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Business Roundtable: Commercial Real Estate

Posted: July 2, 2014 6:36 p.m.
Updated: July 2, 2014 6:36 p.m.
From leff: Dale Donohoe, President, Intertex; Craig Peters, Executive Vice President, CBRE; Holly Schroeder, President and CEO, SCV Economic Development Corp.; and Jim Backer, President, JBS Development. From leff: Dale Donohoe, President, Intertex; Craig Peters, Executive Vice President, CBRE; Holly Schroeder, President and CEO, SCV Economic Development Corp.; and Jim Backer, President, JBS Development.
From leff: Dale Donohoe, President, Intertex; Craig Peters, Executive Vice President, CBRE; Holly Schroeder, President and CEO, SCV Economic Development Corp.; and Jim Backer, President, JBS Development.

As recovery continues in the industrial real estate space, several new projects are finally set to come on line with construction beginning as early as this year.

And as the opportunity for new state of the art building arises, also so does the opportunity to look at the kind of infrastructure that will make Santa Clarita a premier market for attracting companies from outside the area.

We sat down with four experts to look at the state of the Santa Clarita Valley and its future: Craig Peters, Executive Vice President, CBRE; Dale Donohoe, President, Intertex; Jim Backer, President, JBS Development; and Holly Schroeder, President and CEO, SCV Economic Development Corp.

What effect will new construction have on industrial and commercial real estate space?

CRAIG PETERS: We’ve been through a significant recession and recovery. We’re following typical trends. Vacancy drops during recovery and gets low enough for rates to rise. As rates rise, new construction happens.

Fortunately, we have four projects that will start over the coming years to help add supply to take care of all the demand. That’s when you see Starwood’s Gateway 5 and the Sterling Gateway projects start to break ground, as well as activity at Needham Ranch and talk of expanding at Mann Biomedical Park.

That’s critical for us to attract companies and grow companies that are already out here.

Where do you expect the market to go in the next few years?

DALE DONOHOE: Lease rates have not changed much in the past 30 years. When you look at the cost of construction and inflation versus the lease rates, they have not kept up. We’ve had cap rate compression that’s made it feasible for developers and brokers to lease and/or sell property.

What were the lease rates in the early 90s?

PETERS: It depends on where you are in the cycle. People think of the real estate market as steady growth in values. We all know, though reports may show a linear growth, the market is really dipping and peaking all the time.

We probably saw rates in the 90s around $40 per square foot. I could go lease a class B building right now in the upper $40s or lower $50s per square foot. So there hasn’t that much change.

The change has been in Class A product, which is really getting a premium. It’s in the greatest demand.

JIM BACKER: But it’s been hard to capture that premium.

The first deal we did for $2 a square foot was in Town Center in about 1996-97. We were all excited.

Here it is 17 years later, and there are a lot of buildings still selling for about $2. You couldn’t build a new building for that rate.

We’re still facing challenges. The rates still have to go up a little bit more. Fees and cost of construction has continued to go up. Industrial vacancy rates (below 2 percent) are very low, but we’ve haven’t seen the growth we should for that either. There’s still a lot of uncertainty out there. This isn’t a confident business market.

PETERS: Jim’s talking about the office market, which is about 13 percent (vacancy) right now. Industrial is below 2 percent, but is much further in the recovery. Office space (vacancy rates) still needs to drop to push values up to get to new construction.

To Jim’s point, this is a slow painful recovery. There’s not robust growth. Fortunately, we have some key industry clusters out here.

We’re also well aware of the challenges at the state level right now. It’s frustrating to see other states offering incentives to companies that were born and raised here. They take our jobs away to other states, and our state isn’t doing do much about it.

HOLLY SCHROEDER: Given all those challenges, the pending new construction is all the more exciting for the Santa Clarita Valley. We’ve not have significant levels of industrial construction in years anywhere in L.A. County, let alone the Santa Clarita Valley.

