Here are some interesting facts about Temecula Valley’s industrial market: Since 2012, among buildings between 5,000 to 50,000 sq. ft. (the majority of TV’s industrial market): Average asking lease rates increased 69% (from $.52 psf to $.88 psf) and average asking sale prices increased 102% (from $84 psf to $170 psf).
Given these jaw-dropping increases, one would think that developers would be constructing new buildings everywhere and cashing in on these market increases. But that isn’t the case. Since 2012, total inventory in this 5,000 to 50,000 sq. ft. size range HAS ONLY INCREASED BY 4%.
As an economics major in college, the first thing I typically consider is the age-old supply vs. demand chart. Since the end of recession, demand among industrial businesses has grown steadily. Demand hasn’t been “off the charts”, but it has remained healthy and consistent. But the demand side of the equation has not been the main reason for our increase in prices. The primary reason for these large increases in sale prices and lease rates is due to the lack of supply.
But still, despite our historically low vacancy rate of 1.5%, only a handful of new industrial buildings are in the planning or construction stage. Given the high prices and low vacancy, why aren’t we seeing more development? There are multiple reasons for this surprising lack of new development, among them:
1: Increasing Construction Costs: EVERYTHING today is more expensive: lumber, concrete, steel and especially LABOR. One would think there’s plenty of profit to be made at these record prices, but surprisingly that’s not the case.
2: Increasing Regulations: Builders today have to factor in the cost of storm water retention, water quality, stricter Title 24 compliance (energy efficiency for lighting, air conditioning, windows)
3: Longer Timelines: I can recall that when I started my career in the late 1980’s, a developer could be under construction within 6 months of their initial project application. Today – that time has likely tripled to 18 months. Longer development cycles = more development risk as the market conditions may dramatically change in the span of 18 – 24 months.
4: Fewer Lenders: Changes in federal banking regulations has extinguished banks’ interest in lending to speculative commercial development.
5: Fewer Developers: The majority of Temecula Valley’s industrial buildings were constructed by small, entrepreneurial developers. Since the recession, small developers have become almost extinct. As a result, the surviving industrial developers are focused on different markets that cater to e-commerce and mass distribution.
6: Higher Risk: Compared to before 2008, today’s speculative developer is required to invest more cash, agree to recourse financing (personal guaranty) for a construction loan, and will face a much longer development cycle from start to finish – with no guaranty that today’s market will still be as strong 2+ years in the future when their buildings finally hit the market. Even at today’s prices, the potential risk outweighs the potential reward for most developers.
The above factors have contributed to our market’s lack of supply. I expect this supply shortage will continue indefinitely. Assuming demand remains steady, local industrial building lease rates and sale prices will continue to increase in the foreseeable future.
Charley Black is a Senior Vice President and co-founder of Temecula Valley’s Lee & Associates Commercial Real Estate office, specializing in industrial, land and investment properties since 1988. Lee & Associates is a full service commercial brokerage offering industrial, office, retail, land and investment expertise.