Fall 2000: Los Angeles Real Estate Market Overview.

The Los Angeles Basin commercial real estate markets are the healthiest they have been in at least a decade. Demand is very strong, vacancy rates are low and falling, rental rates are on the increase, and construction remains generally restrained. While this is positive news for the real estate investor and developer, it does mean that the user is finding it increasingly difficult to meet requirements.

The Office Market

Demand is strong, driven by a robust economy, particularly among office-using sectors (business services, computer programming, engineering, management consulting, etc.). In the past 12 months, net absorption has totaled 11.2 million square feet, for the strongest performance since the late 1980s. There has been particularly strong activity in South Orange County and West Los Angeles, and Central Los Angeles is finally seeing a significant growth in demand.

Vacancy rates have dropped by more than two percentage points in the past 12 months, and now average a healthy 11.3% (direct vacancy). If sublet space is included in this calculation, the vacancy rate is still healthy, at 12.9%. Vacancy rates are particularly low in West Los Angeles (just 4.0%), the Tri-Cities of Burbank, Glendale and Pasadena (6.8%) and South Orange County (7.8%). However, they remain high in Central Los Angeles (17.9%). In the past 12 months, rental rates have climbed approximately 5% to 10% in West Los Angeles the San Fernando Valley and the Tri-City area, but have been relative flat in Central Los Angeles and much of Orange County.

Construction activity is picking up, and currently there is approximately 8.6 million square feet under construction. Approximately half of this space is in Orange County, where market conditions will likely soften, par-ticu-larly for older Class B and C space, as this space comes on-line. However, conditions will tighten in the South Bay and Central L.A. in coming months, and remain tight in West L.A. and the Tri-City area.

The Industrial Market

Net absorption of industrial space in the Los Angeles Basin totaled 47 million square feet in the past 12 months, setting a new record. More than a third (42%) of the net absorption took place in the Inland Empire, the only area remaining in the Basin with large tracts of vacant industrial land. This is exceptional growth in demand, driven by the booming Los Angeles economy. An additional 3.2 million square feet of research and development/flex space was absorbed (net). Most (76%) of the net growth in demand for R&D space took place in Orange County.

Vacancy rates for industrial space have fallen to just 3.6%, down from 5.7% 12 months ago. They are now about as low as they can possibly go in most of Los Angeles and Orange Counties. In the Inland Empire, they are a healthy 6.9% despite a major construction boom. For R&D space, rates have fallen to 6.8%, down from 8.3% 12 months ago.

Rental rates and sale prices have climbed by approximately 10% per year over the past two years in most submarkets. Rental rates for a 75,000 square foot requirement now range from $0.44 to $0.56 in the basin, with the highest rates in the South Bay, and the lowest rates in the Inland Empire. Approximately 20 million square feet of industrial space is currently under-construction - a large amount, but less than growth in demand. This indicates that market conditions will remain tight into the foreseeable future. Almost half of the construction activity is in the Inland Empire. In addition, 2.4 million square feet of R&D space is under-construction, with the vast majority of the activity in South Orange County. Market conditions there may temporarily soften as this space comes on-line. However, conditions in the South Bay, the Westside and the western San Fernando Valley will continue to tighten.

Storage-cost sensitive firms looking for large distribution facilities are increasingly finding that they cannot find space that meets their needs in Los Angeles or Orange Counties, or if they can find space, it is prohibitively expensive. A growing number are moving their distribution operations to Western San Bernardino County (Ontario, Rancho Cucamonga and Mira Loma) and Western Riverside County (Corona, Norco and the City of Riverside). However, within three to four years, Western San Bernardino and Riverside Counties will begin to "fill up," and new areas will have to be found for affordable distribution facilities. By acting now, investors and developers can look in land in these areas while prices are still low.

Western San Bernardino And Riverside Counties Are Filling Up

It seems hard to believe but large parcels of industrial land (25 acres or more) in Western San Bernardino and Riverside Counties have become scarce. The area has undergone an incredible construction boom in recent years, and this activity has absorbed most of the large parcels of land:

* 39 million square feet was built 1995- Mid Year 2000 (increasing the 1995 base by 28%);

* 9.8 million s.f. is currently under-construction (which will increase the existing base by 5.4%); and

* 29 million s.f. is proposed, with land already set aside for this purpose (which, when built, will expand the existing base by an additional 16%).

