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Latest Allen Matkins / UCLA Anderson Forecast California CRE Survey Suggests Federal Tax Overhaul Favors the Commercial Real Estate Industry

2/05/18

The Winter/Spring 2018 Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey reflects the favorable changes to the CRE market caused by the recent federal tax overhaul. The tax bill is expected to increase the rate of return on commercial real estate and makes investment more attractive. Survey participants predict it will cause moderate though uneven growth. 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.

Tax Bill Causes Mixed Outlook in Office Space Markets

The most recent survey, taken in December, showed increased office developer sentiment for each of the Northern California office markets and marked the first time since June 2015 that all three markets – San Francisco, East Bay and Silicon Valley – have effectively been at least at the dividing line between optimism and pessimism. Similarly, the sentiment for San Diego and Orange County markets has also rebounded from the June 2017 survey. In each of these markets this indicates future rental rates and vacancy rates will be better than they are today. The Los Angeles market, which did not previously see a decline in sentiment, continues to have optimistic sentiment by the survey panel thanks to the entertainment and tech sectors; industries which continue to grow and max out the demand for office products.

Developers in all but the Los Angeles market had expressed the view that office markets would experience a decline in value three years hence until this last survey; a survey in which they see optimism across all markets. However, this change in developer sentiment has not yet induced a change in the panelists’ behavior. These seemingly contradictory facts can be attributed to the recently passed tax overhaul, which, because it is more favorable for commercial real estate owners and developers, leads to the prospect of higher profits and optimism. Nevertheless, the panelists don’t think the difference is enough to change the fundamentals in these markets in a way that would lead them to increase their rate of development. However, if sentiment remains elevated, it ought to lead to more office construction in the future.

E-Commerce Continues to Drive Hot Industrial Markets

Though last June’s panel saw the Bay Area industrial market as being at its peak, events since then, including expected consumer spending increases due to the tax overhaul, have led the panelists to now conclude that there will not be enough industrial space in three years, and that today’s high occupancy rates will hold or continue to rise. In turn, rental rates will increase in step with the lack of available space.

The outlook for Southern California is for a moderate increase in plans for new industrial projects relative to a year ago. This is likely caused by the large increase in imports from Asia, as well as indicators that the economy is still growing.

In addition to import logistics, increased warehouse space will continue to be demanded by e-commerce firms. This demand has slowed a bit from its recent peak, but it is still very high throughout Southern California. With high occupancy rates and an improvement in market conditions, panelists predict an increase in rental rates and a market that will continue to drive new industrial structure construction.

Pessimism for Retail Market Endures Despite Tax Overhaul

Though the tax overhaul was supposed to spur higher returns of investment throughout commercial real estate sectors, that does not seem to be the case in retail development. In fact, the panelists in each of the six California regions surveyed are more pessimistic now than they were before the tax bill passed. Though there have been reports of a strong holiday buying season for brick-and-mortar retail establishments this year, e-commerce and online retail business led by Amazon Prime is growing at a much higher rate. This trend continues to cause the closing of many California stores, including retailers Sears, Kmart, Walmart, Kitson and Macy's, despite the fact that the economy continues to grow.

In the Bay Area, none of our panel of retail developers started a new retail project last year, and very few are planning on starting one this year. In Southern California, just over half of the panel began new retail projects last year, while only a third plan to develop retail in the next year. There are still opportunities out there, but retail is overbuilt in general.

Multi-Family Housing Market Sentiment Remains Positive, Unchanged

There has been no significant change in multi-family developer expectations since the previous survey last June. But unlike retail, multi-family is performing well for investors. Consequently, permits for new units rose by 12.8 percent from the previous year.

Developer activity falls in line with this outlook. In both the Bay Area and Southern California, many more developers have plans to start new projects this year than last year. Vacancy rates throughout Southern California are expected to remain the same or slightly increase throughout the rest of the decade.

The panelists' views on land prices in Northern and Southern California do differ though. The Bay Area’s extremely expensive markets have reached an equilibrium and the cost of land is expected to increase at about the rate of inflation. However, Southern California land prices are believed by the panelists to be increasing faster than the rate of inflation. This can be attributed to job growth in the Southland and the speed at which housing is able to be built. The optimistic sentiment throughout the state shows that the continually growing demand for rental units is reflecting a shortage of housing that continues to affect all California markets.

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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