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LA’s insatiable demand for warehouses starts to gobble up suburban office parks

With the industrial vacancy rate at a record low in LA County, and lease rates at a record high, developers are eyeing suburban office campuses as potential warehouse space.

LOS ANGELES (CN) — In the aftermath of the Covid-19 pandemic, Los Angeles County is seeing the first glimpses of a transformation of the suburban landscape where the dreary office campus, as parodied in the 1999 cult classic "Office Space," is making way for industrial warehouses.

With many office workers slow or unwilling to give up working from home because of lingering concerns about Covid, childcare needs and transportation costs, office vacancy rates in LA County have remained stubbornly high and lease rates, in particularly for lower-end office space, are flat if not down, according to data from commercial real-estate firm CBRE.

At the same time, the pandemic has caused an online shopping boom driven by cooped-up consumers spending on household goods, and online retailers and shipping services, who want to have their merchandise as close as possible to the millions of shoppers in the most populous county in the U.S., have absorbed any available warehouse space for their "last-mile" delivery needs.

As a result, the industrial vacancy rate has fallen as low as 0.5% in the LA region and lease rates for warehouse space in the county are now the highest among metropolitan areas in North America. This in turn has prompted real-estate investors and developers to start looking at underutilized office parks, on land already zoned for industrial use, to redevelop them into warehouses once the leases of the remaining office tenants have expired.

"The industrial market has never been stronger," said Barbara Perrier, an investment broker with CBRE  who specializes in industrial and land sales. "Land prices are up more than 50% and people are saying, 'Where else can we go?'"

Trying to convert obsolete retail space to industrial warehouses is very difficult because of resistance from municipalities, according to Perrier, and there's little or no available vacant land left to build. That leaves industrial-zoned land on which offices have been built as a prime alternative.

It has become simply more lucrative to own a warehouse in parts of LA County rather than a partially-occupied office building where the owner is stuck with rising fixed costs and no way to increase lease rates, said Michael Longo who manages sales of institutionally owned property at CBRE.

"Office rents in secondary suburban markets have been flat," Longo said. "There has been acceleration of pre-existing trends on which the pandemic has thrown lighter fluid."

Rexford Industrial Realty, a real estate investment trust, or REIT, that specializes in industrial properties in Southern California, in February paid $42 million for an office complex on a 10-acre lot in Chatsworth, a suburb in northern LA County. The building is leased in part to the county, but once the lease is expired, Rexford will redevelop the site and put up a warehouse facility.

At the other end of LA County, a unit of Canadian multinational Brookfield in March paid $36 million for a recently renovated, 125,000-square foot, two-story office building in Torrance to eventually replace it with warehouses.

Representatives of Rexford declined to comment on their acquisition, and Brookfield didn't respond to requests for comment.

It will be predominantly the large REITs that have both the funds and long-term game plan to buy up office campuses on industrial-zoned land to redevelop them into warehouses down the road because an investor has to be willing to wait as long as 5 or 7 years for the office tenants to move out, said said BJ Turner, founder of LA-based industrial real estate-investment and development firm Dunleer.

Aside from the huge Southern California consumer market, the main driver behind the demand for warehouse space in the region is the presence of the largest U.S. container-port complex in LA and Long Beach, which handle about one-third of U.S. imports arriving by ship, predominantly from Asia. Here too, the pandemic has fundamentally changed the way importers manage their overseas supply lines.

Because of the pandemic-related lockdowns, U.S. consumers shifted their spending habits from traveling and eating out to online shopping for furniture, home electronics and exercise equipment, most of which gets shipped across the ocean from Asia. The resulting increase of imports clogged up the Southern California ports last year because there weren't enough trucks and trains, workers or warehouse space to process it all.

Last year's supply-chain meltdown has spooked retailers and other big importers who are now not only trying to beat the rush by ordering new merchandise from Asian manufacturers further in advance, but are also looking for more space to stock the additional inventory once it arrives at the docks.

Retailers have been forced to move away from a "just-in-time" approach to bringing in merchandise, which minimizes the amount of inventory they keep on hand, to a "just-in-case" strategy to avoid being left without, said Jonathan Gold, vice president for supply chain and customs policy with the National Retail Federation. This requires them, or their outside logistics providers, to have much more warehouse capacity.

Some retailers are now dealing with excess inventory because they got some of their seasonal merchandise too late, according to Gold. At the same time, they are already bringing in inventory for the coming holiday season, in part because they are nervous about new disruptions at the ports related to ongoing labor talks between the longshore union and the terminal operators.

"We're in the peak shipping season now," Gold said. "A lot of retailers have instigated mitigating strategies to bring in goods early and it all has to go somewhere."

And it's not just retailers who are trying to navigate a new and uncertain landscape when it comes to their overseas supply chains. Manufacturers are also rethinking their globalized model and are "re-on-shoring" some of their operations because of the uncertainty they experienced with their overseas factories getting shut down because of Covid and the inability to visit their factories because of travel restrictions, according to Dunleer's Turner.

"Many businesses want to have greater control over their manufacturing," Turner said. "That's going to require more warehouses."

Other regional trends that have contributed to exponential increase in demand for warehouse space are new industrial users, such as "ghost kitchens," which are restaurants without a dining room for online meal-delivery businesses, and cannabis producers, according to Turner.

Given the penetration of e-commerce, in particular after the pandemic when even the most technology-adverse consumers turned to online shopping for anything from groceries to furniture, the demand for warehouse space in the LA area isn't likely to subside anytime soon. And with the recent rise of fuel costs, proximity to customers has become even more of a premium.

"Fifty percent of supply-chain costs is transportation, so you need to be very close to the consumer," Turner said. "With $7 gas, and even higher for diesel, that becomes even more crucial."

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