Industrial

L.A. Industrial

Investors bet heavily on improving fundamentals.

By David Fults |

The competition for industrial space in the submarkets surrounding Los Angeles is aggressive, and the battle by investors is heating up. While L.A. submarkets have always attracted both local and global industrial investment dollars, commercial real estate investors are now proving that they are willing to push up market prices in cities like Cerritos, Calif., and Commerce, Calif., in anticipation of future market improvement.

The aggressive investment in Greater L.A. is a direct result of increased confidence and competition. Buyers are attracted to these submarkets for several reasons that are unique to this market, including quality product, close proximity to the Ports of Los Angeles and Long Beach, and convenient access to many major Southwestern markets.

Targeting Upside Potential

With such strong competition for industrial space, the key to closing deals in Greater L.A. is a deep understanding of the market, coupled with the ability to react quickly. Examples of investors paying above-market prices based on anticipated upside are plentiful.

In September 2011, James Campbell Trust, an investment company out of Hawaii, paid $130 per square foot for a 309,000-sf facility located at 18021 Valley View in Cerritos. At the time, this was the highest price psf paid for any industrial building in the region. But the trust was not alone in its interest. Other buyers were lined up, all willing to pay top dollar for this stable investment.

The Cerritos transaction illustrates that investors are willing to act now in anticipation of market improvement. The building, which is a bit older and underwent renovations in the early 2000s, is fully leased by RockTenn, a company that produces corrugated and consumer packaging and recycling solutions. RockTenn is on a long-term lease at an above-market lease rate, which is set to expire in October 2022.

During the 10 remaining years on the lease, James Campbell Trust is expecting that the rental market will increase significantly. A substantial increase will be required to re-lease the space for a rent that is at or above RockTenn’s current rate.

The bottom line is that investors are betting on significant rental increases. These buyers have dollars that need to be invested, and with the strong competition in Greater L.A. submarkets, many investors must underwrite significantly large rent growth to justify the prices they are paying for these properties.

A second example of this trend occurred in December 2011 in Commerce, just southeast of downtown Los Angeles. The 445,000-sf Smart & Final distribution center located at 5500 Sheila Street was sold for $54 million or $121 psf, making it one of the highest-priced industrial price psf investment sales ever completed in the Commerce market.

This transaction was a sale leaseback, with Smart & Final taking on a 10-year lease. Like James Campbell Trust, the investor who acquired this facility demonstrated an expectation of rental increases to rationalize its purchase price.

Will Rents Increase?

A key element to note amid this activity in L.A.’s submarkets is that rents have not yet increased. That said, if all parties investing in a specific market are paying high prices, each party will be forced to push rents. The caveat here is that some investors have owned nearby properties for a long time, and for these owners, increasing rents is not a necessity. In fact, some longtime owners are less likely to grow rents for fear of losing tenants.

Even without proof that rents will increase, speculative investment is still gaining momentum. A third example occurred in October 2011, when KTR Capital, a national real estate investment firm, acquired 1.2 million sf of land for speculative development. KTR paid $18.52 psf for the land, which is a high price for a land site, especially with no tenant yet signed.

The site, located at 6100 Garfield Avenue in Commerce, was an ICI Dulux Paint plant. KTR plans to tear down the plant to develop 650,000 sf of state-of-the-art warehouse space in its place.

This transaction is particularly significant because there is very little new industrial development in the Greater Los Angeles market. KTR is investing in the location expecting to draw users from all over Southern California because of the land’s central location in Commerce and the appeal of a state-of-the-art facility.

The trend of speculative investment that has surfaced in Greater L.A. is likely being seen in multiple markets with similar location factors throughout the U.S. Commercial real estate industry experts agree that pricing is now competitive, and investors are more confident than ever that markets will improve. Certainly some markets are still struggling, but as investment dollars pour into more active markets like Los Angeles, confidence will build across the board.

David Fults is senior vice president at Voit Real Estate Services based in greater Los Angeles. Contact him at www.voitco.com.