Category Archives: Deal Strategy

Four Current Forces of the Industrial Real Estate Business

The current robustness in industrial real estate markets obscures many forces that can balance and protect your investment and location decisions.   Technology, Monetary Policy, Political Risk, and Space Transparency are important factors that provide support during good times and bad.

New technologies come at an important time because accommodative monetary policies, that disrupted normal return structures since the Financial Crisis, are coming to an end. Building investments require realignment. New to the U.S., Political Risk is now measurable, and wealthy property owners are seeking global diversification to protect and hedge their property investments. Chinese flight from the U.S. and currency battles are two examples. Space Shortages are still the overriding condition, but it’s important to recognize that public listing MLS services only carry a limited selection of offerings while private deals account for many Sharing and Investment/Development deals. Interestingly, markets remain opaque despite the availability of enormous data.

Technology

Artificial Intelligence, Automation and Big Data, are the technologies I am developing with Block Chain being the one most anticipated.  A modest investment in Data and Digital Operations creates more leads, improves execution and compounds investment. Artificial Intelligence is embedded in many off-the-shelf programs like Excel and Salesforce. In the latter, A.I. is specifically directed at creating more Opportunities. Deeper intelligence is found by hard coding with Python, and its derivative, Pandas. For instance, by crunching large sets of parcel data nationwide and matching them to other data sources, investment and availability attributes appear much faster and with better intelligence than using Access or SQL.  Other programs look at layered data, multi-dimensionally, to predict behavior. Practical outcomes include more deals, better communication, and enlarging my network. In the field, we are experimenting with MappSnap, a geotagging tool for customers as an entry way to experience our Digital Platform directly.

Much differently, Building Owners want tech applications that increase building rent. Industrial building tech includes security, access, monitoring, and optimization. It is achieved using sensors, cameras, and automation. Normally an upgrade of electrical distribution and Wi-Fi is a requirement. The economic goal is to use tech to squeeze more rent from inside and outside of the building. The best example to date is the sharing business but instead of companies like WeWork or Liquid Space, every building owner can install new devices and technologies to increase rent.

Sharing runs a continuum from low to high tech and both create more revenue.  Low Tech Sharing is the most common and while it’s not a recent innovation to rent out unneeded space, the ease of finding tenants has increased.  The fundamental way to share is intrinsic, along physical attributes and divisions based on building shape and lot orientation. For instance, long narrow distribution buildings are routinely cut up in sections. Older buildings are divided so each space has yard and loading. Simple surveillance is managed either internally through building Wi-Fi or externally through cell connections. Digital Surveillance replaces expensive demising walls and frees common areas that can be used jointly.

On the higher tech side, Sharing divides buildings to much smaller increments with Wi-Fi, sensors, cameras and robots to monetize every cubic foot. This creates real time data to measure occupancy and surge pricing for seasonality.  This knowledge and its implementation are currently beyond most individual landlords but many large property owners, who can spread costs over large square footage holdings, are the first to deploy digital infrastructure in their buildings. The best example is how Amazon uses similar pricing metrics for warehouses as they do in computer servers to increase rents by multiples of their contract leases. Many 3PLs are making substantial investments in their buildings to monetize ever smaller fractional units, down to pallet spaces, to increase building revenues as in the case of Flexe. The common model is to contract on the square foot, rent out by the cube and profit on the difference.  Both high and low-tech methods will increase building revenues if promoted actively.

Robots are rapidly arriving to make older buildings more efficient. While many long-time owners are selling these older buildings because of obsolescence, others see these properties as prime infill locations that can be improved by technology retrofits.  Robots make older buildings more efficient by covering space more quickly; replacing lethargic, human workers; and automating manual tasks. Robot makers claim that their robots do more for older buildings than they do for new ones.

Monetary Policy

While Tech is opening new avenues for profit, Monetary Policy is always in the background influencing investor expectations.  One unintended consequence of central banking policy over the past several years has resulted in the mispricing of B and C buildings. Cap Rates for lesser quality assets have historically been 300 to 500 basis points behind A. The institutional and non-institutional markets were clearly distinguished by wide return differences. Spreads compressed dramatically over this past 10-year period because of the reduction of interest rates.

Today the gap between “A” and “B” has shrunk to 50 to 200 basis points and investors are not being properly compensated for risks they are taking for older buildings, in poorer condition, with shorter term and less credit worthy tenants.  By driving down interest rates and flooding the market with liquidity, all spreads became compressed.  Now with monetary policy reversing, spreads will gradually reflect historic norms with a wider gap between property classes. For those who purchased property at low cap rates, they were mostly rewarded with generous rent growth. But with rent increases flattening, buyers will need to underwrite their purchases with a larger margin of safety then they currently do.

My “back of the envelope” method is to give each deviation from prime property a demerit equal to 50 to 100 basis points.  If a property is older, with a poor tenant, in a secondary location, that would add up to a 300 basis point off prime real estate rates. As it stands in today’s market, many investors cut it much closer, so they can gain possession of the asset. Shrewd buyers are no longer counting on an updraft and are returning to cautious underwriting.

Political Risk

Political Risk is a relatively new consideration for U.S. industrial property owners. It can reward on the upside with tax reform, a business-oriented supreme court, or favorable trade policies. On the downside, risks include removal of liquidity, expropriation, foreign influence and legislative uncertainty.  Local risks that affect property owners are laws allowing the homeless to live in front of your building, rent control, and restrictive industrial zoning. Global risk is being staged by economic warfare and is evident by the departure of many savvy Chinese property investors. The Chinese are cashing in their U.S. holdings and returning their profits home.

Among my Chinese customers, disillusionment is clear. Years of very strong investing in Greater Los Angeles is being reversed. Government Sponsored Entities and large Chinese companies were the first to cease their purchases.  Now, members of the Chinese international trading class, buyers of industrial buildings at top prices, are also departing. The clear call is to repatriate their capital back to China quickly and reinvest at home, Southeast Asia and along the Belt and Road.  As poor consolation for their excellent trading acumen, the Chinese will leave wealthier, with their properties and neighborhoods in far better condition than they originally found it.

