By Rick Ellison, SIOR
Executive Managing Director, Industrial Brokerage & Global Supply Chain Solutions
Cushman & Wakefield
In the supply-constrained Southern California industrial markets—which have the tightest vacancies in the nation—landlords are becoming increasingly more selective about new tenants, opting for higher credit and passing over lower credit. This trend is consistent throughout Southern California but most prominent in the infill markets of Los Angeles and Orange County.
Historic low vacancy and strong demand from e-commerce related companies are providing landlords the opportunity to improve property value in ways beyond just increasing rents. In today’s landlord favorable market, it’s common for there to be multiple competing lease offers for a single availability. Given the opportunity of choice, landlords are naturally opting for better credit which presumably lowers default risk. Strengthening tenant credit profiles increase a property’s value while making it less vulnerable to an economic correction. Vacancy rates spike during recession, in part, because of tenant defaults. A portfolio comprised of larger companies mitigates this exposure. Increasing credit tenancy also increases the health of the market, making it more resilient to volatility. However, as a result, small businesses are feeling the brunt.
This trend is evident at various junctures. The most common situation is a small business looking to expand and finding itself competing against larger, often name brand or Fortune 500 businesses for the same space. But we also now see it affecting renewals, where tenants that have been in the same building for years are not extended by their landlord because of their credit. Typically, smaller tenants are pushed out to accommodate an existing larger tenant’s expansion but far more frequently landlords are electing to swap a lower credit tenant for a higher credit tenant even without the credit tenant yet in hand. Without a written option to extend, the lower credit tenants have little choice but to move out. An interesting counter action to this trend is that credit quality of the active requirement pool is weakening as more smaller credit tenants are actively looking for space. Another effect is that these Los Angeles and Orange County tenants have turned to the Inland Empire markets for relief.
The Inland Empire has long been the eastern outlet for coastal LA and Orange County business, offering more availability, newer product and lower rents—but moving east has its challenges. The Inland Empire is further from the consumers living in the population dense LA and Orange Counties and is further from the LA and Long Beach Port Complex which many importers rely on for their supply. Increased distance from the port and or customers means increased transportation cost which, in the past, has been mitigated by lower rent and availability of more efficient buildings. However, the Inland Empire markets are now at historically high occupancy and rent levels making the traditional migration path more difficult. Small businesses are now forced to consider out-of-state solutions. My fellow Cushman & Wakefield brokers in the Las Vegas and Phoenix markets, which have capitalized on the dramatically increased demand from small businesses migrating from Southern California, define this trend as being like a real life game of “kick the can.”
Meanwhile, industrial property values in Southern California continue to skyrocket. Larger tenants with better balance sheets are having a strong, visible influence in the investment sector, which remains red hot. Investors of all types are competing for the most desirable assets, with tenant composition, along with location and product class being key factors in buying decisions. Higher credit tenants are perceived to provide better stability which is particularly appealing to investors concerned about the late stage of this current bull market cycle. Thus, as landlords become more selective in filling their assets with higher credit tenants, their assets become more resilient and investor demand for their properties becomes greater. The market is considered safer from a risk perspective and values rise.