Monthly Archives: January 2015

Strong Demand But Not Much Product

2014 ended on a strong note at year end.  All my listings are either leased or sold and it confirms the space shortage that is looming throughout Los Angeles. Tenants should be looking six months prior to lease expiration and be prepared to pay double rent as soon as they find a space they like. Not only has there been very limited new construction over the past several years, but high sale prices have taken a lot of buildings off the lease market. This has put upward pressure on lease rates for functional distribution type warehouses.   Most new developments are exceeding their proformas with deals being struck during construction, especially on the sale side. The predominance of cash buyers, both from foreign investors and funds is dramatic even as the march of higher prices and lower yields continue.

Chinese investment in Los Angeles in nothing new, but the breakout trend is away from traditional areas in the San Gabriel Valley.  The overriding purpose is to buy anything that looks reasonable and has a modest return. Because of the cultural and language barrier the Chinese investor arrives with a translator, real estate expert, and often family.  They are all business when it comes to closing sometimes wiring in the funds even before contingencies are lifted. Los Angeles is a favored destination for this type of foreign investment because of the Pacific location, the strong Chinese Community, vast trading opportunities and the federal visa programs. I predict you will see more Chinese investment across the United States as opportunities in Los Angeles diminish.

There is a strong divergence between functional and non-functional buildings. Buildings with decent loading and ceiling heights are renting at new highs. Buildings that are obsolete have seen minimal rent increases over the past several years. However this is not true on the purchase side. Sale prices for older, non-functional building are also increasing as buyers will spend money on improvements where they won’t on a lease. Owners of older buildings don’t want to invest in improvements because the rent growth isn’t there. And they don’t want to sell because of tax consequence.

The pace of the Los Angeles industrial market is a strong contrast to the global economy and other international flash points. In addition, serious, local economic issues have not deterred investment. This past year we lost several major employers including Toyota, Tesla and Occidental Petroleum to other states. Labor slowdowns in the port have long term consequences because of shipper’s forward planning. Current delays are unconscionable threatening permanent economic damage.  The drought is taking a large toll on local farmers and will require massive investment in water supply that, in many cases, outweighs the value of the crops. Recent rains so far this winter have not significantly helped. Even with the S&P 500 up almost 90% over the past 5 years, the California pension system is vastly underfunded causing local municipalities to steer tax dollars away from basic services to make up the funding deficit. I could list other financial strains in California but it doesn’t change the picture. Industrial real estate prices keep chugging along quite comfortably. Supply constraints, lots of buyers, recovering industry, lower oil prices and rock bottom interest rates are providing momentum for the L.A. industrial market. 

Looking at US Industrial with the US Cluster Mapping Project

The Cluster Mapping Project (CMP) was pioneered by Michael E Porter of Harvard University. He is just as well known for his works on Competitive Advantage.  His work is a necessary foundation for US Industry and business organizations. I reprint his Value Chain diagram below for company diagnostics, which has been repurposed to examine the competitiveness of regions. To understand the implications of location and clustering, you can read an article Professor Porter published in 1995 about the strategic location of inner cities which is just as relevant today. 

CMP moves the competitive business insights into a geographical framework. The primary mission is to make regions more competitive by harnessing their own primary activities and resources. Just as in the example of Inner Cities, the CMP has uncovered many industry clusters on a national basis that is intended to help regions understand themselves, but can also guide industrial real estate users and developers into areas of specific strength and concentration.

 It’s well worth looking at the CMP site and spending the time to understand the background concepts.  Be sure to read all the appendices because they demonstrate the different industry categories.  The CMP can lead to a very good understanding of U.S. industry that is specific and data intensive, both which will help make investing decisions.

Because the CMP has so much data available and flexibility in query and reporting, it can used for other purposes. For instance, the CMP can be used to locate deals, not in the specific sense of finding property, but to steer your effort and energy.  If the focus is on big industrial and land, the CMP shows in darker shades of blue where the most number of establishments for Distribution and Electronic Commerce occur. 

 

The top 15 regions with the most enterprises for distribution and ecommerce are:

Region Name Establishments 2012
New York-Newark-Jersey City, NY-NJ-PA

34,319

Los Angeles-Long Beach-Anaheim, CA

28,269

Miami-Fort Lauderdale-West Palm Beach, FL

14,202

Chicago-Naperville-Elgin, IL-IN-WI

13,676

Dallas-Fort Worth-Arlington, TX

8,534

Houston-The Woodlands-Sugar Land, TX

8,363

Atlanta-Sandy Springs-Roswell, GA

8,221

Philadelphia-Camden-Wilmington, PA-NJ-DE-MD

7,279

San Francisco-Oakland-Hayward, CA

6,103

Boston-Cambridge-Newton, MA-NH

5,631

Minneapolis-St. Paul-Bloomington, MN-WI

5,276

Seattle-Tacoma-Bellevue, WA

5,069

Detroit-Warren-Dearborn, MI

4,947

Phoenix-Mesa-Scottsdale, AZ

4,528

 

One can also query the industry data by comparing regions for the highest growth rates in establishments for the same category of Distribution and Ecommerce. By looking at the data in this additional way, you can also add, Riverside-San Bernardino and Las Vegas-Henderson-Paradise. From personal knowledge and not from the CMP, I would add the Columbus- Cincinnati-Northern Kentucky corridor and Memphis. Distinction also should be made between regional distribution centers, local distribution and the new breed of ecommerce. Some companies will only need to be in the regional centers with limited locations. Other companies need to be in every metropolitan area but with a smaller footprint.

The CMP breaks down clusters into sub-cluster groups by NAICS numbers. These NAICS numbers are helpful in identifying specific companies by searching industry databases by employee size and NAICS. It turns out that in the general cluster of Distribution and Ecommerce there are both growing and contracting business types. The chart below shows that several sub clusters – warehousing and storage, wholesale trade, electronic shopping, and pharmaceutical distribution – are among the most robust segments. Not only will the CMP point to regions that are growing particular industries, but it also shows which particular segments of an industry has the most growth potential. With the corresponding tools of parcel data and industry classifications, the CMP can guide both the selection of real estate and the tenants who occupy the space.