Realignment of geopolitics affects supply chains. Los Angeles industrial has achieved remarkable success as the primary U.S. gateway to Asia and It has earned many local landlords a fortune. Nothing says boom times last forever and using personal experience, I’ve seen several ups and downs already in my career. Anything that disrupts Asian containers rolling off the docks, will be felt in Los Angeles first. China’s Belt and Road, the controversial infrastructure plan, that is being developed with colonial finance, intends to create another route for Chinese goods through Central Asia and terminating in Europe’s historical trading centers along the Rhine. Los Angeles will always be a superior industrial building market but as global power shifts, other supply routes will become excellent investment targets.

Are Chinese capital movements a harbinger of Political Risk avoidance? Can industrial building diversification run parallel to global financial diversification?  My European colleagues have deep historical reasons to think so and have careers helping foreign investors spread their wealth across national boundaries. For investors who have made California and Los Angeles their primary investment focus, is it time to reconsider homogeneity?

On recent trips to Europe, I have learned that investing in Europe has many similarities to the U.S. in terms of cap rates and its relationship to property class distributions. Newer buildings in prime markets, major capitals and distribution centers, sell at cap rates below 5% and increase incrementally depending on condition, location, and tenancy. Just as in the U.S., product is hard to find and the only way to increase returns is to add value and grow rents. Occupiers need to examine locations differently because the best investment markets are not always where the labor is available. Currently, Americans have a significant financial advantage with favored exchange rates and more aggressive searching techniques.

Space Transparency

While Space Scarcity is the overwhelming market condition, space transparency is also at fault. There’s a crisis in the space listing services and information is compromised by tech wars and unrealistic subscription pricing models. Data is more fragmented than ever and while the promise of the internet is complete transparency, on the street, data is often dispersed in the hands of market participants.

50% of my deals are off-market, transacted through private networks, colleagues, and data I have accumulated.  As an example, large, experienced owners will often “get the word out” months before a vacancy appears and well before a property is formerly listed. When purchasing, these same Professional Owners, aggressive in chasing deals, have a better searching/data operation than most brokerage houses and are financially motivated to solicit directly. In practice, it is equally useful to use old-fashioned means of seeking out the brokers who work the markets instead of relying on listing services.

A flaw of Central Listing services is once you post, the data is no longer your own. In an era when many wealthy customers prefer discretion, private transaction marketplaces are growing. Every large brokerage has their own private client distribution network and they use them frequently. Crypto Markets and Dark Pools are not yet commonplace but elements of each, particularly privacy, are effective ways to sell property securely and privately.  The market is more opaque than infrequent participants realize and those that rely exclusively on central listing services will come away with a false impression of inventory limits.  Contrary to the internet’s promise of clarity, the real estate business is heavily composed of personal relationships and pocket listings. Data is no more transparent today than it was when hard copies of the Industrial Multiple was physically distributed weekly and updated in 3-ring binders. Although the public listing marketplace is mature, deals are still found through private networks established organically and methodically. Transparency is based on trust, reputation, relationships and experience while electronic distribution can be restricted by timeliness and secrecy.

Disruption affects the industrial real estate business. Those who spend time understanding markets, expanding their network, and investing in infrastructure will find deals that others miss. There is no uniform way that works for everyone. While conditions appear calm on the surface, instability leads to opportunities for the inquisitive, capitalized, and technically able.

Thanks for Subscribing,

Jim Klein, SIOR
310-451-8121
jimklein@kleincom.com

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Winter News 2016 – Industrial Real Estate Profits

development Deal Strategy

The current cycle is being propelled by three major conditions: Space Scarcity, Capital Markets Pressure and Rent Surge. Market dynamics are still very favorable for development and will only be disrupted if demand begins to weaken. Otherwise, strong fundamentals are the prevalent condition in most major U.S. markets.

Space Scarcity is an affliction felt in urban, infill industrial markets across the United States. There is a short supply of Class-A industrial space at central locations. With high cube warehouses and superior loading being a minimum requirement for running a modern distribution business, Occupiers either need to pay up for central locations or move to the exurb where land is available. While it’s a tricky balance choosing between centrality and quality space, both Developers and Occupiers continue to push outwards for new development.

Capital Markets Pressure is exemplified by too much money chasing too few deals. In addition, finance for industrial real estate has changed. Although there is a lot of money looking for deals, the bulk of it goes to a select few. Investment conditions are excellent with historic spreads between interest rates and yields. New industrial building remains profitable with market pricing comfortably in excess of development costs. This distortion is partially caused by a regime of artificially low interest rates and Space Scarcity. In this environment, premium prices and generous loan terms are commonly obtainable for long term, credit leases. The influx of foreign capital, industry consolidation, and increasing portfolio values are all related to the competition of capital.

Rent Surge is the driving force behind good investments. Because of Space Scarcity, rents are advancing at one of its fastest clips ever, greatly exceeding inflation. Firstly, low rents made at the depth of the recession are rolling over at large increases. But Space Scarcity is the larger contributor because when there is nothing available, Landlords have unprecedented power to set new rates. While this trend has already been playing out with some frequency, there are still many pockets with room to grow.

These three conditions are driving business. Space Scarcity is causing many companies to move to the exurb for new development. Many parts of the U.S. are seeing the same thing whether it’s the Inland Empire, Central California, South Dallas, or Exit 8A off the New Jersey Turnpike, they have all become regional distribution centers attracting companies leaving the largest metros. One of my primary business goals is to show Occupiers how critically important their occupancy is to the economic success of new development. There are particular ways to structure a deal that can have outsize financial benefits. Conceptually, it’s fairly easy to understand, but very difficult to pull off because it takes skill and market knowledge. Great deals are made by leveraging the Occupier’s long term occupancy against development risk. To be able to do this anywhere in the U.S. is a special attribute.

