Inland Empire: California's new frontier

Situated immediately east of greater Los Angeles, the Inland Empire is generally seen as Southern California's newest development frontier. The area consists of Riverside and San Bernardino counties; if these two counties were a state, it would rank 30th in population (3.1 million), 32nd in total income ($58 billion) and, with 32,293 square miles, would outsize several U.S. states.

Until now, Inland Empire has mainly consisted of warehouse and distribution sites and single-family housing. However, with significantly lower land costs and rents, Inland Empire will attract more companies looking for alternatives to the increasingly expensive markets of Los Angeles, as well as Orange County, which lies immediately south of Riverside County.

The region began its growth a decade ago, but the real estate crash of the early-1990s stopped forward motion and set the area reeling back. According to local brokers, rents and selling prices still have not regained their 1990 levels in some categories.

Less than adequate infrastructure has been one obstacle to growth since the end of the recession, but that is quickly changing. In September, the city of Ontario completed a $25 million expansion of its airport, increasing the facility from 70,000 sq. ft. to 530,000 sq. ft. and adding 26 passenger gates. Meanwhile, Riverside is soon to get its own cargo airport with March Air Force Base transferring to local government and George Air Force Base integrating into the Southern California International Airport.

Land transportation has also improved. Highway 410 recently opened, providing a faster link to and from Orange County. Also, existing freeways are being upgraded

In addition, the Southern California Metropolitan Water District's multi-billion dollar Eastside Reservoir project is four years from completion. This reservoir will create the state's largest lake, with 26 miles of shoreline, and will assure water for the area for decades to come. Finally, GTE and Pacific Bell are rapidly updating the region's telecommunications structure.

Despite these technology advances, the lack of population in the area has restricted the region's business centers. Riverside, the region's largest city, has about 350,000 people, while Ontario's metro area has about 300,000 people.

But according to the San Bernardino, Calif.-based Inland Empire Economic Partnership (IEEP), the region is the fastest growing in the nation, with approximately 1 million people expected to be added by 2005. A study by IEEP reveals that 247 companies entered the market and 223 existing ones expanded between 1995 and 1998.

Industrial market leads growth As previously mentioned, the industrial sector has led the way in Inland Empire's growth. According to the IEEP study, the top-five industrial categories are plastic injection, aerospace, semiconductor, furniture assembly and distribution and office product distribution, which together accounted for 8,352 jobs. Nearly a third of the companies, with 10,359 people, were involved in logistics and distribution. Among the larger users are Home Base with 675,000 sq. ft. and World Bazaar with 720,000 sq. ft. in Ontario and Mattel with 810,000 sq. ft. in Chino.

According to Scott Ostlund, principal and senior vice president with Ontario, Calif.-based Lee & Associates, 1998 was a record breaking year in the industrial market. Based on the Ontario-Mira Loma market's 6.4 million sq. ft. of absorption in the first quarter of 1999, Ostlund expects the area should do even better this year. He reports the regional vacancy rate is 4.4%, with the greatest demand in Ontario, Rancho Cucamonga, Fontana, and Chino.

Temecula is also seeing rapid growth, according to California Real Estate Journal. Several developers - including San Francisco-based Catellus Development Corp., San Mateo, Calif.-based Legacy Partners and Newport Beach, Calif.-based Koll Development Co. - have large speculative projects in the pipeline in various markets.

In Victorville, Laguna Hills, Calif.-based Stirling Enterprises Ltd. will spend $418 million to create a global distribution hub and business and industrial park. Smaller companies also have projects in development, with Murietta, Calif.-based Temecula Valley Developers building 75,000 sq. ft. Sky Canyon Business Center in Murietta and 100,000 sq. ft. Redhawk Business Park in Temecula. Both buildings are light industrial.

Ostlund says high-cube distribution facilities of 100,000 sq. ft. and up had been the only things moving; but the focus now is on smaller properties. He pegs rents at about $0.30 per sq. ft. triple-net for 100,000 sq. ft. and up, $0.37 per sq. ft. for 50,000 sq. ft. and $0.41 for 25,000 sq. ft. According to Northbrook, Ill.-based Grubb & Ellis, rents are highest in Temecula and Corona (due to their proximity to Orange County) and lowest in Riverside and Moreno Valley.

Ostlund reports REITs and other institutional investors have largely depleted the high-cube investment inventory, shifting activity to the smaller product. At the same time, institutional investors are making strategic sales. Recently, Boston-based John Hancock Mutual Life Insurance Co. sold five properties adjoining the Riverside Airport to Garden Grove, Calif.-based Abbey Co. The properties include a 131,263 sq. ft. distribution facility occupied by Mendocino Forest Products.