The fact that the first major, high-quality new buildings are being built out here in the post-recession era is a really good thing.

There are all these challenges, but that’s what makes it all the more remarkable that we’ll have these new buildings on the market soon.

PETERS: Fortunately, we have a very pro-business city and county, as well as the the SCVEDC and Chamber of Commerce. We have some arrows in the quiver. That’s one of the reasons we’ve been able to attract some great new companies to the area and others have been able to expand here.

DONOHOE: Unless we can attract outside capital, we’re not going to be able to compete with providing these new buildings. The thresholds, the margins of profit, are shrinking. A lot fo the newer buildings are going to be first class to drive the premium, which helps attract new companies.

But the cap rates they’re building to are 6.5 to 7, when we’re used to building at 8.5 to 10.

The cost of construction and delivering the land is a lot higher, which means it’s going to take a lot bigger capital that’s willing to work on a reduced margin. So you’ll see a lot of these developments being done by the bigger players.

Is the attraction of the EB-5 program a possibility for these projects?

DONOHOE: Absolutely. We can get the cheap money, then we can afford to build in our fees and make it a lot more attractive for the people coming overseas.

PETERS: There is a lot of capital worldwide that’s looking for a home. if we can attract less expensive capital, then we can compete.

BACKER: The length of time you get to use the money is attractive, as well. I don’t think the American financial system is set up to support developers. They want to give you 18-24 months to get everything built and stabilized, and then they want their money back. God forbid, we should go through a recession in the middle of that.

EB-5 is looking at a 5-year time frame, a much longer range, and there’s no personal guarantees.

Essentially, a bank wants you to risk everything you’ve ever made to start a project. Most of us don’t want to sign up for that anymore. There’s just too much risk.

Systemically, we’ve got to find better ways to do it.

We’ve all been long-term planners in this valley, and we all see long-term opportunity. I’m sitting on a couple great pieces of property, but until I can get them structured financially to go forward, we’re just going to sit there.

Do you see financing opportunities changing because of those conditions?

BACKER: Traditional lenders are finally waking up to the fact that they’re making money when they do loans. But that just means they give you a better loan-to-cost percent.

Do you see future growth with nontraditional lending?

BACKER: If the opportunity is there, I’d say so.

PETERS: Most of the development that’s occurring Southern California is in the Inland Empire. They have about 17 million square feet under construction right now. Institutional investors are doing that. Institutional investors are behind the major deals in this area, as well. The traditional days of a local developer going out and getting non-recourse bank financing are probably gone for while, or maybe forever.

For the foreseeable future, it’s large institutional investors that will be the key to new development.

DONOHOE: Absolutely. They’re willing to work on a smaller margin. It’s basically Wall Street money, if you will. For all the developers out here, I think those days are gone.

The new trend is to use other people’s money, and they use us as basically a fee-developer and consultant.

I could see the projects Craig is working on only going to very large, institutional players.

PETERS: One of the changes that happens with institutional investors flooding the market, is they like to build a certain type of product -- larger, industrial-type buildings. But there’s always been a need here for smaller incubator industrial projects. Nobody is talking about doing that right now, but there’s a tremendous need for it. That’s one of the things that allows us to grow small companies here. It allows them to move from a 1,500 square foot space to 5,000 square feet. Next thing you know, they’re in 100,000 square feet, hiring a bunch of people.

So we need new product in the very small and very large square footage ranges?

PETERS: There are holes in the market now because of the low vacancy. There are areas where there is no supply at all. The institutional investors will fill one hole, but finding smaller spaces has usually been left up to the smaller local developer to build. And it’s played a very important role in our local economy.

Is there any build-to-suit or spec building going on?

DONOHOE: I don’t think any of my lending institutions, despite the low vacancy, would allow me to build a spec building without any leasing.

If they were to do it, they would price it so high, your returns aren’t worth it.

So it’s not a good arena to jump in as builders and developers, but there’s demand there?

