Urban Growth Supplants California's Orange Groves

By Maura Webber Sadovi
From

A cooling economy and rising commercial vacancy rates in Southern California's Inland Empire haven't slowed a torrent of new stores, offices and supersize distribution warehouses.

The two-county area extends east from Los Angeles to the Arizona and Nevada borders and includes a mix of suburban tracts, dwindling agricultural land and expansive desert as well as the longtime resort destination of Palm Springs and such fast-growing cities as Riverside and Ontario.

The region traces its nickname to the 19th century, when it was known as the "Orange Empire" because of its citrus crop. In the past 20 years it has become a wunderkind of the warehouse-distribution sector, and more recently, a haven for residents priced out of coastal Southern California. That pushed up the population to 3.9 million last year and made it more populous than about two dozen states. "We are today's Orange County," says John Husing, an economist with consulting firm Economics & Politics Inc., based in Redlands, Calif.

During the past year, both population and economic growth have downshifted, albeit from white-hot levels to still enviable above-average rates. Total net migration dropped to 91,400 last year from a peak of 109,700 in 2003. New residents still were arriving at about three times the national rate in the 12 months ended June 30, according to Moody's. Year-to-year job growth for the region in August fell to 3%, from a 5% pace in the year-earlier period, according to the Bureau of Labor Statistics.

At the same time, new construction is expected to nudge up vacancy rates in the warehouse, office and retail sectors, though rental rates are also forecast to rise, according to Property & Portfolio Research Inc., a Boston-based real-estate research firm. The shift is subtle but notable in the robust warehouse sector, where vacancy rates ticked up slightly to 5% in the second quarter from 4.7% in the first quarter -- the first quarterly upward movement since early 2003, PPR says.

Developers -- led by the warehouse sector, including some of the country's largest distribution centers -- appear undaunted. The Inland Empire was the biggest warehouse builder in the nation of 54 major markets surveyed by PPR for the 12 months ended in June, during which some 15.4 million square feet were completed. The average annual pace of supply growth will slow through 2010, but PPR says the market will remain the nation's lead warehouse builder over the period, followed by Chicago and Dallas-Fort Worth. Other sectors are also ramping up. About 4.7 million square feet of retail space is scheduled to be completed this year, up 13% from last year, plus 2.5 million square feet of office space, up 18% from 2005.

Market watchers say the warehouse sector will remain strong, thanks to the region's proximity to the flood of Asian imports coming into the ports of Los Angeles and Long Beach, and to its relatively cheap rents -- at least compared with coastal prices.

Denver-based ProLogis, which owns more than 26 million square feet of industrial distribution space built or under development in the region, is continuing to expand. This summer, ProLogis purchased a 700,000-square-foot industrial building in Redlands for an undisclosed price, and recently signed leases with clients that will fully occupy a 1.2 million-square-foot speculative distribution warehouse it completed last year in nearby Rialto. "The Inland Empire is at a high point in the cycle," says Larry H. Harmsen, managing director of North American capital deployment for ProLogis. "I think it's a broad peak that will last some time because of the fundamentally strong demand."

Office developers, who have enjoyed strong demand for space from mortgage companies and home builders, could be more vulnerable to a housing slowdown. More than half of the 120,000 jobs created in the area between the first quarter of 2002 and the first quarter of 2005 were tied to the housing market, PPR says.

Chris Atkinson, vice president ofBates Co., a real-estate company in Monrovia, Calif., says the profile of tenants he expects to fill his planned 10-story speculative office building in Ontario by the time it's completed in about two years could shift to include more accountants and law firms and fewer real-estate companies. However, he says new office construction is the natural follow to the industrial and retail expansion the region has seen to date. "Everyone's skeptically optimistic," he says.

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