Working with Occupiers has a beneficial spillover effect on Developers and Land Owners because they can also profit with a sophisticated Occupier-in-Tow. While building Spec will result in higher profits if the timing is right, many developers appreciate having a sure thing as long as they are being compensated for their capital, risk and expertise. The same logic applies to Land Owners. All things being equal, having the Occupier-in-Tow, substantially removes the risk of default and results in more profit for everyone.

lan develop process

Investors are delighted to have a long term lease in hand. It drives down the cost of financing and reduces cash outlays. The Occupier-in-Tow and the surety of cash flow is the important component to obtaining the best funding. Many of the best lenders will not take leasing or vacancy risk but as soon as the lease is in place, capital becomes more competitive with a sure thing. Occupiers with multiple locations have been able to receive lucrative portfolio valuations by creating a separate real estate entity based solely on their own occupancies. The business is made by connecting Occupiers with Real Estate Capital; Big Industrial is the vehicle.

Besides new development, Space Scarcity, Capital Markets Pressure, and Rent Surge have a corollary effect in infill, metro locations. For instance, in Gardena, just like many infill markets across the U.S., Rent Surge is creating profits. Firstly, leases made at the depth of the recession are starting to turn over at large increases. But Space Scarcity is the more effective influence because with nothing available, Landlords have unprecedented power to set new rates. While Rent Surge is causing many Occupiers to move, it also greatly benefits owners of centrally located property, no matter the age. This is a clear case where developers are being rewarded for refurbishing and re-leasing close-in industrial. Many of these smaller and older properties are not institutional quality but because of their locations, have considerable upside. The biggest barrier is access to capital.

Private investment groups have the most impact on infill because deal size is smaller and conventional lenders are too onerous. These developers tend to raise money the hard way – one investor at a time. The investment groups are normally led by a market insider and apply a strategy, as explained above, to infill markets. They create deals with the Occupier in hand and take risk where there are strong fundamentals. Properties with extra land or expensive tenant improvements tend to retain longer occupancies. This is how we do deals in Gardena.

In our business, we receive support from four major areas. Investments in our technology platform, called MAPP and described elsewhere, gives us superior market analytics and allows us to deal in the entire universe of Big Industrial. Our relationships with SIOR brokers, due to decades of personal contributions to the organization, gives us the generous cooperation of the best brokers in every major U.S. and International market. We recently staffed up our hiring both on a junior and senior level so we can keep up with the new business. Finally, it’s our clients that deserve the most thanks because of the confidence they give us to innovate with markets, techniques and technologies.

What can change the momentum? A slackening in demand from low growth and global weakening is the biggest threat. Interest rate increases, of course. But as things stand today, there are profits to be made because market dynamics are still dominated by Space Scarcity, Rent Surge and Capital Markets Pressure.

Notes From the 2015 SIOR Fall Conference in Chicago

space scarity cropped

Here are a few notes from the SIOR Fall Convention 2015 that was held in Chicago this past weekend, October 8-10.

National Industrial Perspectives

This session was moderated by Jim Costello from Real Capital Analytics who brought excellent research slides and five superior panelists including Roy Splansky from the sidelines. The primary emphasis was to contrast different strategies based on the type of capital being used. There was a REIT specializing in secondary markets; a buyer of NNN assets who also does joint ventures and pre-sales; a buyer of value-added industrial; and a mortgage broker.

For instance, one buyer borrows from Life Companies to finance new industrial construction with long term credit tenants in major markets. In addition if you have an investment grade and long term 20-year lease, it is possible to take cash out, in excess of replacement cost, as in a Credit Tenant Lease (CTL). In contrast, a different buyer relies on CMBS finance, now available in greater quantity, to finance older buildings in secondary locations with weaker credit. Yields are of course higher. Additionally, CMBS will lend on older product at 75% of appraised value even if the deal price is lower. The common thread shared by all buyers is they are looking for at least a small advantage that boosts returns.

Real estate portfolios were a strong topic. Cash makes large institutions nervous. Real estate is a secure yield and offers safety. Large Buyers need to deploy cash in very large chunks. They can’t do that in one-off transactions. Portfolio Sellers receive better pricing than if they sell a single LLC and can include difficult properties at the same time. In particular, Sovereign Wealth Funds have a different profile than most other investors. Sovereigns rely on low amounts of debt and very long holding periods, but they won’t purchase single properties. For others, portfolios are a strategic way to spread risk over many buildings while taking on lower credit and shorter lease terms thereby mitigating overall exposure and retaining their own high credit rating.

In this low cap rate environment, many look to build. The market is ripe for new construction because of historically low vacancies, especially in Class A space. Because of the space shortage, large users have no other option than new buildings. Speculative construction is well rewarded in most parts of the U.S. The choice these panelists face is either to pay up for for existing product or take on development risk. Normally developers are receiving 150 to 200 bps for taking on the additional risk of speculative development. Texas has a lot of product in the pipeline, whereas the Southeast has supply shortages and good demand fundamentals. Developers naturally seek out markets with strong population growth. In order to obtain financing on new construction developers need one of three things – pre-leasing, a guarantor, or equity.

In terms of finance, Moody’s Corporate B yields are a good precursor to the movement of cap rates. Recent market turmoil has caused CMBS to increase by 80 to 90 bps; Life Companies are only up by 20 to 30 bps. In terms of interest rates, Life Company spreads are 180-200 bps over 10-year treasuries for 65% leverage. CMBS spreads are 245-275 bps over 10-year swaps for 75% leverage.

There was a lot more to this session and I thank the remaining panelists, William Barry, Draper & Kramer; Don Pescara, Griffin Capital Corporation; Ryan Stoller, Venture One Real Estate and Brad Sweeney, STAG Industrial.