PETERS: Yes. I would bet this time next year, someone will be building a small incubator space. I bet the market will get to that place.

SCHROEDER: We’re talking about some macro trends, in terms of availability of capital. But it’s, at this point, really about having the small space, that progression of different sizes of space. We’ve historically had that progression in this valley, and that’s been part of our success. We need to make sure we are planning for that in the future.

It’s nice timing to talk about this after last month’s discussion on entrepreneurship. Those are the guys that will need that small, incubator space, so they can stay here no matter what size they grow to.

These macro trends really come home to roost here in our valley.

DONOHOE: The demand is there, but it’s tough for a developer to deliver the project.

PETERS: The economy is an efficient model if not interrupted.

At some point, if somebody pushes price points high enough, somebody will come out here and build that product.

It’s tougher to build today. It’s a product that’s desperately needed. But there isn’t institutional money there for it.

BACKER: Companies don’t plan their moves very well. It’s not always their fault because it’s growth-related. But time is the enemy of all deals.

Typically, from the time you have a signed lease, you need 15-18 months to move in to a build-to-suit.

When you have empty space, you have somewhere to move people into. When you don’t have that available, you could lose prospective new businesses -- they may not have the time to build something.

PETERS: Most companies have probably not done a build to suit before. They have a tough time looking a piece of land and visualizing the building. All they see is the risk.

SCHROEDER: They’re in the business of running their business. They’re not in the business of acquiring new property. We do want a certain amount of vacancy.

SCHROEDER: We want something we can show, so companies can start visualizing what it’s like to be out here and getting creative. It’s part of our attraction process. It’s a little bit of human nature.

What size spaces are companies looking for, and what have been the hurdles?

SCHROEDER: All sizes. That’s why we want to see more product come online, so they have more to choose from.

We’ve been in a recession, which has put these businesses in a hunker-down mentality. They will maximize their ability to survive in their existing space before they make a really big business decision.

PETERS: Picture it as a pyramid. In the bottom, the size range is 1,000-5,000 square feet. Once you get to the top, you’re in the 300,000-500,000 square foot range. Average demand is around 35,000-40,000 square feet.

In the ideal model, we have available spaces in all those different segments.

Then, we’ve got at least one building available that fits any company’s needs, so we don’t lose a client.

DONOHOE: We would all benefit from a program that would streamline the process of moving an out-of-area company into a build-to-suit.

If we cut that time frame from 15-18 months to 8-12 months, brought brokers and developers on board, and established a pre-arrangement with the city or the county, we could guarantee a maximum price for the building that a new company wants. We would already have gone through the process with the city or county, and could provide them the steps. We could assign them a project developer that would help the company from A-Z.

We have built spaces like that a couple times before -- that fast. If we had an agreement with the city to fast-track these things, now you’re talking about the same time frame it would take them to move anyway.

Because of cap rates, the cost for a new building is rapidly coming down to the cost of an existing space. With a build to suit, you’re willing to take less as a developer because you’ve taken a lot of risk off the table.

PETERS: Advanced Bionics and Precision Dynamics are both reasons why that type of team works.

DONOHOE: The more we use it and refine it, the more we develop a reputation that it works.

What makes Santa Clarita more attractive than other markets?

PETERS: Our buildings here are newer than, say, the San Fernando Valley. We have better clear heights, loading areas, fire protection systems, higher image, column spacing and parking.

Some of the older buildings in other areas were built in the 70s. They weren’t built to accommodate the super trucks on Interstate 5. From an efficiency and productivity standpoint, we’re able to deliver a class-A building.

Quality if life is also something we sell out here every day, as well as great housing options. We have a lot of amenities available out here, beyond just the functional components of a building.

DONOHOE: We also have industrial parks.

