By Tucker Hughes
The Los Angeles real estate market had a very strong 2016.
The office sector of the market experienced nearly 4 million square feet of positive absorption causing vacancy rates to drop from 11.0% to 10.3% from the prior year. This reduced the total supply of vacant office space to just over 42 million square feet relative to the market size of just over 400 million square feet. Average office rents also increased on a per square foot basis from $2.57 to $2.76, primarily fueled by the reduced availability of space and the high cost of the new inventory coming onto the market.
The industrial sector of the market performed well too, however, simply looking at absorption and vacancy rates is not indicative of the true strength of the asset class. For example, positive absorption for 2016 was only 325,000 square feet, which given the enormous nearly one billion square foot industrial market throughout Los Angeles country, didn’t even reduce vacancy by a tenth of a percent. It still hovers at 2.2%, which is more or less where it was for the entire duration of 2016. During this same period though, triple-net rental rates increased from $0.81 per square foot to $0.87 per square foot, which amounts to over a 9% increase in rents. Given the extremely limited supply of available industrial space, it is to be expected that rents will continue to rise while vacancy remains static of even increases slightly. The vast majority of heavy net absorption is now occurring in the Inland Empire, where land is much more affordable and easily converted into new buildings.
At the end of 2016, there was a total of 4.2 million square feet of office space and 7.1 million square feet of industrial space under development. Considering that the office market is less than half the size of the industrial market and has a much higher vacancy rate, it is easy to question why developers are choosing to build so much office inventory. The bottom line is that they don’t have a choice with where land prices have risen to in most areas of Los Angeles, unless they want to lose money on their investment.
The solution for making the development of industrial product pencil? The largest owner of warehouse space in the United States, Prologis, believes it is double or triple stacked warehouse buildings. Prologis is responsible for a project in Seattle that is best described as stacking two industrial buildings on top of one another with a third level for corporate office space. While the construction costs of building such a structure are very high, it dramatically brings down the per square foot contribution from the cost of land. As retailers move distribution centers closer to customers to speed up delivery times and reduce the associated labor costs, expect this urban warehouse trend to continue.
On the office side of new development, all of the speculative new construction is occurring in West Los Angeles and Downtown, which makes sense given that they are the largest and second largest Class A submarkets in the country.
What does all of this mean for tenants in 2017? Be prepared for increased rents, especially for industrial space users, as the supply/demand equation further tilts in favor of landlords county-wide.
Tucker Hughes is managing director at Hughes Marino, an award-winning commercial real estate firm with offices across the nation. As head of Hughes Marino’s Orange County and Los Angeles offices, Tucker specializes in tenant representation and building purchases throughout Southern California and beyond. Tucker makes frequent media appearances to speak on the future of commercial real estate, and is also a regular columnist for Entrepreneur.com. Contact Tucker at 1-844-662-6635 or email@example.com.