Small tenants push industrial building market in Sacramento Region

Sacramento Business Journal

From the August 1, 2005 print edition

Small tenants push industrial building market

Mike McCarthy

Staff Writer

Greater Sacramento's industrial real estate market is headed for its best year by far since 2001 -- the result of a recovering economy, population growth, the housing boom and the spread of new stores and restaurants.

The huge leases by West Coast distribution operations that dominated the Sacramento warehouse market in the late 20th century may be permanently headed away from Sacramento toward cheaper land in other areas, observers say. Instead, the local market now caters to the myriad smaller tenants that serve growing communities.

Still, the upswing is good news for industrial landlords like Buzz Oates Cos., and McClellan Park, the huge business park being created from the former McClellan Air Force Base.

"We could have a banner year at McClellan if everything happens that we're dreaming of," said Nate Ellis, a vice president of leasing at McClellan Park. He said leasing at the project is on track to double this year. McClellan is not the only submarket having a good time.

Maybe 3 million this year

Through the first six months of this year, the total amount of industrial space occupied -- the "net absorption" -- in Sacramento, Yolo, Placer and El Dorado counties grew by 1.9 million square feet, passing or almost matching the annual tally for each of the past three years, according to CB Richard Ellis.

Grubb & Ellis reports that the Sacramento region's net absorption leasing has reached 1.98 million square, almost double the net for the first half of last year.

Grubb & Ellis counted most of this year's volume in the second quarter, while CB Richard Ellis says most of the growth happened in the first quarter. Commercial real estate brokerages tend to take slightly different approaches to figuring market trends. But the outcome is the same: The year so far is looking strong.

The last really good year for the market was 2001, when occupied space grew by 6.5 million square feet, according to the brokerage. But even if this year is not that big, the industry seems satisfied.

"It's been a pretty good year," said Mike Lyons, a veteran industrial broker with CB Richard Ellis. "Based on the kind of inquiries we're getting, we could hit 3 million square feet."
The first quarter was strong, with occupancy growing by 1.7 million square feet. Net absorption in the second quarter reached only 201,255 square feet. But the third quarter should strong, he said.

Why leasing is up

"It's because of normal expansion of the economy and pent-up demand," said Kevin Ramos, president of Buzz Oates Real Estate. "It's been OK the past few years. But it hasn't been as hot as in the past."

Historically, Ramos said, this market grows by about 4 million square feet per year.
"One reason for the growth is that so many people moved here to live," said Dave Leatherby, a veteran industrial broker with Colliers International.

Population growth and new-home construction create the demand for stores and services; in turn, that expansion stimulates demand for more distribution space.

The leases this year come from companies "all across the board," meaning the basic companies one might see in a diversified, growing economy, Lyons said.

McClellan Park saw some of the biggest leases this quarter, including a 42,000-square-foot lease by First Data Government Solutions, a company that processes data, including payroll checks.

McClellan also leased 93,000 square feet to Nelson's Marine Inc., which stores boats and RVs, and 78,000 square feet to Loman Trucking.

"Business in general is growing," Ellis said. "Four or five larger tenants came here just because there are new business opportunities for them in Sacramento. It must be the new jobs."
Construction down, rents up

The analysts also noted that industrial construction is down this year. Just 1 million square feet of space was under construction at the end of the second quarter, compared to 1.5 million square feet at the end of last year, according to CB Richard Ellis.

Construction has been slow since 2000, when it reached 4 million square feet by year's end. The volume dropped to 2.1 million square feet at the end of 2001 and has generally hovered between 1.2 million and 2 million square feet since then.

Much of this decline has been attributed to weaker demand after the dot-com economy flopped. But these days, local observers cite the scarcity and cost of industrially zoned land, combined with the rising cost of materials and public fees.

Ramos said the cost of industrial land has risen to $5 to $6 per square foot, sometimes more, from $2 to $3 a square foot just two years ago. Also, some of the relatively small supply of industrial land has been rezoned for hotter uses, including housing.

"We're getting to the point," Lyons said, "where there is no land for businesses to expand or modernize here."

These factors, plus the increasing cost of materials, have driven up the cost of "delivering" a building to the market by about 30 percent since 2003, Ramos estimated.

The combination of rising land and construction prices and slowed construction is pressuring rents upwards as well, he said, and this is driving some bigger tenants to Stockton, Tracy and other markets outside Greater Sacramento.