SCHROEDER: Because we’re in industrial parks, we’ve designed better transportation corridors. We have parks adjacent to the freeway and roads leading into those parks that accommodate the trucks. You’re not going down a narrow road in the middle of the valley that was designed in the 50s. It’s designed for the way goods move.

BACKER: The city and Newhall Land have done a good job of spreading those benefits around the valley.

But we, as a community, need to be a lot more aggressive at competing, not just in California but with Phoenix and Austin and all these other places.

What will we need to compete? Will bandwith become a part of that conversation?

BACKER: Yes, but it all comes back to: Do you want to pay for it? Infrastructure takes huge investment, sometimes too big for one company to pay for it.

I just got a notice the other day that AT&T is putting fiber in on Tourney Road.

SCHROEDER: Upgrades are coming slowly.

PETERS: Let’s fast forward past that. Everything will be paperless. The need for speed will be even more important 10 years from now. The whole way we do business is changing and evolving.

But there are myriad problems right now. Tenants may have the infrastructure but don’t want to pay for it. One company may end up paying for it for the entire building because they need it. Other companies may need it but don’t have the infrastructure and need to move.

We’ve got to get there if we want to be competitive going forward.

SCHROEDER: There’s a shift going on. The availability of fiber and bandwidth is becoming an infrastructure item -- and it didn’t even exist when we started building parts of this city.

It’s a new, national conversation. Who pays for it? Who’s in charge of it? Who is responsible for bringing it in? We need to monitor how the technology changes and figure out how to get it in place.

What about mixed-use buildings?

BACKER: We’re working on it. That’s what Vista Canyon is. It’s all there: 1,100 units, a metrolink station, miles of trails. You can do everything within a community. We would hope to start that next year, but it’s very difficult to create those environments. You need land and the ability to spread things around.

There are still a lot of people that don’t want that. But we talk about attracting the 20s, and we need to think about that moving forward.

A lot of business synergy happens in the business parks -- that’s part of the business clusters discussion.

It takes risk and money. Unfortunately, the banks aren’t set up to do it. Individuals aren’t set up to do it.

As ecommerce grows, are we too landlocked to attract those mega warehouse businesses?

PETERS: About the biggest building we can envision here is around 500,000 square feet, so I’m not sure we’re going to see those types of companies. We may see some ecommerce-related businesses.

The trend is: If I order it today, then I’ll get it today. That means more warehouses where populations are. When people start talking about delivering with drones, it changes the whole landscape. I think we’ll see some ecommerce and new media companies.

What do we see for Santa Clarita in the next year?

DONOHOE: Even with all the negatives, it’s still Southern California. There are a lot of pluses that will outweigh the negatives. A developer or institution will find a way to make work.

In 2015, you will see buildings up, and you will see them leased. That will spur more activity. Those buildings will be well-designed, state-of-the-art and have all the latest features, hopefully fiber and common spacing. Our building parks still look good; the new buildings will look even better.

I think the future is bright.

PETERS: You have a lot of marketing behind these projects on a regional and national level. That acts as a great attractor for new companies. Beyond that, we have Newhall Ranch and Vista Canyon kicking off, which will attract more people to this area. With people moving into homes, you start to see more businesses moving to the area, especially small ones. I’m very optimistic.

DONOHOE: The industry clusters already have a nice base, and they’re gaining momentum. If we provide additional space for them to move into, that will help us that much more.

SCHROEDER: One of the things we’re working on at the EDC is making it known that Santa Clarita is a city for business and industry. It’s remarkable to me how many people have lived here for years yet don’t really know how many businesses we have here.

We have nine business parks and 30 million square feet of commercial and industrial office space. We need to continue to get that word out. These projects provide a great springboard to continue that message and attract businesses in those clusters.

BACKER: Once these businesses start growing, they really go. We need to have the space available for them to move into.

But I’m like these guys -- we’re going to start seeing a lot of activity in the next 15 months. I hope Vista Canyon is among them. But activity begets interest.

I’m pretty optimistic about Santa Clarita.


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