Business Press Article
July, 2006

by
John Husing, Ph.D

Inland Empire's Surging Office Market.

Glance around the major cities in the Inland Empire and you see it everywhere ... steel frames moving into the air. After being dormant for over a decade, the region’s office market is suddenly on a hot streak. The data tells what is happening … but not why!

Growth Replaces The Doldrums. From 1991-2002, the Inland Empire’s office market was a scary place. First, Grubb & Ellis found that net absorption of space by users fell for six straight years until it went below zero in 1996-1997 (see Exhibit 1). In that period, more space was being vacated than was being leased. That was followed by a false recovery with absorption growing to a high of just under 1.0 million square feet in early 2001. However, just when office brokers and developers were starting to feel comfortable, the market again plunged, falling below zero by early 2002. If investors were not frightened before, that should have scared them away.

Since then, the inland area’s market has gain considerable strength. In 2003, it moved up to a record plateau with net positive absorption at a four quarter running average of 1.2 million square feet. For some reason, far more office space was being taken than vacated. In 2004, the market appeared to swoon again, falling to low as 400,000 square feet of net absorption. But, this time the cause was not firms giving up space. Rather, the problem was a lack of available space to meet the continuing demand for it. This was seen when the vacancy rate fell from 10.4% in first quarter 2004 to 9.5% in the fourth quarter.

Seeing these conditions, several developers decided to build new Class A and B facilities bring the totals in the area’s major markets to Riverside (5.1 million sq.ft.), San Bernardino (3.4 million sq.ft.), Ontario (3.9 million sq.ft.), Rancho Cucamonga (3.0 million sq.ft.), Corona (1.4 million sq.ft.) and Temecula (1.4 million sq.ft.). They have not been disappointed. In 2005, absorption reached a four quarter running average of 1.9 million square feet and stayed at that record plateau into first quarter 2006. Amazingly, despite 3.2 million square feet of construction from first quarter 2004 to first quarter 2006, the vacancy rate fell from 10.4% to 7.0%. Depending on who is doing the rankings, that registers as one of the three tightest office markets in the U.S.

Lease Rates Rise. Of equal importance is the fact that the lease rates in several Inland Empire markets are now yielding returns to owners that compete with what they are earning in several of Southern California’s coastal county markets. This gives developers and investors incentives to continue building in the region. Thus, in March 2006, CB Richard Ellis indicated that office space in Corona was leasing for $2.08 per square foot a month (Exhibit 2). In nearby areas, that was above three of Orange County’s five sub-markets (west, central, north). Ontario ($1.99 sq.ft./mo.) and Riverside’s Hunter Park ($1.97 sq.ft./mo.) ranked above two of Orange County’s markets (central, north) as well as several markets in San Diego County. Southwest Riverside County ($1.91 sq.ft./mo.) and Downtown Riverside ($1.85 sq.ft./mo.) bracketed north Orange County and yielded higher rents than places like South Bay near LAX or Visa and Escondido in San Diego County.

Housing And The Office Surge. There are three essential reasons for the surge in the Inland Empire’s office market. In the Corona and Riverwalk area of Riverside, much of the increase in demand can be attributed to the residential real estate market. Thus, in first quarter 2006, Dataquick found that a record 55.6% of all new detached single family homes sold from the Mexican border through and including Ventura County were located in the inland area. As a result, virtually every major home builder now has opened a main office or a regional office in the region. Many of the architects, civil engineers, land planners, surveyors and other professionals that work for the industry have done so as well. Accompanying them have been the back office operations of the large financial groups that process mortgage loans, escrow documents, title and property insurance.

A risk for office developers in this portion of the Inland Empire’s office market is whether this segment of the demand will stick if there is a prolonged lull in residential demand. As the phenomenon is new, the answer is not obvious. However, one fact argues strongly for them to stay … dirt … or rather the lack of it in Southern California’s coastal counties. Like it or not, most of home builders will be specializing in the inland region for the foreseeable future.

Growing Economic And The Office Surge. In other areas of the Inland Empire, the growing demand for space is being powered by the fact that the region’s economy has become a powerhouse. Its population is now 4.0 million, making it larger than 24 states starting with Oregon. The job base is now 1.27 million, equal to San Diego County in 2004. In addition, the 2030 forecasts by the Southern California and San Diego associations of government anticipate that the region will add more people and jobs than Orange, San Diego, Ventura and Imperial counties combined from 2000-2020. In 2005, for instance, the area added 56,700 jobs or more than Orange and San Diego together (53,800). Office based firms can no longer easily compete to serve a population and economy that are this big and expanding this fast from their coastal locations. There is thus a growing need for them to lease space in the Inland Empire. Given the forecasts for the region, it is hard to see the demand for office space going any direction but up.