At current absorption levels (approximately 15 million s.f. per year), the current and proposed construction activity will provide approximately a three-year supply. Even if absorption should slow to the average witnessed 1985 to 2000 (approximately 10 million s.f. per year), this would provide just a four-year supply. Thus, by the middle of this decade, construction activity in Western

San Bernardino and Riverside Counties will be limited to smaller in-fill projects, and major construction activity will have to shift elsewhere. Land prices in the area have already increased by approximately 65% in the past five years Finished land is now running $5-$6 per s.f. in Ontario, and $6-$7 per s.f. in Corona.

The question is, where will the activity shift? We believe that two areas which will benefit include the Perris/Moreno Valley and the Southern Central Valley.

The Perris/Moreno Valley

The Perris/Moreno Valley is the closest area to the Ports of Los Angeles and Long Beach that still has industrial land available for under $1 per s.f., Drayage costs from the Port areas are roughly comparable to those of Ontario ($200 to $225 per container.). The area is adjacent to rapidly growing population areas in both the Los Angeles Basin and San Diego County, and labor is readily available and relatively affordable. The area is highway and rail-served, and significant improvements to Highway 74 are scheduled for 2001. There is also talk of converting March Air Force Base into a freight facility, although this is far from a certainty at this time. Most importantly, there is ample industrial land available. The area has many of the same characteristics that Ontario had 20 years ago.

Activity in the area has already picked up, starting approximately 12 months ago. Important transactions include:

* Lowes Home Improvement, which bought just over 100 acres at $95,000 per acre to build a 1.2 million s.f. distribution center. This facility is currently under-construction;

* Phillips Lighting Co., a light fixture distributor, has leased a 250,000 s.f. facility presently under construction at the March Cargo Facility.

The Southern Central Valley

The Southern Central Valley is further from the urbanized portions of the Los Angeles Basin than is the Perris/ Moreno Valley, but it has advantages in terms of low labor costs and the ability to serve both Southern and Northern California within a 4-hour trip. Drayage costs from the Ports of Los Angeles and Long Beach are dropping, and are now approximately $285 per container, approximately 20% higher than they are to Ontario. We expect drayage costs to the area to continue to drop as a critical mass of distributors develops in the Southern Central Valley.

The area is also rail-served, although the current intermodal facility is to the north, in Fresno. The BNSF is planning to build an intermodal facility approximately 13 miles north of Bakersfield in the ITTC (International Trade & Transport Center). This 700-acre development is also in a foreign trade zone and maintains Enterprize Zone status. Land costs in the Southern Central Valley are low, ranging from under $1.00 psf to $2.25 psf for improved land.

Recent prominent activity includes the decision by IKEA to build a 1.8 million s.f. facility at the Tejon Industrial Complex. A major factor in this decision was the ability to hire truck-lift operators at a wage approximately 30% lower than in Ontario.

Conclusions

Now may be an excellent time for developers and investors to become active in the Perris/Moreno Valley and the South Central Valley. For example, large tracts of land currently under agricultural preserve between Norco and Mira Loma could unexpectedly be made available, siphoning off demand that otherwise would have gone to the Perris/Moreno Valley.

Also, in South Central Valley, the Tejon Ranch and ITTC have already positioned themselves as the dominant players. The Southern Central Valley has seen activity in the past 6 months from users with requirements totaling over 9 million square feet, with an average need of 700,000 square feet. The political climate is favorable with a building permit cycle of under 6 weeks.

Now may also be an excellent time for investment in Western San Bernardino and Riverside Counties. Property values, which have been relatively flat in recent years, will almost certainly increase as development slows starting in approximately three to four years. While the potential for a huge return is less than with the Perris/Moreno Valley and the South Central Valley, the risks also appear smaller.

This article was provided by Lisa Liang, Director of Marketing for NAI Capital Commercial Real Estate.