Over the last two years, our industry has experienced a significant pandemic-induced shift, presenting numerous challenges in conducting business. The Los Angeles industrial market has seen meteoric rental growth, and land values are pushing toward $200 per square foot, depending on size and location. We see a surge of developers electing to raze or repurpose former low-rise office and retail structures to accommodate low coverage industrial uses associated with e-commerce and logistics operations.
The shift impacts all industries and individuals within our region and beyond, significantly changing our consumption of goods and our relationships with traditional retail. Comparative to most retail storefronts, warehouse rents are low, as most have truly embraced shopping online, and we do not see that trend changing. Another major consumer challenge is that we expect our purchases to arrive on our doorstep within hours, yet most do not want to see the trucks on the roads required to deliver them. Many cities are pushing back on industrial uses by taxing landlords or tenants or downzoning industrial areas near residential properties to discourage heavy transportation uses. By doing so, further limitations are set on supply in the face of unprecedented demand, putting extreme upward pressure on rental rates.
When negotiating new lease transactions, industrial landlords want to take advantage of the “below 1 percent” vacancy and the associated higher rents. Tenants are stunned to see 50-75 percent rental increases from what they are currently paying. Most lease transactions are now stripped of rental abatement incentives and tenant improvement allowances. Plus, these new leases and renewals now present the burden of 4 to 5 percent annual rental bumps and prepaid security deposits that can equal a year of rent. Many tenants looked to the Inland Empire as a release valve to escape the high Infill rental rates and find cheaper, more modern alternatives in previous years. Unfortunately, that option is no longer available because rents in the Inland Empire have increased 50 percent in the last 12 months and vacancy rates are at historic lows below 0.5 percent.
While the option to relocate is always on the table for tenants, the challenge is convoluted by lack of inventory, high moving costs, required technology upgrades, and overall business disruption. Unless one can make significant reductions to one’s leased area, staying put is often the least painful alternative. Several larger institutional landlords provide modest discounts on renewals due to lower costs associated with downtime, lack of refurbishment expense, and reduced brokerage fees.
Looking ahead, we do not see any relief in the immediate future. Finding available land to build on is exceptionally challenging and expensive, so we cannot count on a glut of supply hitting the market any time soon. Suppose American corporations and consumers keep buying at this unprecedented rate. In that case, dozens of ships will continue to wait outside our ports to unload their goods. Then, those ships need to find warehouse availability to store products until the required distribution and transportation arrangements are available to reach the end-user.
Potentially, increased interest rates could reduce corporate and consumer buying power, which would slowly dampen the demand and ultimately alleviate stress on the supply chain. Still, reductions of the sort will likely take several months, if not years, before we see definitive results. It is a great time to be a landlord or seller of industrial real estate, but challenges and fluctuations remain present for tenants and buyers.
Chris Sheehan(left) and Mike Foley are executive vice presidents at Colliers.