New Data is Out

Executive Summary

As tenants right size, inventory is building up in Class B properties while the leasing cycle is slowing in Class A properties. However, lease rates are not going down across the board. Largely subleases are absorbing at lower lease rates and new deals are being padded with a little extra free rent. That means tenants have the opportunity to shed excess space, and to pick up shorter-term sublease deals, while investors still get to take advantage of market-to-market strategies. Everyone wins, and everyone loses to some extent. 

On the investment sale side, we are doing lots of BOVs for clients who need to transact due to reaching the maturity of their investment horizon and expect more transactions to occur in the next two quarters. However, values are based on the WALT (weighted average lease term), whether an investor or user deal, the loading, and the future development potential. You can see deals trading from $271 to $758 PSF in the same submarket during the same period of time. Getting the right team, testing your underwriting assumptions, and dialing in your highest and best-use business plan has never been more critical in finding pricing arbitrage and winning deals.

Executive Summary

Here are the next batch of lease comps from the last quarter. Each one has its own unique story that we can elaborate on upon request. 

Prologis Earnings Call Key Takeaways

• Occupancy is trending slightly down, yet net operating income is trending up. How can that be that there are less tenants and more rent? All those leases that rolled in the last two years that increased 2x -3x are now hitting NOI.
• Southern California
  • Port volume is down due to the labor strike.
  • Christmas season shipping decisions have largely already been made regarding what port to ship to and what warehouses to hold inventory for retailers.
  • Tenants in So Cal are more price sensitive to future lease rate increases because they are already high.
  • “We wish we had more Southern California” from a meta-perspective—still the highest long-term growth rate.
• Portfolio commentary – NOI growth is expected to be 7.5%, even with no new rental growth.
• Risk is in the bulk markets like South Dallas, North Fort Worth, Indianapolis, and West Phoenix, where supply coming online is substantial. Prologis is largely isolated from that risk.
• Big trend – We are back to 2019 market dynamics.
• Customer retention is down to the lowest rate of 70.5% over the last 5 quarters. Why? There is a fine line between pushing rents and losing tenants. 70-80% retention is a good ballpark. Pushing rents is still the superior strategy over softening rents to increase retention.
• Blackstone purchase commentary – Very collaborative process between the two teams. The deal came together rather quickly and added to their ideal portfolio makeup.
• 3PL commentary – The 3PL business is a small-margin business. If rents go up 10% and your business goes down 10%, you have to right size. The right move is adjusting your space and taking advantage of the mark-to-market opportunity with a sublease.

Rexford Earnings Call Key Takeaways

• Concessions have increased this quarter from $1.25 PSF to $1.65 PSF, which is still lower than pre-pandemic.
• They still have plenty of room for growth in their current operating platform.
• Although there is decelerating mark-to-market opportunities quarter to quarter, the prior and current mark-to-market strategy is yielding increased cash flow over the next five years and has 31% embedded NOI even if there was no future market rent growth.
• 4% annual increases are embedded in all their deals, with a portfolio average of 3.5% increases.
• Bad debt accounts for 35 bps, up from 25 bp. That increase is all from one tenant. Their bad debts are surprisingly low. They only have seven tenants of their 1,600 that are on their credit watch list. Pre-pandemic was 50 bps.
• Downtime for lease up stays constant at three months, down from pre-pandemic four months.
• There is a bifurcation in the market between warehouses that have been upgraded or not. Rents pop in the upgraded warehouses. Of the greater market negative net absorption, they experience positive net absorption. Not only that, only 18% of the sublease that is available on the market are within upgraded warehouses meaning they are more insulated from the sublease pressure that is modestly growing.
• Half of the Southern California industrial inventory was built before 1980 and has/had some form of functional obsolescence. 

CoStar Report Key Takeaways

• Southern California Imports Trends: Imports to Southern California have seen monthly volatility but typically peak in summer. However, using a 12-month average, there’s a noticeable decline in imports with a 21% drop year over year.

• Pandemic and Post-Pandemic Consumer Behavior: During the pandemic, imports reached an all-time high due to an increase in consumer spending on goods, especially as the 2019 trade war with China slowed down. Post-pandemic, consumer focus has shifted from goods to services, resulting in a decline in imports. Retailers are also decreasing their inventory, which reduces the demand for storage and warehouses.

• Los Angeles Occupancy Rates and Trends: There’s a significant correlation between imports and net occupancy in the Los Angeles industrial market. A notable decline in imports correlates with reduced occupancy in Los Angeles. The total vacated industrial space in Los Angeles within a year is nearly 14 million square feet, a near 2% loss of its industrial inventory. This decline is attributed to companies becoming more selective about leasing, favoring newer, more functional warehouses, and moving away from older facilities.

• Inland Empire’s Reversal: After a peak of 33 million square feet in net absorption by the end of 2021 (which followed a spike in imports), the Inland Empire is seeing a negative trend. National retailers and logistics providers are contracting, primarily because of overexpansion during the pandemic.

• Orange County Occupancy: There’s been a minor decline in occupancy levels in Orange County. However, despite the decline, Orange County maintains one of the lowest vacancy rates nationally due to its limited availability of land for development.

• Dockworker Agreement: West Coast dockworkers and shippers have reached a tentative six-year agreement, ensuring a smoother flow of imports to Southern California.
• Future Outlook: The demand for industrial space hinges on consumer spending on goods. Although there’s been a decline from the pandemic highs, there is potential for improvement if the economy remains stable.

Media

• Book #1
  • Industrial Intelligence, The Executive’s Guide for Making Informed Commercial Real Estate Decisions
    • Audible / Audiobook Now Available!
    • Buy Paperback & Kindle
• Book #2
  • Industrial Income, The Investors’ Guide to Maximize the Value in Commercial Real Estate Leases
    • I’m currently targeting a publishing date of January 1, 2024, and looking for beta readers for advanced copies of the manuscript now. 
• Podcast
  • Subscribe to the show or listen to individual episodes here.

We’d love to catch up with you and brainstorm how we can make your goals come to life.


Best Regards,

Justin Smith, SIOR              Grant LaBounty                     
jbsmith@leeirvine.com         glabounty@leeirvine.com        

Chris Vassilian                     Jeannette Cano
cvassilian@leeirvine.com     jcano@leeirvine.com