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California Commercial Real Estate to Be Negatively Affected Through 2023 Due to Impact of Pandemic


In the wake of the current pandemic-induced economic recession, the Summer 2020 Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey shows uniform pessimism and a drop in sentiment for developers across all commercial real estate spaces in 2023. The biannual survey projects a three-year-ahead outlook for California's commercial real estate industry and forecasts potential opportunities and challenges impacting the office, multi-family, retail, and industrial sectors.

Overall, survey panelists see office market demand decreasing due to work-from-home policies, industrial only moderately decreasing due to the shift to online shopping, retail continuing its downward spiral, and multi-family only moderately decreasing due to the continued shortage of housing across the state.

Demand Uncertainty Fuels Office Space Market Pessimism

Given the continuing pandemic, there is much uncertainty about how the experience of working from home will affect todayís office space market. The panelists' shared sentiment is about as gloomy as it was in December 2008, during the height of an implosion of economic activity. They see rising vacancy rates and downward pressure on rents over the next three years. This is consistent with the UCLA Anderson Forecastís projection that a rapid return to pre-recession, office-using employment is not likely.

The implication of the drop in sentiment is, as in 2008, a continued decrease in new office construction over the ensuing three years. Although half of the Bay Area and Southern California panelists said their plans for the coming 12 months were unaffected by the pandemic, one-third are ramping back development by more than 15 percent from their previous plans. For the third that will engage in some new development, the panelists in each market believed that land, building materials, and labor costs would be more favorable. Given the uncertainty about office space demand, these responses seem reasonable and indicate growth in development beginning in late 2021 and a slow return to pre-recession levels.

Industrial Demand Drops Less Than Other Sectors Due to Increased Online Shopping

Although there has been consistently high occupancy and superior rate growth in the industrial market over the past several years, the deep economic recession has caused sentiment expressed in our latest survey to drop precipitously in all markets except the East Bay Area. However, the panelistsí actions also indicate that they do not feel as pessimistic as the overall index suggests. Sixty percent of the panelists in Southern California and 43 percent in Northern California are planning at least one new development in the next 12 months, and 39 percent and 29 percent are planning multiple projects, respectively. When one considers that this is in the middle of a recession with a great deal of overall economic uncertainty, these numbers are quite telling.

With an increase in household savings, a recession, and a continued trade war with China, there will be near-term downward pressure on rental and occupancy rates. However, this is from a very high level. If the demand for warehouse space and the stock of warehouses are increasing at about the same rate as projected, then 2023 will see a mild erosion of rental rates when adjusted for inflation, and there remains the possibility of some erosion in occupancy. However, that does not mean that industrial space markets will be depressed, rather that they will not be as imbalanced as in recent years.

Recession Furthers Retailís Downward Spiral

The current recession has tripled down on the struggles retail already faced during the previous economic expansion. First, household loss of income and shelter-in-place policies reduced current demand for brick and mortar retail. Second, the inability to physically frequent many retail establishments created a new set of online shoppers. Third, increases in the savings rate on the part of households in response to the recession portends less consumption. To be sure, some activities will return, particularly personal services and experiential retail. However, marginal properties will not find tenants willing to pay sufficient rent to keep the properties in the retail space.

The pessimism expressed by panelists from the Bay Area and Southern California in the latest survey is an extension of the trends from the past three years. The current view is that retail properties will be generating significantly lower returns in 2023 compared to the middle of 2020. In the Bay Area and Southern California, two-thirds of panelists will not develop any new properties in the coming 12 months. Approximately the same percentage expect difficulty with current leases and expect plummeting property values.

Continued Housing Demand Minimizes Multi-Family Market Downturn

Though the pessimism that has come with the recession has hit each of the multi-family markets in the state equally, the view that rental and occupancy rates will not be as good as they are at present has not affected the rate of activity by developers.

As the economy grows, the demand for housing in the Bay Area and Southern California will grow alongside it. Though the UCLA Anderson Forecast is looking at a 30-month recovery in the State, and there remains a great deal of uncertainty with regard to the current public health crisis, it is likely that the market for multi-family housing will remain robust. Indeed, in spite of the turnaround in sentiment from each of the six panels, almost three-fourths of the Southern California panelists and two-thirds of the Bay Area panelists have stated that the pandemic has either not changed their plans for future activity or increased it. Thus, we expect to observe a quick turnaround in this sectorís sentiment with the December 2020 survey.

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, in furtherance of their interest in improving the quality of current information and forecasts of commercial real estate.

About Allen Matkins
Allen Matkins, founded in 1977, is a California-based law firm with more than 200 attorneys in four major metropolitan areas of California: Los Angeles, Orange County, San Diego, and San Francisco. The firm's areas of focus include real estate, construction, land use, environmental, and natural resources; corporate and securities, real estate and commercial finance, bankruptcy, restructurings and creditors' rights, joint ventures, and tax; labor and employment; and trials, litigation, risk management, and alternative dispute resolution in all of these areas.

About UCLA Anderson Forecast
UCLA Anderson Forecast is one of the most widely watched and often-cited economic outlooks for California and the nation and was unique in predicting both the seriousness of the early-1990s downturn in California and the strength of the State's rebound since 1993. More recently, the Forecast was credited as the first major U.S. economic forecasting group to declare the recession of 2001.

About UCLA Anderson School of Management
UCLA Anderson School of Management is among the leading business schools in the world, with faculty members globally renowned for their teaching excellence and research in advancing management thinking. Located in Los Angeles, gateway to the growing economies of Latin America and Asia and a city that personifies innovation in a diverse range of endeavors, UCLA Andersonís MBA, Fully Employed MBA, Executive MBA, UCLA-NUS Executive MBA for Asia Pacific, Master of Financial Engineering, Master of Science in Business Analytics, doctoral and executive education programs embody the schoolís Think in the Next ethos. Annually, some 1,800 students are trained to be global leaders seeking the business models and community solutions of tomorrow.

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