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June 27, 2017
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Election Seen as Having Little Impact on California Commercial Real Estate

2/02/17

The Winter/Spring 2017 Allen Matkins/UCLA Anderson Forecast Commercial Real Estate Survey, taken entirely after the November 8th election, shows no discernable economic shift, despite Hillary Clinton having been the heavy favorite among state residents. The biannual survey projects a three-year-ahead outlook for California's commercial real estate industry and forecasts potential opportunities and challenges affecting office, multi-family, retail and industrial sectors.

Observations from 2016 remained unchanged, and the natural cycle in commercial real estate appears to be running its course somewhat independent of the presidential contest. This may be due “to the upward bump in consumer confidence and stock prices and in part because the regulatory environment in California is not likely to change much,” says Jerry Nickelsburg, Adjunct Professor of Economics at UCLA Anderson School of Management and Senior Economist with the UCLA Anderson Forecast. “While the outlook for 2017 may look relatively good, the strong move towards online shopping, higher interest rates, a continued redefinition of the office environment, and the dropping of fertility rates [remain the] driving factors in commercial real estate.”

More Evidence of Topping Out in Office Space Markets

The latest survey provides continued evidence of a new topping out in the office market space. For each of the six California regions surveyed, the trend in positive developer sentiment—which peaked in the middle of 2014—has weakened, indicating we are experiencing the end of the office boom. Developers have become more pessimistic about real rental rate growth and vacancy rates. However, pessimistic sentiment does not mean office space demand is imploding. Rather, it says that one ought not expect it to be more robust in 2019 than it is today.

For the Southern California panels, sentiment has slowly diminished, indicating the survey participants believe the office market will be no better, but no worse, in three years. Those surveyed are still optimistic, but barely so.

The outlook is different in the Bay Area. The San Francisco, Silicon Valley, and East Bay panels all think that by 2019 real rental rates and vacancy rates will be worse than today. The downward trend is now decidedly pessimistic relative to other markets, in spite of Propositions M and C, which limit both new building and the conversion of existing B and C office space in the city.

Multi-Family Residential Markets: Too Much Housing?

Multi-family developer optimism has remained strong and consistent over the first four years of the survey. The demand for multi-family housing tends to follow job growth in the more densely populated regions of California. Hence, one would expect multi-family housing demand to remain strong and builders to continue to churn out new units. But survey results suggest this market has topped out as well. This is one case where the trends were not there prior to developer sentiment turning down.

While there have been limited new building permits for homes, California has been overbuilding high-end, multi-family housing. This has occurred both because job growth in tech has generated more high-income earners, and the cost of land in the coastal cities and the cost of the building process pushes builders away from low-to-no-margin apartments, except in less expensive parts of the state.

Industrial Markets Remain on Fire

The basic underlying economic forces driving the demand for industrial space in California are manufacturing; the export of goods to Asia and Mexico; U.S. importation of consumer goods from the manufacturing centers in Asia; and of increasing importance, e-commerce. The current survey of industrial space developers indicates little change in sentiment compared to last year. Industrial markets, particularly the warehouse segment, remain on fire. This optimism, expressed in each of the regions surveyed, continues to be manifested in new building. With extremely low vacancy rates at present and an optimistic view by developers, the building boom should continue through at least 2019.

The shift to e-commerce is happening faster than warehouse space is being built, resulting in a strong demand for space. For example, warehouses in the San Pedro Bay to Inland Empire region used to be an extension of the ports, but are now an industry in their own right. The bump in income in late 2017 and early 2018 is forecast to push import growth even faster. In conjunction with e-commerce, this will continue the strong demand for warehouses.

Experience-Shopping Trends Still Driving Retail

For the past several years, retail has been undergoing a profound change from distribution conduits to experience-shopping venues. Online purchases shift retail demand from brick and mortar distribution to warehouse distribution systems, and with the continued strength in industrial space, one would expect developers to have a negative sentiment towards retail. Yet, the survey only observes strong pessimism in Los Angeles and Orange County.

The answer for the other regions may lie in recent increases in spending power in the Bay Area and San Diego, the increases in home construction, and a general move towards experience-based retail. Nationwide, brick and mortar retail is up, however, this is very location-specific. Many retailers in old-line outlets nationwide are reporting flat-to-negative sales numbers for the last holiday season.

Tax cuts and upscale shopping in the Bay Area may make developers optimistic overall, but perhaps not so much as to jump in with a new retail project. In Southern California, spending power has come to upscale consumers a little later, and the refurbishment of somewhat tired malls is now attractive.

About the Survey

The Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey and Index Research Project polled a panel of California real estate professionals in the development and investment markets, on various aspects of the commercial real estate market. The survey is designed to capture incipient activity by commercial real estate developers. To achieve this goal, the panel looks at the markets three years in the future, and building conditions over the three-year period. The survey was initiated by Allen Matkins and the UCLA Anderson Forecast in 2006, furtherance of their interest in improving the quality of current information and forecasts of commercial real estate.





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