I recently had the opportunity to attend and participate as a retail panelist at the RENTV Inland Empire State of the Market Conference. I enjoyed sharing the podium with Matt Magnaghi of Kimco Realty Corporation, Chris Kehl of SRS Real Estate Partners and Todd Huber of Paragon Commercial as we provided an update on the SoCal Inland Empire retail real estate scene.
Because I spend most of my time swimming in the retail pool, one of the things I enjoy most about these types of conferences is the opportunity to get a quick overview of the non-retail product types that affect our region.
In addition to retail, there were panels covering the industrial, office and multi-family sectors. There was also a finance panel as well as two focused sessions that addressed economic activity in the High Desert and the City of Ontario.
The following are 12 key takeaways that are worth sharing.
1. The Industrial Availability Rate Has Soared: The industrial availability (vacancy +sublease) rate was 3.2% in the 4th quarter of 2021 and now stands at 11.6% today. That is 87M square feet available across the two-county region. The worst availability is industrial spaces from about 100,000 to 300,000 SF. Per CoStar, there are 194 of those spaces on the market today. Despite this fact there is an additional 25M SF under construction. Interestingly, the bigger the box, the higher the lease rate with lease rates for spaces 500,000 SF and larger exceeding $1.50/SF including NNN charges.
2. The Office Availability Rate is Near Record Lows: Yes, you read that correctly. Despite all the negative office news strewn across the media, the IE office market is one of the best in the country. This is likely because it is easy to take your own vehicle to the office in the IE vs relying on public transportation. Also, much of the office space serves healthcare and government which are two industries that need and require their employees to be present. The current availability rate is 8% with only 6.1% of the space vacant. Last time it was this low was 2005. Except for a small number of build- to-suits, there has been virtually no new construction since 2008. With top of market lease rates at $2.75 full-service gross, it is not likely we will see much new construction for many years to come. According to the panel, lease rates will need to be about $4.00/SF to justify new construction.
3. Multi-Family Sales Volume at Record Lows: In the first quarter of 2024, only $64M of product traded hands. This is off 87% from the average quarterly sales volume over the past decade. That is an unbelievable drop in velocity. The complete year of 2023 was off 66% compared to the 10-year average. This has huge implications for the retail investment market as many people who sell multi-family subsequently trade into retail properties. A part of the reason for this reduction in volume is that most property values have fallen 20 to 25% because of cap rates increasing from record lows, but the rental increases have not been sufficient to make up for the higher cap rates.
4. Unentitled Industrial and Multi–Family Land is More Appealing than Entitled Land: This concept really caught me by surprise. I have always viewed entitled land as being more valuable than unentitled, but the concept came up both during the multi-family and industrial panel. Basically, the point was that if a developer does not want to start construction now vs. a few years from now, it does not make sense to pay a premium for entitled land.
5. Virtually No Distress in Any Product Type: Across the board, no one indicated that there is any significant distress in the Inland Empire commercial real estate marketplace. For those that are hoping for some REO opportunities, this will likely not occur as lenders seem to have learned that they are not good operators and are much better off either working with the existing borrower or selling the loan at a discount to someone else who can either foreclose or do a loan workout.
6. Insurance, Security, and Trash Costs Are Rising Disproportionately: A common theme amongst the panels, especially the retail panel, is that property expenses are increasing faster than inflation, especially as it relates to insurance, security and trash. The finance panel stressed that a loan applicant, especially on an acquisition, better have a live insurance quote when they submit their application to establish credibility for the insurance expense line item.
7. Developers Can’t Get Electricity, but California’s Government Wants Everyone to Go All Electric: This theme is going to dominate the landscape for likely the next decade. Various government agencies are pushing all forms of buildings and transportation to electric, yet the panelists talked about how difficult, if not impossible, it is to get power for their projects. This could create a very real stalemate and harm economic development, which is likely fine for those on the environmental side, but very painful for those that create jobs and other societal amenities. Not only is it hard to get power to development sites, but there are still supply chain issues with transformers and service equipment. Our retail panel discussed the challenges of getting retailers open when you can’t get the electrical service equipment to their buildings.
8. Three Major Projects Underway in the High Desert: After being in some form of planning for at least 30 years, the master planned Silverwood project is now under construction in Hesperia. Over 15,000 dwelling units are planned. Model homes are about a year out. The second project involves the BNSF Railway which is planning the Barstow International Gateway (BIG) project on 4,500 acres of land. This project will create thousands of permanent jobs with its rail yard, intermodal facilities, and warehouse projects. Lastly the Brightline rail service, which is privately operated, recently broke ground and when completed will take passengers from Las Vegas to Rancho Cucamonga with two stops in Apple Valley & Hesperia and is anticipated to be operating within the next 5 years.
9. Exciting Projects Coming to Ontario: The Ontario Ranch master planned community is set to double the city’s population over the next 20 years. The City is making substantial investments in Downtown Ontario with residential projects under construction and the City taking back Euclid Avenue from Cal Trans. The Ontario Convention Center is slated to double in size to about 450,000 SF. The parking lots surrounding the Toyota Arena are slated to be turned into an urban oasis with dense residential, entertainment and restaurant options, and a planned state of the market office tower. The new regional sports complex in southern Ontario is 200 acres and will include a minor league baseball stadium, 10 soccer fields, 2 football fields, four baseball fields, four softball fields, an aquatics center and possibly a partridge on a pear tree! To top it off, a 340 acre “Grand Park” is also slated for southern Ontario.
10. A 10% Debt Yield is the General Rule: Loan to value or Debt Service Coverage Ratios are the tools that most of use when determining the maximum loan amount a lender will provide. The finance panel stressed the 10% Debt Yield rule. This rule effectively involves taking the net operating income and dividing it by 10% to determine a maximum loan amount. If you have a $10M property with an NOI of $550,000 (5.5% cap rate), you can determine that the maximum loan is likely about $5.5M ($550,000/10%).
11. Bridge Financing is Keeping Lenders Occupied: The lenders stressed that they are all very focused on bridge financing right now. Apparently, there are a lot of projects that are either in development that are taking longer than expected, or they are finished but taking longer to lease up, or they are finished and leased but the ownership does not like what the capital markets are telling them about pricing.
12. Stop Thinking It Will Ever Be 2020 to 2022 Again: This concept was frequently repeated as many of the panelists are service providers like me and we encounter owners every day that so badly want it to be 2021 again. They want the record prices that were mostly a result of the record low interest rates. Not only did the record low interest rates provide record low loans, but they also created a huge incentive for people to move their money out of cash and into real estate. The overriding sentiment was that these days are history and it is taking some time for the markets to find new ground.
Conclusion
As you can see, I love to learn and I learned a lot. That is one of my key measures of a successful event. My thanks to Steve Bloom and the RENTV team for putting on an excellent event. Also, keep in mind RENTV hosts similar conferences in Orange, Los Angeles, and San Diego counties. If you do business in these markets, I highly encourage you to check out the RENTV.com website to learn more about these events.