California’s Industrial Real Estate Remains Hot, Despite Softening Demand: Report

US Postal Service employees, some wearing Santa hats, sort mail at the Los Angeles Processing and Distribution Center in preparation for another busy holiday season in Los Angeles on Nov. 30, 2022. The center operates 24 hours a day, 365 days a year in a warehouse the size of 22 football fields. Frederic J. Brown/AFP via Getty Images

Industrial real estate in California is the best-performing sector in the commercial industry, according to the recently released summer edition of the biannual collaboration between real estate law firm Allen Matkins and the University of California–Los Angeles’s (UCLA) Anderson School of Management.

The California Commercial Real Estate Survey (pdf) questions commercial property owners, developers, financiers, and investors about market insights and their sentiment looking three years into the future.

“Industrial markets, which continue to experience historically low vacancy rates, remain poised for a good run of new building and superior returns,” the authors wrote in the report.

While responses suggest less optimism than in prior surveys, the report notes that the industrial market was growing—with decreasing vacancy rates and new development—at unsustainable rates during the last two years, and the slight shift in sentiment does not indicate a significant change in lease prices or vacancy rates.

Commercial real estate is composed of four sectors: industrial, multi-family housing, office, and retail. Industrial is made up of properties dedicated to production, manufacturing, warehousing, storage, and distribution.

“In the commercial real estate realm, industrial space has been the star performer of late,” the authors wrote. “Industrial markets throughout the state have been overheated for some time and the turn indicated here represents a slight cooling of development.”

Sriracha Hot Chili Sauce is bottled at the Huy Fong Foods plant in Irwindale, Calif., on May 14, 2014. David McNew/Getty Images

Vacancy rates remain at record lows, with Southern California averaging 1 percent and Northern California closer to 4 percent, according to the report.

“Lower leasing volume has not stopped industrial development. Developers who have their projects already under construction haven’t pulled the plug. Instead, there’s tens of millions of square feet of space that’s currently under construction,” Jonathan Consani, a partner at Allen Matkins, said in the report.

Several million square feet of development are under construction in Southern California, with a number of warehouses planned for Los Angeles and the Inland Empire, according to the report.

With 2021 being the only exception, more developers are planning new industrial projects than at any time in the last eight years, according to the report.

“At some point supply should catch up, and when it does, vacancy rates will increase a bit further,” the report found. “It is this increase in vacancy rates that led the panelists to indicate in the previous and current Surveys that 2026 will not be as profitable as 2023.”

Market for Office Space Continues to Suffer

With industrial leading the pack, other sectors in commercial real estate did not fare as well, though retail and multi-family housing both saw improved sentiment compared to six months ago.

Office space continues to suffer, dragged down by work-from-home practices and public safety concerns in some cities.

“[M]ulti-family has bounced back rapidly; the turn in sentiment for retail has not yet resulted in significant new building, but the last two surveys now point to that occurring in the near future; and office markets have a long road ahead,” Jerry Nickelsburg, of UCLA’s Anderson School, said in the report.

A pedestrian walks by a commercial property for lease in San Francisco on Oct. 27, 2022. Justin Sullivan/Getty Images

The prior report—released in February—forecast a recession, and the current analysis sees such occurring later than expected, with a late 2023 or 2024 slowdown now anticipated.

“In the six months since the last Survey, interest rates and cap rates have bumped up, and the recession that some said was supposed to happen moved further and further into the future,” the authors wrote.

If such a downturn occurs, California is projected to navigate the recession better than other states, according to the report.

“The empirical evidence on the economic trajectory for 2023 indicates that whether the economy enters a slow growth period or mild recession later in the year, it will be milder in California than for the rest of the nation,” the report said.