The industrial sector is going to be a mixed picture over the next three years. While development activity remains strong, supply is expected to grow faster than demand, signaling that new development will eventually begin to cool. E-commerce is currently a primary driver of new industrial development, with the use of artificial intelligence (“AI”) and the corresponding demand for data center space becoming a rising influence, ahead of cold storage and electric vehicle facilities. Drew Emmel, Partner at Allen Matkins, and Chris Rising, Co-Founder & CEO of Rising Realty Partners, discuss the factors influencing these trends as part of the Winter 2024 Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey.

The Top Performer is…The Inland Empire

Drew Emmel and Chris Rising agree that the Inland Empire, a metropolitan area adjacent to coastal Southern California east of LA County, has been one of the best performing real estate markets in the nation for the last several years.

According to Rising, “It is really hard to get away from the fact that the Inland Empire is just so dominant. Given the Port of LA and Long Beach, it's really hard to pick any other market.”  While projects have softened a bit closer to the port, those projects are not the big projects that have become in such demand.

Submarkets are the Key

Emmel believes it is important to think about industrial markets based on different subsections or submarkets, particularly in connection with the size of buildings. “In the Inland Empire, buildings under 500,000 square feet are in decent supply right now, and rents are starting to flatten out and even decrease. On the other hand, there's not much supply for the larger buildings. Rents for those over 500,000 square feet are holding steady, even though there's been a slight decrease in demand.”

Besides the size of buildings, another important sub-market is infill projects, according to Emmel. The growth of infill projects is only going to continue exponentially as online shopping remains high and consumers continue to demand same day and next day delivery. After all, even if a project is delivered by a drone, it can't be stored in a warehouse that's more than 60 miles away.

Rising is focused on what some call Class B or Shallow Bay, which he calls multi-tenant light industrial. Post-pandemic, a lot of businesses are comfortable having a smaller office as part of their warehouse, and he is seeing a lot of opportunity to redevelop or just upgrade existing Class B across the country.

What drives interest in industrial development?

Rising identifies three key questions that need to be asked to drive an industrial project forward:

1. Is the project located in a community that trucks can access without disrupting neighborhoods?
2. Is there access to fast internet? It’s almost impossible for businesses to operate without the fastest possible connections.
3. Is there direct access to highways? The more complicated it is for a truck to go from the project to a major highway, the less desirable it’s going to be.

The Impact of External Influences

There are a number of external factors that exert influence on the success of both industrial markets and global supply chains. For years, the ports in California have had a huge impact on industrial development. Goods would flow from Asia into the ports of Los Angeles or Long Beach and then be stored in the Inland Empire, and finally put out a train and distributed throughout the country. Emmel points out that manufacturers got burned by heavy reliance on that supply chain during the pandemic and they started looking around for alternatives to source their goods, or made their products themselves.

He also sees the Panama Canal as another global force impacting the industrial market. In 2023, they had to limit the number of ships going through the canal because of severe drought conditions, which are expected to continue in the near future. To that effect, development of warehouses is likely to continue near the Mexican border around new manufacturing facilities and also near rooftops because those are the critical parts of the logistics supply chain.

Emmel sees emerging trends such as the commercialization of AI driving demand in the industrial space, especially for facilities that meet the unique needs of digital infrastructure tenants.

“The net effect of these external factors on the US industrial market is positive. With increased manufacturing in the US, there will be more product that has to be stored in warehouses and the overall supply chain domestically is likely to grow.”

Looking Ahead

Rising says that due to excessive vacancies in certain markets, development will taper down over the next 12 to 24 months. He sees a lot of the large markets right now softening due to overdevelopment and this softening needs to work its way through the system. According to Emmel, “While industrial growth has slowed, the sector is expected to remain relatively healthy in the coming years with strong leasing activity and new construction.”