The Evolution of Small-Bay Industrial Development in California

Demand drivers and underwriting considerations

For years, industrial development in California was largely a story about scale. Bigger buildings, higher clear heights, larger truck courts and enormous distribution footprints dominated both the development pipeline and the conversation surrounding it.

Small-bay industrial was often treated as something else entirely. Older product. Local tenants. Smaller leases. Useful, certainly, but not particularly exciting from a development standpoint.

That perception deserves another look.

Demand for smaller industrial space has proven remarkably durable, particularly in infill markets where contractors, service companies, distributors, manufacturers and other local businesses need functional space close to their customers. At the same time, relatively little modern small-bay product has been added to many markets. CBRE’s research found that vacancy for shallow-bay industrial began running below overall industrial vacancy in 2017, with demand increasingly tied to service-oriented businesses and last-mile distribution.

The opportunity, however, is not simply to build smaller buildings. The more important question is whether developers are underwriting them differently.

The Tenant Base Has Changed

The traditional image of the small industrial tenant does not quite capture today’s demand.

A 5,000- or 10,000-square-foot user might be an electrical contractor, specialty manufacturer, building-services company, equipment supplier, e-commerce operator or regional distributor. Many of these businesses are not choosing industrial space based solely on the lowest rent available. They are looking for locations that make their businesses work.

That changes what “good industrial real estate” means.

Access to customers and employees matters. Parking matters. Loading matters. Power can matter enormously for certain users. Secure outdoor areas can be valuable. So can the ability to combine warehouse, office and operational functions without paying for substantially more space than the business actually needs.

This is part of a broader shift toward functional industrial space. CBRE’s 2026 occupier research found that cost, lease flexibility, transportation access and modern building characteristics are playing significant roles in tenant decisions.

For a small-bay developer, that creates an important distinction: square footage alone does not create the product. Functionality does.

Small-Bay Economics Require Different Math

One of the easiest mistakes is taking the underwriting logic of a larger industrial development and simply shrinking it.

Small-bay projects can carry more complexity per square foot. More demising walls. More entrances. More restrooms. More office improvements. More electrical distribution. More parking considerations. More individual tenant improvements. Eventually, more leases to negotiate and manage.

A 60,000-square-foot building divided among ten tenants is a fundamentally different operating proposition from the same building occupied by one tenant.

That additional complexity needs to appear in the underwriting before construction begins.

Developers should be asking what the realistic tenant size is for the submarket, how frequently suites may turn, what level of improvements tenants will expect and whether the proposed configuration allows units to expand or contract without expensive reconstruction.

There is also a temptation to justify higher development costs with higher projected rents simply because smaller industrial suites often command a premium on a per-square-foot basis.

That premium may be real. It should not automatically be treated as unlimited.

Industrial occupiers are paying close attention to occupancy costs, and CBRE notes that affordability pressures are becoming particularly relevant for light-industrial tenants. A project can be perfectly designed for its market and still struggle if the rent required to support its basis exceeds what local businesses can reasonably absorb.

Design for the Second Tenant, Not Just the First

Small-bay development also rewards flexibility in a way that larger industrial projects sometimes do not.

Imagine underwriting a 40,000-square-foot project as eight 5,000-square-foot suites because that configuration produces the strongest rent assumptions. What happens if actual demand arrives in 2,500-, 7,500- and 10,000-square-foot increments?

The building should be able to respond.

Bay spacing, utility locations, loading positions, fire separation, parking allocation and office configurations can either preserve that flexibility or quietly eliminate it.

This is where developers can gain an advantage before a shovel ever hits the ground. Instead of asking only, “What tenant are we building for?” ask, “How many different tenants could this building accommodate over the next 15 years?”

California’s industrial inventory makes that question particularly relevant. Occupiers nationally continue to demonstrate a preference for newer, more functional facilities, while older inventory is increasingly vulnerable to obsolescence.

The building that can accommodate several types and sizes of businesses has more ways to remain relevant.

The Opportunity Is in the Details

California industrial development is not suddenly becoming a small-bay story. Large distribution, manufacturing and logistics facilities will continue to represent an important part of the market.

But small-bay deserves to be evaluated on its own merits.

Recent California sentiment supports a more constructive industrial outlook. The Summer 2026 Allen Matkins/UCLA Anderson Forecast survey found that respondents expect industrial vacancies to decline in Los Angeles, the Inland Empire, Orange County and the East Bay, while development intentions increased in both Northern and Southern California.

For developers considering small-bay projects, that does not mean every infill parcel is an opportunity. Quite the opposite. The smaller the tenant, the more important it becomes to understand exactly who will occupy the building, what they can afford and what operational features they actually need.

That means underwriting demand at the suite level, not simply the building level. It means testing rents against the economics of the businesses expected to pay them. It means treating parking, power, loading, circulation and divisibility as financial decisions, not merely design decisions.

Small-bay industrial can look simple from the street.

The development strategy behind a successful project should be anything but.