Market Still Sending Mixed Messages

For the last 6 months we have been wondering when the headwinds we are all feeling these days will finally blow the Southern California industrial real estate market in another direction.

But, rampant inflation, a doubling of mortgage interest rates, major bank failures and runaway federal and state deficits, among other things, have only been able to ease the market off the gas pedal rather than go hard on the brakes. Our gut tells us something not good is headed our way, but the most recent market metrics send a mixed message. 

Lease rates are holding at record levels, but it’s taking longer for space to lease up. That’s led to a steady rise in vacancy, but we are still in the 2% to 3% range (depending on submarket) which is historically low. Net absorption is spotty, but that may just be from the lack of good supply. Sales prices are still at record levels, but that may also be the result of tight supply, as inventory of for-sale properties is near zero in most areas in the Southland. There are fewer active lease and sale requirements in circulation, yet every building seems to find a tenant or buyer within a reasonable time at a premium price.

You would think that a doubling of the cost of debt would have an immediate negative impact on sales prices, especially for owner/user deals that rely so heavily on leverage. Yet, every building that sells brings a high price. You would also think that a landlord who has a property on the market for five months would have to lower his rate to secure a tenant. Yet, every building finds a tenant at or near the asking price at the end of the day. It’s perplexing to say the least and it’s hard to keep the faith that the market will just plow through it all and resume the bull run.

But, as a good friend of ours always says “gravity works” and we grow increasingly concerned that many of our clients, especially those near retirement age who are sitting on piles of unrealized equity, have held on too long, and for one reason or another, refuse to adjust their exit strategies. For some it’s an aversion to paying taxes. For others it’s not having a retirement plan that sounds fulfilling. But, the big one we hear all the time is having no idea what to do with all that money when it’s no longer locked inside the walls of their buildings. Whatever the reason is, it’s increasing risk levels every day.

We think this is a time to be decisive because there are more reasons to believe the market will correct than there are for it to move higher in the near term. As we just mentioned, no one market metric has significantly moved the needle yet, but working together over time, they probably will. Logic and experience tells us that something has to give. We just don’t know exactly when or to what degree.

If you own an industrial building in Southern California, you own a winning lotto ticket. Good for you. You deserve it for working hard and taking risks. But, a lotto ticket expires in 6 months if you don’t make your claim. 

In a few days we will have Q2 market statistics to share with you. Maybe they will tell us something new, one way or the other, so we can help you make good choices. Stay tuned.