Technology Disruption in Commercial Real Estate (CRE)

Steve Weikal from MIT ran two sessions focusing on industry disruption from many new CRE technologies. One session began with Brandon Weber of Hightower who pointed out the commercial real estate business is rapidly institutionalizing and these acquiring entitles require new tools for reporting, transparency, metrics, analytics, and prediction. He also posted a quote from Marc Andreessen, “software is eating the world” foretelling how the real estate industry will evolve.

During the presentation, Mr. Weikal divided the technology applications into two major categories, Workplace and Workspace. Within these categories he named almost 50 applications out of hundreds more that are available. Up until this point, most of the “app economy” has been targeted at residential real estate but the sights are now drawn to commercial. There will be a lot of niches to exploit once you put together the right technologies.

While I won’t list all the products that were named, the categorization alone was enough to gain a sense of where the industry is headed. Each sub-category shows how the industry is splintering and different vendors are carving out areas to master. Under the Workplace category came Data Visualizing, Find and List, Analyze, and Manage the Process. Under the Workspace category, we looked at Workflow and Traffic, Sharing Economy, Virtual and Augmented Reality, and Big (small) Data. My personal favorites are the apps that help me do more transactions.

In a follow up program, I hope to learn how quantitative data is serving large buyers and developers to make big decisions. As in other industries, technologies like those discussed, directed to the business of commercial real estate, will have disruptive consequences to the status quo. It’s now our turn.

During the presentation, Mr. Weikal made the following additional points: There is a strong city focus with millennials looking for the urban experience for creativity and energy. If not 24 hour cities, at least ones that are open 18 hours. “Urban Burbs”, live work and reduced car ownership are parts of the new development patterns. He also reiterated more data and better transparency; analytics and decision making; and decreased transaction friction underlie many of the new technologies.

I was happy to hear that the brokerage business would not disappear like travel agents. Commercial real estate is a complicated business that benefits from experience. However, those that take advantage of new technology are the ones who will prosper.

Economic Update

The premier real estate economist, Dr. Peter Linneman, closed the conference. His first point was the troubling gap in GDP from a normal growth pattern is attributed almost completely to weak housing production. We are producing only 65% of what would be expected under historical conditions.

Consumer spending at “Brick Retail” is flat because of increasing internet sales. However if ecommerce ran under normal revenue assumptions, the price of goods would need to rise 25%-40%. How long can companies afford to pay for growth?

Other factors that weigh on the economy include average Consumer Confidence, below average Small Business sentiment, and low rents in suburban office. One surprise was that industrial construction is at the highest levels ever, and while not by itself a cautionary signal, if demand falls, we could be facing excesses. Still, the overall market continues to have very low vacancy rates.

Conclusion

It was an excellent conference. Many major developers and investors attend on a regular basis to get access to the finest brokers worldwide. Social activities are an important part of the conference where we can personally meet our peers and clients. Meanwhile SIOR is embarking many new initiatives and ventures so we can continue to provide relevant and effective services to our clients. Next year we will be in San Diego, London and New York City.

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.

 

 

Economic Development in Greater Los Angeles


 

More so than ever before, cities are vying for companies that create jobs. There's the policy aspect that favors clean and green jobs. Then there's the backroom bargaining that favors successful outcomes. Companies that can offer employment would do well to study some of the recent newsworthy examples. They include the failed attempt by Los Angeles to attract AnseldoBreda, local jostling to snare Tesla Motors, competition for Eli Broad's museum, Los Angeles Stadium in the City of Industry, and the smaller manufacturing  deals coming through the CRA of Los Angeles. Each one is fairly lucrative to the company and does not necessarily fit any set model. They are similar to the large retailers, like Costco or Walmart, who were able to negotiate attractive packages for redevelopment funds, property tax breaks, and property development benefits. I haven't seen any studies if these retail developments met city economic expectations, but certainly the recent raise in sales tax makes up any marginal differences. It pays to understand the multitude of incentives available from local, state and national agencies.

On a large scale, the $800 Million Los Angeles Football Stadium also carries enormous political capital. Instead of being tied up in protracted and costly legal wrangling on the local level, the developer was able to obtain an exemption from the California Environmental Quality Act (CEQA) from the State Senate. Plus the City of Industry will also underwrite a $150MM bond for infrastructure. For those other developers who have spent a small fortune meeting the guidelines of an EIR and satisfying the demands of local citizenry, they will realize the value of this exemption. But not to rest on his laurels, the Governor will be seeking to do the same for other large developments facing similar obstacles. Jobs are replacing regulation as a California priority.

 

On a smaller and perhaps more typical scale, the CRA is working through a manufacturing project in the Goodyear Tract for an older 47,000 square foot building. It's not a clean jobs proposal, but one in the garment industry. It's also a generous deal if it gets approved. While it is often difficult to read through the economic development language, it appears the developer will be receiving the $3,000,000 property for nothing. An additional $3,000,000 of rehabilitation financing is being provided by governmental agencies, of which, at least $750,000 will be forgiven. One-half the 70 jobs will be at Living Wage. As reported in the Los Angeles Times, the CRA Board is split on approving this deal and a final vote is planned this week.  Many companies would move to Goodyear for this incentive. Unfortunately, these type of packages are rare. Perhaps, the CRA could get more benefit from their economic stimulus if they were more widely marketed. But in this poor economic climate, at least government is trying to create jobs.

The Broad Foundation is looking to house its art collection with a generous package from the City of Santa Monica. A prime 2.5 acre site will be given for a $1.00 per year. All permits, fees, and off-site work will be paid by the City. Broad will pay for the building and its operation. Similar to the Stadium deal, there is a clear delineation between private development costs and public approval and infrastructure costs. For example, local cities often look to developers to pay for traffic signals, street widening, public safety and other off-site costs. But for projects that are in demand, the developer can negotiate a more equitable sharing of development fees.

