Rene Ramos, Jr. forecasts industrial trends through 2020
As seen in primary markets like Los Angeles, the industrial real estate market has begun its historical recycling plateau in the United States. The demand for industrial space and land is high and still rising in both primary and secondary markets. However, supply in all of these markets are sparse causing companies to look for space in bordering markets with access to primary and secondary markets.
Large and small industrial warehouses are the new quasi-retail, where computers manage inventory and the space is now used for assembly and distribution. The demand for large industrial inventory is growing rapidly and not just for bigger but even taller structures. Retail is in need of increasing its industrial distribution and fulfillment centers. With such high demand and low supply, prices are force companies to rethink their real estate strategies. Because of the demand, supply will be built to accommodate.
Supply vs. Demand
Companies seeking business opportunities in primary markets are struggling to find affordable space within their means in the primary markets and are looking to tertiary markets to fill their industrial spaces. Consequently, with most of the industrial companies moving to tertiary markets, demand remains high and the supply is extremely limited. The costs in tertiary markets are subsequently rising.
Since 2010, California remains the top state for distribution and fulfillment centers with over 29 million square feet of space. Inventory is also becoming more expensive because of the demand for quality of each asset. These facilities are particularly different from traditional distribution centers and are specifically built to support high-volumes of inventory. The buildings structures require higher ceilings, additional dock doors, larger storage, more parking, restrooms and levels with more floor space. When selecting a site for industrial space, companies seek locations near airports, waterways and ground transportation networks for shipping.
Buyers are finding available inventory in San Gabriel Valley for ±$200 per square foot, but drive down the freeway for 15 minutes to Ontario, buyers will find industrial options for $155 per square foot as well as if they drive an additional 15 minutes to San Bernardino. Buyers are willing to put in the miles and distancing their industrial operations to justify doing business in Los Angeles and other primary markets. Buyers are relocating from LA to Inland Empire.
This trend strengthens tertiary markets and inflates their industrial per-square-foot rates. When secondary markets rise in value and demand in a market peaks, reciprocating behaviors follow this trend in industrial real estate and the economic market. Ontario, CA, is on the cusp of primary market value status as their income and value rates increase. Inland Empire can accommodate companies’ industrial needs for space and price.
A well-performing industrial market is healthy and there shouldn’t be much of a slowdown in capital demand for industrial in general for the next couple of years. Foreign investors are pouring resources into the American market more than ever and are buying up industrial real estate throughout Southern California with a focus on the Inland Empire. The national industrial vacancy rate was the lowest rate on record despite more than 170 million square feet of new supply completing in the first three quarters of 2017.
Price inflations lead companies to grow, but this growth is not sustainable nor is it long-term for continued in-state business. Companies react by either fleeing from the inflated prices and pay for mid-level, or will flee even farther to save a few more dollars. Other companies will exit a market and will patiently wait and watch the economy, governmental changes, market trends and other external factors before moving again. Although, this trend has occurred before there aren’t many options or solutions.
Forecasts through 2020
This industrial pattern could continue until 2020 with no immediate signs of it stopping. However, surge trends in throughout American history have also seen spikes. Companies seeking secondary markets and tertiary markets aren’t going to keep heading south, southwest, or west within the state to make their business in primary markets like Los Angeles justifiable. Doing so will completely alter their distribution strategy.
As traditional retailers begin to inherit the idea of multi-level properties, combining fulfillment centers and physical retail stores, industrial product will need to remain close to the customer. Upon maximum trend inflation, companies may consider leaving the state for business altogether, restructuring their industrial strategy in manufacturing, distribution and delivery.
Many companies fleeing from Los Angeles aren’t jumping ship just yet, but are sitting patiently and waiting to see if the federal government will be making significant changes in its tax reformation plans. Under the new Whitehouse administration, many companies are feeling unease to pack up and move or to expand operations while the land is still a hot market. For the Inland Empire, tax reform could lead to potential employment increase and lead a surge of people seeking alternative careers and living structures to travel South, Southwest and West.
Effects of tax reformation
Tax reform has often played an intricate process in the economy under new White House administrations. President Trump has propositioned in reducing the current complicated seven-bracket system down to three and cutting taxes in each of the remaining brackets to 15 percent, which would be one of the lowest corporate tax rates in the world. A rate too high is impeding economic growth and potentially driving American businesses overseas.
In 2015, the high-volatility commercial real estate banking regulations placed on banks in 2015 required 15% hard equity contributions for new development loads, making it extremely difficult to build up new industrial facilities. Even if the tax rate drops from 35% to 20-22%, industrial manufacturers may benefit from this allowing more room in their budgets to afford more staff, employees, workers or even equipment. This won’t just affect big-bog industrial owners but will trickle down to even the smaller shops and warehouse users.
Tax reform will cause a lot of movement in the employment market, attracting younger generations, like millennials, from the big cities to the suburbs where they will find more sustainable living options.
Yes, markets are hot, but companies won’t jet out of the markets just yet because of high taxes and 1031 exchange policies or also known as like-kind exchanges. When an investor sells an asset, they pay a tax on their earnings. Section 1031 allows investors to defer that tax if they reinvest their money within 180 days in a property similar to the one they sold, a legislation that Congress has been attempting to change for five years.
President Trump’s proposed tax plan may lead to major changes, or the repeal of section 1031, which could negatively impact investors. Investors may no longer get a tax break for deferring capital gains leading them to consider other investment opportunities outside of the real estate market. The 1031 exchanges will likely survive the tax reform, but no one can be sure.
Those that want to leave will move. Typically, those who are patient remain in their markets. As is the case now in Southern California, many companies are waiting for tax reform before they drive farther down the road or uproot their primary market location and relocate to additional markets.
Over $20B in total investment in industrial real estate occurred in 2015 and 37.5% of buyer activity came from foreign companies investing in property in the U.S. The American political climate is on edge waiting to see if President Trump’s tax reformation plan helps or harms this the foreign investment trends. Companies abroad may be subject to new security criteria under a Trump administration. Things could also go the other way seeing that Trump is a real estate mogul, more foreign investment in real estate is also likely.
Industrial hasn’t hit its peak yet. The industry is overwhelmingly an underbuilt market and will spike in activity until at least a few more years.
Written by Rene Ramos, Jr., Senior Vice President at CBC Advisors