarters.

Effective Rent Growth Keeping Pace with Base Rent Growth

• Due to strong average base rent growth, rising escalations and stable concessions, average effective rents are growing just as fast as starting rents. From last quarter, LA County posted the strongest growth, but the Inland Empire has the strongest rate of growth year over year, with the average effective rent up by more than 50%. 

Check out the full slides below! 

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