There are normally two types of incentives – legislated and discretionary. The former includes hiring subsidies, tax credits, accelerated depreciation, lower cost financing, and green/clean incentives. Normally legislated incentives  occur in enterprise zones and are attached to creating employment. There is also a large category of legislated incentives related to sustainable projects. Discretionary incentives are direct grants, development offsets, or other negotiated agreements. To obtain discretionary  incentives there normally needs to a large multiplier effect in job creation, tax revenues, construction employment, or an application in a city sponsored direction like green, biotech, or energy. In addition, cites may have redevelopment areas set aside where they can offer property and targeted economic packages specific to a specific goal. One such example is the Los Angeles Cleantech Corridor that combines the entire arsenal of development tools.
 
 

Cleantech jobs are helpful in obtaining incentives. These are businesses that generally minimize waste and pollution and use energy efficient production. But they are only a small fraction of employment. As the clamor for jobs increases, many government officials will not be as discerning to the nature of the work. This is especially true when a longstanding employer is looking for assistance to grow their business locally. Jobs are the critical component.

Finally, the start of 2010 brings great optimism in the City of Los Angeles with the appointment of Austin Buetner as the First Deputy Mayor and Chief Executive for Economic and Business Policy. He is now in charge of many of the City's economic resources including DWP, Planning and Safety, Building, CRA, LAX, Housing, the Harbor, and several other agencies. We hope Mr. Beutner brings a business deal mentality to economic development. While many of the departments already function adequately, they are managed in political silos and not open to new collaborative practices.  Many business people will be examining the City's best assets to unlock the economic potential.

My daily work highlights the difficulty that many companies have keeping their doors open. But with low real estate prices, a large labor pool, and the availability of economic incentives, it could be the best time to negotiate a new beginning. That is, when the banks begin to lend.

The Year Ahead – 2010

 

General Sentiment

To judge the health of the industrial market, I rely on activity reports from fellow brokers. Across the board, its been obviously weak. Most of my peers are squeaking out a living from short term leases and renewals. Sales and investments are moribund. There's a bit of government support and stimulus work for those in the pipeline, but not enough to have a broad impact. Many agents have left the business. Most of my broker friends anticipate the same for 2010. We may be nearing the bottom of the cycle, but most sellers and banks are not willing to accept the greatly reduced prices. 


 

Statistically, keep your eyes on container imports, unemployment numbers, and lending reports. Improvements in these categories should translate directly to greater Los Angeles industrial.  Those investors who bet heavily on a "port strategy" have seen the value of their investments erode. Logistics was, and still is, the primary factor for industrial real estate investing. The same failures apply to many owner users who financed purchases with the China Trade in mind. They have received a double whammy with falling building prices and lower trade income. While expectations are weak, survivors are changing the way transactions occur. Tenants are taking an incremental approach in making decisions until they get a better picture of the future. Once business conditions shift to more certainty, companies will focus on permanent and sustainable decisions.

 

Incrementalism



Characterization Advantages Disadvantages
Take space when needed; piecemeal Short forecasting horizon Hodgepodge of facilities; lacks overall plane
Short term decision making No need for long term decisions Conflicting and confusing
Functional space, no amenities Opportunistic in real estate market No consistent image
Uncertain or fast changing business conditions Short and relatively riskfree commitments No macro saving or operational effectiveness

 

  

Standardization



Characterization Advantages Disadvantages
Standard policy and specs Reinforces identity and stability Difficult to modify when needed
Measured and efficient More economy to scale Reinforces existing structures
Certainty in business Reduced confusion Stifles creativity and change

 

 

One industry fallacy is the marketing ploy of offering short term teaser rates.  As these discounts are often negotiated, rents increase on an arbitrary date which the tenant may or may not be able to afford. Sometimes landlords are forced to extend the low rate or lose the tenant all together. Plus reasonably intelligent tenants will calculate the inducement in a present value calculation and not fall subject to an unaffordable rent increase. To truly be effective, these "discounted" rents should mirror the tenant's operations with metrics based on gross sales, employment, or pallet positions. Maybe a return to percentage rent is warranted in certain circumstances. If the loan can be serviced under this variation, fixing the rent to the tenant's business would lease buildings faster than having a teaser promotion.   

  

  

Short Term Leasing Triage

  

 

As owners find current rents or their business model will no longer support their mortgage, they begin to seek unusual solutions.  I've seen import companies use their existing operational infrastructure to branch into public warehousing. Others will simply offer warehouse space and offices with no more security than a handshake. Video cameras and security guards offer enough protection that an expensive demising wall is foregone. Some businesses who are familiar with Container Freight Stations find this a normal solution. Meanwhile many tenants are adaptable. Communication and data is portable and goods can be transferred easily. Some of these operations have learned from military logisticians who supply goods on the fly. Portability can be a competitive advantage because legacy competitors are often stuck with costly capital investments in real estate, employee costs and infrastructure.  


In a soft and agile market, flexibility is particularly advantageous with product launches and uncertain sales forecasting. The corollary in the retail world are pop up shops that feature a designer branded product for a few months and then moves to a new location with another product. The new fad of Twitter food trucks that navigate the city and message their fans are another example of a flexible business model. Needless to say restaurants with fixed overhead costs are not as enamoured with this new dining experience. As economic challenges bring fresh ideas, expect to see more short term occupancies supported by new technology.



 

 

 Pension Plans

 

 

Pension funds are major investors in the real estate world. Because of their size, pension funds can dominate a market. Along with REITS, their influence is felt throughout Los Angeles industrial and commercial property. Unfortunately, group-think has caused a collective failure with overpriced property and non-performing land. For Pension Advisors and their related investment vehicles, it is not enough of an excuse that they made the same mistakes as everyone else. The advisors are well rewarded to avoid such bad decisions. The largest pension fund of all has fallen the hardest and many signs are pointing to incompetence, poor ethics, and corruption. The result of poor pension investing is destabilizing municipal finance. Government services will  be cut to pay for faltering pension obligations. Of course, a large part of the blame goes to the pension industry itself. There are too many financial obligations negotiated through labor agreements that will not be satisfied by either prudent or risky investing. Some cities will need to go bankrupt to shed their costly pension plans. The next wave of investing is just starting as funds look to purchase distressed assets. The expectation is large returns over a short holding period. Hopefully, pensions will also look long-term at some of the individual problem assets in the market. A turn around strategy with a longer holding period will reduce volatility and maintain steady gains in excess of actuarial payouts.


