Office Oasis in the California Desert

Office investment sales in the vast desert east of Los Angeles known as the Inland Empire are heating up. In late July, a Temecula, Calif.-based investor, The Garrett Group, paid about $74 million for 584,000 sq. ft. in eight buildings formerly owned by Equity Office Properties Trust of Chicago. And in May, Hall Equities reportedly paid $43 million to Arden Realty, the Los Angeles-based real estate investment trust, for a quartet of buildings.

Why so much investor interest in this trade area of 3 million people? This fast-growing market has one of the lowest vacancy rates of any suburban area in the country — 10.4% in the second quarter, compared with 13.1% a year earlier, according to Grubb & Ellis. A high absorption rate — 500,000 sq. ft. last year and 330,000 sq. ft. in the second quarter alone in a market of 16 million sq. ft. — augurs rising lease rates and low vacancies for the market in the near term. To put that in perspective, absorption in the second quarter registered 393,970 sq. ft. in Los Angeles County, an office market with an inventory of 169 million sq. ft.

“Companies are taking advantage of the local labor pool,” says Tom Pierik, senior vice president for Lee & Associates, who points out that the Inland Empire will generate 30,000 new jobs this year.

The growth of the Inland Empire follows a familiar pattern in Southern California. The region started out as a set of suburban bedroom communities for neighboring Los Angeles and Orange counties. Industrial development came next, powered by the combination of the Ontario International Airport and the existing freeway network, making the Empire into a warehouse-and-distribution hub. Now, office space has come to house the businesses seeking to expand into the growing trade area.

“It looks like Orange County did 30 years ago,” says Michael Ross, a senior vice president in the Los Angeles office of Colliers Investment Services, which represented the buyer in the Arden portfolio sale, along with Lee & Associates.

While the Empire is attracting some tenants from older markets such as Orange County and eastern Los Angeles County, much of the leasing activity in the Inland Empire represents expansion of existing firms into a new market, rather than relocation out of older ones. Class-A space goes for $21 to $22 per sq. ft., full-service gross, in contrast to the $25.44 that similar space commands in Los Angeles County.

Fred Cordova, another senior vice president at Colliers, says he expects a limited supply of Class-A space will likely keep vacancy rates low for the foreseeable future. Although 400,000 sq. ft. of office space is currently under construction, he sees “a lag in supply.”

But with land prices starting to soar, he does not foresee much new construction until lease rates reach $26 per sq. ft. to justify the economics.

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