Abbey says part of the attraction in the Riverside purchases was the inclusion of a significant amount of scaarce developable land.And according to Paul Earnhart, Also of Lee & Associates, almost every available parcel of developable land in the Ontario area changed hands in 1997 or 1998.

Mary Jane Olhasso, director of economic development for the city of Ontario, says manufacturers are beginning to show greater interest in the region. Both Los Angeles and Orange County have begun to run short of industrial land and, because of this, Ontario will begin intensive marketing to manufacturing and high-tech companies in both regions, she says.

Office market improving The Inland Empire's strong industrial sector may be lending inspiration to its office market, where vacancy rates are still high but improving. With rates checking in between 12% and 14%, according to Palo Alto, Calif.-based Marcus & Millichap Real Estate Services, the Inland Empire office market would appear not to be in great health. But as Kevin Assef, regional manager in the Ontario office of Marcus & Millichap, points out, the figure stood at 27% less than two years ago. And in some submarkets, notably Ontario and Riverside, vacancies are in the single digits.

According to Gary Mullin, an investment specialist in the Ontario office of Grubb & Ellis, the entire region saw a sharp increase in absorption in the first quarter, along with an upward movement in rents, particularly in Class-A. Class-B and Class-C make up some 90% of the market.

Assef puts rents at $1.50 per sq. ft. to $1.85 per sq. ft. for Class-A and $0.85 per sq. ft. to $1.10 per sq. ft. for B and C, all full-service gross. The almost total absence of new construction means rents should continue to rise.

Most office growth from outside the Empire consists of regional branches of service providers such as stock brokers, insurers and lawyers or corporate backed offices. For example, Southern California Edison will open an 87,000 sq. ft. customer service center in Rancho Cucamonga.

Mullin reports sales are slow, primarily because climbing rents have persuaded owners to hold on to properties. Assef says sales have ranged from $51 per sq. ft. to $96 per sq. ft., with an average of about $69 per sq. ft. Assef gives the average cap rate as 9.9% but according to Mullin, the market should begin to pick up soon.

Retail is rebounding As the future looks up for the office market as occupancy rates slowly rise and the market improves, retail, which has been in a long-time slump, has also rebounded. Workers who commute to Los Angeles have been a defining factor in this upswing. The Mills Corp., Arlington, Va., has found success at Ontario Mills, a 1.7 million sq. ft. entertainment center that opened in 1997. Ontario Mills drew 17 million people in its first year and, in combination with the expanded Ontario International Airport and the recently completed $66 million Ontario Convention Center, the center has made Ontario the region's hub of retail development.

According to David Moore, executive vice president of Encino, Calif.-based Capital Commercial Real Estate Services, San Bernardino is especially active due to influences from Orange County. The largest project in development in the Inland Empire is the 1.7 million sq. ft. Promenade Mall in Temecula by Cleveland-based

Forest City Development Inc. The Palm Springs resort area is also experiencing retail development. El Paseo in Palm Desert bills itself as the Rodeo Drive of the desert and the high-end retailers located there confirm this claim. The newest entrant to the market is The Gardens on El Paseo, a 225,000 sq. ft. project by Cincinnati-based Madison Marquette.

Assef reports monthly rents average about $1.45 per sq. ft. triple-net for anchored centers and $0.90 per sq. ft. to $1.10 per sq. ft. for unanchored, but Moore says pads at the best new centers are commanding up to $2 per sq. ft. Assef reports retail property sales averaged $64 per sq. ft. last year and climbed to $70 per sq. ft. for the first four months of 1999.Both brokers say properties are moving slowly, though Moore reports a significant amount of retail land is on the market.

Pockets of hotel hotspots The Inland Empire's hotel sector is much like area retail - with pockets of activity. As the gateway to San Bernardino National Forest and Joshua Tree, the region has more than its share of motels, but not many hotels. The exception is the Coachella Valley, home to Palm Springs, Palm Desert, Indio, La Quinta, and other desert resorts.

Brokers say the Ontario market is ripe for moderate and family-rate development thanks to the airport, convention center and Ontario Mills.They say developers held projects back because of cautious lenders. The current inventory of rooms is adequate to cover demand, but if demand increases, additional rooms will be needed soon.

Multifamily development slow While the single-family market is booming, multifamily development is weak. The reason people move to the region is the affordability of homes. Observers do not expect the pattern to change until local job growth creates demand for short-term housing.

In a survey of properties with a total of 57,000 units throughout the region, Marcus & Millichap found the average vacancy rate at 5.5%, down two points from a year ago. Although the vacancy rate suggests the market is ready for new product sales prices are still below replacement costs.

With Inland Empire's healthy industrial market, new infrastructure, rebounding retail sector and growing office market, the area has the potential to become a major player in California commercial real estate.

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