The other irony in the pension mess is that many pension funds are considering the finance of municipal infrastructure. In exchange for a toll or bankable cash stream, the investor will finance the capital improvement like a bridge, road, port, or water system. In the past, municipalities would be able to finance this improvement through a bond issue or other financing vehicle. But partly because of high pension obligations, governments can no longer afford to finance important municipal improvements and are turning to funds supported by pension monies. Not only will municipalities need to increase contributions, but they will also be paying fees to these same pension companies. More importantly, California needs vital improvements to attract new business whether it's publicaly or privately financed.

  

 

Lenders 

Banks have moved to center stage in many negotiations. Properties being sold today are often underwater. Personal guarantees, blanket encumbrances, and cross-collateralization are complicating closings. Before a Buyer gets too far into a deal they need to look at the indebtedness before spending a lot of time on other issues.   In one deal, the seller agreed to bring additional funds to close the sale. In another, the deficiency was shifted on to other properties, including the Seller's home. Luckily, those were the easy solutions. The painful and common situations, like bankruptcies and foreclosures, are not as easily solved.

 

The other interesting part of the financial crisis is each bank will solve things differently. Some won't cooperate at all because of their own individual problems. Others will discount the note, but will not accept a cram-down. Some banks will temporarily reduce mortgage payments as long as their interest is covered. Many banks favor big borrowers over Mom and Pops. SBA borrowers are in the most difficult circumstances because many have pledged their homes and have mortgage leverage that vastly exceeds market rents.

 

Over all, industrial foreclosures have been limited in comparison to multi and single family residential   But year end defaults of industrial have increased. There should be enough problem industrial next year that the buyers will examine workouts instead of shopping traditional brokerage offerings. When interest rates increase, some of the favorable short term loans that have been extended to landlords should also increase defaults. If you are looking for industrial and not scouring for defaults, you will be missing some of the best opportunities.

 

  

Regulation 

Companies are awaiting new legislation that affect their business. Health Care reform for small business will affect most of my clients and may damper rehiring. New banking rules that set increased capital requirements will translate directly to real estate investing. Finally the California Air Resources Board will soon establish rules to reduce greenhouse gasses. With a cap and trade mechanism forecast it will create winners and losers among industrial companies and dramatically change the value of some industrial properties.


  

Conclusion

Fundamentally, the brokerage business remains the same. It's about representation, finding deals, and negotiating. Companies will look for lower real estate costs and better locations. But 2010 will also be influenced by many new factors and alert participants will find some real gems because of the market disintermediation. More importantly, as we climb out of recession there will be many new and different rules to conduct business.


 

Finding Deals In Foreclosure Land

Foreclosure pricing has set the tone in the residential market. While we remain in Foreclosure Land, everyone wants a bargain. This way of thinking bleeds to what was once the “normal functioning” market. Many are anticipating the same will happen in the commercial area. But whether in good markets or bad, the same thing holds true. It’s hard finding deals and it takes ingenuity to make them work. Now more than ever, a tenant is the critical ingredient in almost every purchase.

If there ever was a time for conservative underwriting standards, it’s in Foreclosure Land. We are seeing a return of risk reduction, large deductions for vacancy, and the inclusion of many line items that were neglected in better times. A few of these line items include bonus commission rates, long lease up periods, and substantial T.I. costs. These expenses can easily be 10% of the Purchase Price. Assuming an additional 2 point difference in cap rate (say from a 6 to an 8), the price is reduced another 25%. Factoring in a modest 1% rental growth rather than the previous assumption of 3% annual, could be 15% more off the purchase price. All together, conservative underwriting standards lead to a 50% reduction in the optimistic valuations of the recent past.

While lenders support conservative standards when they are making the loan, these same rational justifications are unconvincing when the banks are selling. Their hands are tied until they can find some way to take the loss. Without more capital or help from the government, the Lender will hope that market conditions improve. REO will often be a discount but not enough to satisfy the most conservative investors. A similar philosophy exists in the non-REO market.

With some properties, Lenders will look to Users because they are not driven solely by financial return. The purchase is not judged by a cap rate but by improvement to the business bottom line. Ideally, the building should have some intrinsic value because it is more functional and better located. However, too many users made the same mistake and didn’t evaluate the purchase carefully but relied on future appreciation. The mortgage needs to be in line with market rents. Otherwise, why buy? A smart User will start from the conservative investor’s mindset and add the value of the features. For instance, increased sales because of location, more productivity because of design, or reduction in labor because of function.

Perhaps the best solution is an investor with a user in tow. This combination marries a business need with the investor’s knowledge. The risk is removed from the investment, more cash can be invested, and loan terms will be improved. The tenant will see better opportunities while getting an investment return for their occupancy. The Seller receives a higher price because they are not heavily discounting an empty building. Coming out of the recession, everyone wants to take advantage of foreclosure pricing. Too many tenants lack the experience and the cash. Meanwhile investors want risk-free prices. Combining forces is a strategic way navigate the delicate terrain of Foreclosure Land.

In a similar vein, some businesses are also looking carefully at distressed Condos. With the large number of condo projects either in default or foreclosure, some local businesses are considering bulk purchases where they can house their employees on a rental basis. This too removes the risk of purchasing empty units and gives employees a better place to live. With many condo prices now at rent levels and lenders unable to absorb all the empty apartments, a business owner can buy an entire building and also give the employees excellent benefits.

We are tracking the commercial defaults very carefully. Investors want to come off the sidelines. Activity on the User side is just staring to stir. Finally, when commercial and industrial property prices start to make sense, we could be back in the real estate business. After the destruction of the last two years and the continuing fall out from the real estate collapse, neither capital, nor grave dancing, nor growing businesses are the answers by themselves. The way out of Foreclosure Land goes to those who can put all the pieces together.

