Industrial Property Recession

Industrial property in Los Angeles is suffering for three major reasons. Poor business conditions, an unfavorable societal environment, and a credit freeze. As these trends continue, business will be conducted under recessionary circumstances.  Meanwhile, new attention will be drawn to overcoming the current malaise by innovations in financing, industries, investors, and deal structures. Until then, it’s simple. Owners will drop their prices.

Business conditions are worsening. From last year, container imports are down 10%. This is an important factor for a region focused on port traffic. There is almost 8% unemployment. Consumer spending is dismal.  The ISM Manufacturing Index dropped to 43.5% – the lowest since 2001. We’re seeing a record number of store closings.  And of course, financial implosion. These, and other factors, directly reduce leasing and sales activity. 

Socially, the region has a host of problems that worsen with falling tax revenues. The State has a tremendous budget problem and uses short term fixes to meet legislative time frames. We have low student test scores, a lengthy building permit process, gang violence, unbearable traffic and high business and property taxes. While there are excellent pockets of innovation, once a business reaches a certain size, California loses its economic attraction. 

Credit and banking are broken and has made the purchase and sale of property extremely difficult. Pricing will come down to meet very conservative underwriting standards.  Instead of extending credit, many lenders are calling their loans. This requires investors to post more cash to meet revised lending standards. SBA loans are available, but buyers need to weigh higher mortgage payments and declining prices against lower rents. 

Recessionary negotiation tactics are back: Free rent to maintain a high base rent.  A secondary market to fund tenant improvements for broke developers. Assumption of existing leases to induce tenants to move. Full fee and bonus commissions for brokers. Abundant cheap sublease space competes with direct lease space.  Property tax reductions   Landlords renew leases at lower rents for longer leases. Owners will deal based on their personal bottom line and not on “market” rents.

For purchases, loans will be calculated on market rents and not the resale market.  Replacement cost will be a misleading indicator as both construction and land costs decline.  Cash starved sellers will entertain options, participations, financing, and other creative structures.  Many wealthy families that have been on the sidelines for the past ten years are returning to the scene to realize superior cash returns.

On the brokerage side, everyone agrees that business is slow. Listing Agents are succumbing to Tenant Brokers who will bargain mercilessly for their client. This role reversal leads to an abusive atmosphere that is characterized by concession fervor – obtaining as many tenant perks as possible. This zealousness is not unlike some landlords who were just as larcenous by passing through every conceivable and creative line item they could justify. Unfortunately, when markets change, payback is justified.

Many tenants will comprehensively shop the market only to make the best deal where they are.  With leasing competition so intense, every landlord will exert themselves to snap up any live body under any halfway reasonable scenario.  Meanwhile, brokers are so hungry that no tenant will be left uncalled bearing offers to beat any deal that is under current negotiation.  When markets are in free fall, participants act like it’s a free-for-all. 

There will be unusual leasing circumstances. Poor credit, unsavory characters, short leases, and undesirable uses will be a few.   Building Sharing, a relatively common occurrence in the logistics area, will become more widespread as tenants seek ways to reduce overhead. 

Innovation will spring from desperation. Without the mania of securitized lending, buyers will need more cash.  As Wall Street hegemony vanishes, investment partners from local sources will be sought. But funds won’t come cheap.  Using Warren Buffet, with his recent investments as an example, investors will want 10% and a share in the upside. But only for “A” deals.  Investors will clamor for significantly higher returns for the typical Los Angeles industrial property. 

With financing scarce, not only will the broker need to find the deal, but he’ll also need to procure the tenant before closing, except in the most distressed situation. The broker will need to do twice the work “on the come” before being paid.  In this pre-lease atmosphere, users will gain control of the market.  Investors, for empty buildings, will need to take out such large deductions for leasing risk, marketing carry, and fees, that their offers will be undesirably low. 

Tenants will be helped by being very specific about their needs. For example, the most modern distribution buildings  come with  high rents and property taxes. Since many buildings were purchased by institutions under the smallest of margins, there is a not a lot of negotiation room.  However, if a tenant can use a building that is less functional, they may be able to find one that is in older hands and considerably reduce their overhead.  

Joseph Schumpeter, the great economist of the 20th Century, taught that after economic destruction arises strong creative forces to start the next business cycle.  Leaders will come from the entrepreneur class, a very dynamic group in Los Angeles. Companies such as SpaceX and Tesla Motors may be the renaissance of the region’s great aviation and automotive tradition. Several local apparel companies, like Forever 21 and American Apparel, are creatively combining both vertical manufacturing and retailing while many of their competitors are quickly retrenching.   The City of Los Angeles’ CleanTech Redevelopment Project on the former 20 acre Crown Coach Property is the first of several industrial projects that will incentivize “green” manufacturing businesses.   Likewise, Cal Poly has set aside 65 acres for its Innovation Village that seeks industries of the future. 

While the pain is clear and solutions will be difficult to implement, a region like Southern California will always have opportunity. First we need to deal with the present. But innovation, team work, and hopefully, capital, will lead us to the best buying environment of a lifetime.

                                Clean Trucks Program

The Ports launched their Clean Trucks Program earlier this month. It bans older trucks (pre-1990) now and all others must meet 2007 standards by 2012. While the sentiment may be right, the timing is bad.  The logistics industry is slumping and one major mechanism to finance new trucks was vetoed by the Governor. Many truckers can’t afford to comply.  Unfortunately, this is a common problem while trying to green in a recession.

Rents for truck yards are falling. Recently there were no sites, now there is no demand. Many feel if Clean Trucks remains law, larger trucking firms will acquire the smaller firms to gain oligopolistic pricing control. In this case most large truckers will want cross dock buildings with large parking lots and ordinary truck parking sites will no longer be needed. That is, if we still have a thriving trucking and logistics industry when the recession ends.  

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Avalon and Rosecrans, Gardena, CA – 8 Double Dock-Hi Units – 5,000 sf to 10,000 SF  – Available November, 2008..

 

 

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