SW Riverside Industrial Real Estate
The market vacancy rate is below 1%, Sale Prices and Lease Rates have regained almost all that was lost during the Great Recession.
Based on prior market cycles, by now one would expect several speculative industrial developments under construction (it’s always occurred before).
However, I don’t expect to see any speculative buildings under construction in Temecula, Murrieta, Wildomar or Menifee until at least 2017……and there’s no certainty we’ll see new buildings then!
So why the gridlock? Where’s the new construction?
There’s no single answer to this question. However, after a few failed escrows and many discussion with developers, engineers, governmental officials and those who are smarter than I, I’ve reached the following conclusions:
- The type of developers who historically have built spec buildings in Temecula / Murrieta are now extinct. The small, “entrepreneurial” developer has gone the way of the dinosaur. Today, the entitlement process is long, demanding, expensive and complicated. An entire real estate cycle may come and go from the time a developer starts planning a project until the time he is able to build it.
- Construction financing is extremely difficult to obtain. Local banks have little or no interest in financing speculative construction. The banks who survived the last downturn have NO taste to jump back into speculative construction financing. Federal regulators aren’t giving the banks any financial incentive to stick their necks out either. If you can find a loan, terms will be tougher. As the old saying goes, the only ones who can qualify for a construction loan are the ones who don’t need it!
- Construction costs are higher across the board. Labor, materials, architecture, engineering……..everything costs more in 2016 vs. 2006.
- The cost for permits, fees, and regulatory approvals have increased considerably. Title 24 requirements are now much more extensive. Water quality, water conservation, storm water retention – detention…….the list goes on. Wet and dry utility hook up costs are only increasing as well. City Hall is not always to blame here……..the source for many of these new layers of regulations originate in Sacramento and / or Washington D.C.
- With all of the higher costs combined with today’s sale prices, smaller building development simply isn’t as profitable anymore. I’ve contacted most every active industrial developer in Southern California to tell them about the opportunities here in SW Riverside County’s industrial market. Most are not interested. They’re busy constructing 1 million sq. ft. behemoths 40 minutes north, then leasing and then selling them to Wall St. and Insurance Pension Funds at 4.5% cap rates. These developers have all the equity partners they need. Their profit margins are much higher in developing one 800,000 sq. ft. facility vs. developing dozens of 8,000 sq. ft. buildings One of my best clients told me just last week that he’s no longer going to consider a 5 acre or 10 acre project. The “brain damage” to entitle a 50 acre development is the same as entitling a 5 acre project. He said that he might as well “go big” if he’s going to subject himself to the pain.
- Landowners need to adjust their price expectations. As mentioned – building prices have once again reached 2006 levels. But that doesn’t mean land values are once again back to 2006 levels. With all of the additional costs in 2016 (read #’s 2 thru 5 above) that didn’t exist in 2006, how can a developer expect to pay the same price for vacant land? Answer: they CAN’T. By requiring all new projects to handle all storm water runoff on site, developers either need to allocate +/-15% of the land for above ground water retention, or they are forced to construct expensive below ground storm water containment vaults. In 2006, one could buy a finished 1 acre lot for $8 per sq. ft., construct a 15,000 sq. ft. building and be “all in” with their total cost at $105 – $110 per sq. ft. At $8 per sq. ft. in 2016, that same developer will be “all in” at $130 – $135 per sq. ft. Assuming a developer needs to see a 20% profit on cost, then the building will need to sell for $168 per sq. ft. Today’s building sale prices will need to increase another $35 to $40 per sq. ft. before developers can afford to pay $8 per sq. ft. for finished land.
The above factors have definitely left a vacuum (and perhaps an opportunity for someone who can endure the pain?) in this market.
Current supply is woefully short. Though user demand isn’t overwhelming, the lack of supply definitely makes it feel this way.
Lease rates and sale prices have increased dramatically in the past 2 years. Typically, one might expect a pull back after such an increase. Not this time. The simple economic principal of supply vs. demand will force even higher lease rates and sale prices in the coming year
One final quick story sums it up: Yesterday I ran a summary of all vacant, existing industrial space for lease between 8,000 and 20,000 sq. ft. in the combined cities of Temecula, Murrieta, Menifee, Wildomar and Lake Elsinore (this comprises a total market size of approximately 17.5 Million sq. ft.). Total # of buildings available: 1 And the only way it qualified was because it consisted of 2 separate but adjacent suites of 6500 sq. ft. and 2,000 sq. ft. each. I bet I have it leased by next week!
Charley Black, SIOR | Senior Vice President
Lee & Associates Commercial Real Estate Services, Inc. – Riverside
Temecula Valley Office