Foreclosure Land

It’s late in the Summer and temperatures are hitting 100 degrees. A few people are setting up large beach umbrellas in a tall tree planter. Others are unfolding beach chairs. Someone is dragging  a large cooler full of beverages and food for the day. It’s not an unemployed broker’s beach paradise, but the west steps of the County Courthouse in Norwalk – the largest property auction of our lifetime. On an average day $30 Million of Trust Deeds are sold.  The daily street auction is unsanctioned by the government and there is no institutional oversight. Day after day, it is the lender’s clearinghouse of foreclosed mortgages  where  clever real estate buyers  stuff their portfolios full of cheap property. It’s a feeding frenzy of real estate bargains that may never be repeated.

 

Even though the sale takes place under tattered canvas and bidders are mostly clothed in shorts and sandals, it doesn’t mean the bidders are naive. Just the opposite. Many are armed with bluetooth headsets, tough book computers, and researched spreadsheets. The bidders are linked to their investors who have accumulated large pools of money to purchase property at 50% discounts. The sheer number of properties being sold, distant locations to underwrite, and fast pace requires competence and organization. While several websites like Foreclosure Radar and REtran  monitor the data, it’s the buyer’s experience in building, marketing, and financing that is essential.

 

Sales are closed in real time without due diligence. Many investors monitor simultaneous auctions in Van Nuys, Pomona and other county locations where vast foreclosures occur. Some buyers simply come to the sale with a list of properties and their top price. Others are evaluating on the fly while their associates are scouting the sites to make sure the properties aren’t damaged. While on-site bidding increases by hundred dollar increments, the investors use the precious few minutes to make final decisions.

 

For years, late night pitchmen showcased the money making potential of foreclosures. Most viewers felt misled because there were no distressed properties. Finally, the foreclosure charlatans have been vindicated. It’s true. There’s a lot money to be made buying foreclosures. Latest statistics show 10% of L.A. County homeowners have received delinquency notices. Still with hundreds of properties being sold on a weekly basis only a very few buyers can participate. It’s all cash at the sale and you need to show your funds before the bidding starts. On sale days, millions of dollars in Cashiers Checks are stuffed into worn envelopes, but they reside in only a few hands.

 

There is no competition from institutional investors. Decisions are instantaneous and although total sales volume is high, each property is too small for large organizations to analyze.  As it stands now, the best buyers are smart entrepreneurs, many from distinct ethnic backgrounds. Armenians buying Glendale, the Chinese in the San Gabriel Valley, and Persians covering Beverly Hills. A few years of this business and fortunes are made.

 

Meanwhile, plenty of mistakes occur. Many properties are purchased too early in the cycle only to see values fall farther. But with 50% margins, these buyers can drastically undercut the average homeowner. They are not trying to resell at the market price, but only at a profit. It partly explains the downward cycle. In many markets, pricing is being set at the foreclosure level.  While a few buyers will rent the properties and enjoy the cash flow. The majority will flip so they can redeploy the cash into new bargains. Occasionally, commercial properties are purchased, but most of the behind the scenes activity occurs  a few blocks away in the County Recorders Building.

 

Normally, the Recorders Office wouldn’t cause much excitement. It houses marriage certificates, fictitious business names, and voter information. Occasionally there’s an Erin Brockovich wannabe (dressed as such) investigating a major cover-up and announces the expose on her cell phone. But in Foreclosure Land, the Recorder is the source of all the loan and contact information for the lender, junior note holders, plaintiffs, and property owners. Often immediately before the foreclosure, there’s a lot of scrambling with note sales, substitute trustees, bankruptcies and lawsuits. And after the sale, the Trustee Deed is recorded by the new owner. In the past, Title Companies would simply email the documents, but with California’s ill conceived Senate Bill 133, it  has restricted Title services and many active buyers find it more comprehensive to go to the Recorder in person.  Even with Erin’s investigatory skills the trail has many dead ends because of litigation, environmental, and excess debt.

 

Once the property becomes bank owned, it’s generally not an immediate bargain. The bank will first try to get a price that covers the loan. Normally the price is too high and the overwhelming bet is against the banks ability to reach par. Chock full of non-performing assets, the banks become a large repository of problem properties. They are hamstrung by capital ratios because too many write downs lead to closure. At the same time holding problem real estate ties up capital and will also bring ruin. The government delays the day of reckoning by suspending mark to market accounting. TARP infusions have also provided limited stability. With additional time, there is the hope that the market improves and new capital can be raised. But as prices continue to decline, the waiting game is fraught with risk because less money will be ultimately realized. A few clever buyers are able offer the bank something of value in terms of a profitable banking relationship to help offset the loss. But it appears the end game for many banks will be failure. Once a new financial institution is found to purchase the failed bank’s assets, the new bank will  will receive a substantial discount generously aided by a loss sharing agreement from the federal government. This means the taxpayer will absorb the majority of the losses and the new property buyers will be able to finally purchase at realistic prices.  It may take a while longer, but here in foreclosure land, commercial buyers will eventually see bargains just like the bidders on the steps of the  Norwalk Courthouse.

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.  

   ———————————————————————

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

 

 

The New Language of Industrial Real Estate and Its Pitfalls

 

Over the past 20 years, the decision matrix for locating a warehouse has grown so complicated that only a few real estate brokers have the ability to communicate on a technical level with clients.  Many warehouse companies require labor studies, network rationalization models, transportation studies, and warehouse design.  Many large brokerage companies have complied by starting practice groups within their firms or have hired talent outside to provide these services. Professionals that talk this new language are generally at the forefront of controlling the relationship. 

One major pitfall to this analytical approach to site selection has arisen.  There was no accounting for high fuel prices.  Many companies located distribution facilities on the fringes in order to get large, bulk warehouses that were regionally central, but far away from population densities.  Now, with the advent of high fuel prices, traffic congestion, and sustainability issues, some of these decisions are fraught with unexpected, and even, out-of-control costs.  In many cases, anticipated savings from operational efficiencies and cheaper rents are being vastly eroded by high oil prices.

In a previous business cycle, manufacturers made location decisions a different way. They picked locations based on proximity to major customers, suppliers, and labor. The benefits were easily recognized with quicker deliveries and more personal interaction.  For instance, if you were in the aircraft business, you would locate near the primary contractor so you could easily supply Northrop, Douglas, or Hughes.  In addition, the social relationship helped suppliers refine their components to more closely meet the needs of the customer. This explains why Southern California became a hub of aircraft and defense manufacturing. This same trend is noticeable when foreign car plants are situated in Southern or Midwestern states. There is a follow on trend with many suppliers moving close to the final assembly plant. This logic creates clusters for more efficient production. In contrast, the trade route dynamic places warehouses almost anywhere, as long as there is a major road.

Many leaders in the logistics industry have a global level perspective that measures international traffic on an hourly basis. Working backwards from delivery times,   concepts such as intermodal, inland ports, and supply chain have riveted the industry. Shipping patterns from Asia to domestic ports have captured the imagination of developers and brokers alike. Many major developer/owners have made significant investments in large land tracts and buildings in the hinterlands to take advantage of supplying product as fast as possible.

The result is larger warehouses, lots of loading, and land to park trucks.  In order to find large sites, warehouse construction has moved far away from the urban core to the periphery and into neighboring states.  More profoundly, what once housed the U.S. defense industry, now serves Southern California as inland ports and warehouse centers.

All of a sudden, high fuel prices, traffic congestion, and poor consumer sentiment have made many of these distant locations very expensive to operate.  Compare Tesco’s new warehouse in Moreno Valley to Safeway’s presence in El Monte or Albertson’s new Paramount location.  Look at 99 Cents Stores’ warehouse in their ancient but centrally located buildings. Central warehouse locations are now a competitive advantage to keep prices low. It’s completely opposite to what many consultants recommended in their views of efficiency.  Today the cost of fuel to inland ports could easily be two to three times more than the monthly rent of a brand new building in central Los Angeles.

New intermodal inland ports have to address other concerns in the way of transportation costs.  Since these locations are normally located far from the harbor, the combination of rail, plane, and truck should provide superior transportation amenities.  However there are hurdles.  With the exorbitant cost of trucking, oligopolistic rail lines will increase their rates to gain additional revenue into the expanding margin.  Besides many of the rail links still don’t exist from key short haul routes like the Alameda Corridor.  Air has limited applications except for dedicated providers.  The majority of air freight still comes in the belly of passenger planes through LAX and is transferred to truck.  DHL’s flight reductions to March Air Force Base is one example how a major dedicated provider can put the entire model in jeopardy.

Despite the intermodal amenities, the main reason companies look at inland port locations is because of cheap land and labor.  While intermodal can be important in some cases, it is often a marketing tactic to sell more dirt. But fuel costs are making these locations look very expensive.

Labor may also be a surprise.  Many companies try to locate where there is non-union labor.  But because of the Clean Trucks Program slated to be adopted by the Ports of Los Angeles and Long Beach, an interesting wrinkle has surfaced.  The Teamsters have allied with the Green community to reduce pollution in the Harbor area.  By removing independent and arguably illegal operators from the road, smog can be reduced by greening larger carriers. While years of litigation will be the next step, many companies are not looking forward to union deliveries, no matter how far away they locate.

One more current sweeping the industry is sustainability. For now, a lot of focus is on managing LEED buildings to be carbon neutral.  For factories, the emphasis is on limiting emissions through a variety of trading and control mechanisms.  For trucking and warehousing, sustainability will be measured by fuel efficiency. Many customers are picking service providers from the perspective of good stewardship and cost saving.  Deadheading to far flung warehouses will be a highly negative factor compared to a coordinated central location.

This is not say premium rents are being enjoyed in central locations. For now rents are decreasing because of the general business malaise and a pull back from over optimistic times.  Still over the next few years, if there is no relief in fuel prices, many businesses will look at central locations differently.  Many developers are considering multi-story warehousing as a way to overcome high land prices.   Roof top truck parking will pay for expensive infill land. Other developers are tearing down portions of their buildings to provide better trucking and truck parking. As has been proved in other cases, the underlying land can be worth more than the marginal value of older buildings and teardowns will continue.

As total operation costs become aligned with rent, higher infill pricing will look reasonable even for low clear warehouses.  New concepts will first be tried as a build-to-suit for progressive companies looking to promote image and save costs. If they prove successful, the value of infill locations will further increase.  Soon, the language that placed warehouses on the outskirts will add some new vocabulary to drive these companies back to the center.

SIDEBAR:

THE FUTURE OF GODDS MOVEMENT

The movement of goods throughout Southern California has been endlessly studied by government and quasi government agencies.  One overriding solution is to develop a major inland port at one of the former air force bases in the Inland Empire. It will cost billions of dollars and is many years away. Plus it’s not a practical solution for goods returning to Los Angeles. To see some of the ideas proposed, go to http://www.scag.ca.gov/goodsmove/   

A more immediate solution is to get Los Angeles cities to adapt zoning regulations to allow more distribution space by increasing height and FAR limits. Other cities need to re-examine their unreasonable ban on warehouse and distribution uses. This effort can be coupled with a floor or gross receipts tax to pay for infrastructure costs.  For municipalities, warehouse jobs and added revenue will replace loses from retail and housing.

Certain parts of Los Angeles could serve as a testing ground.  Big swaths of industrial in Rancho Dominguez, East L.A., Goodyear Tract, or Broadway/Rosecrans could accommodate these changes without disrupting residents.  Until there is a concerted effort, developers and users will continue to fight the battle on a project-by-project basis, while pushing perceived negative impacts farther down the road.