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Allen Matkins/UCLA Anderson Forecast California CRE Survey Finds Adaptive Reuse of Office Buildings is on the Rise

2/14/24

This report provided by Allen Matkins and UCLA Anderson School of Management

The Winter 2024 Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey (“The Winter 2024 Forecast” or “the Forecast”) just released reveals that nearly a quarter (21%) of California real estate owners and operators plan to redevelop existing office space over the next three years for alternative purposes across multifamily, industrial and retail. The findings underscore the industry’s growing lack of conviction in the sector as high interest rates, declining valuations and ongoing remote work continue to impact office buildings across the nation.

The Allen Matkins/UCLA Anderson Forecast is a bi-annual survey that polls a panel of California’s real estate professionals to project a three-year ahead outlook for commercial real estate and the macroeconomic trends impacting industry participants across the multifamily, office, retail and industrial markets.

Allen Matkins partner John Tipton said: “With a significant portion of the office market continuing to underperform, there is increased focus on the conversion of older and obsolete product into more productive uses such as housing or mixed-use facilities. While the financial aspect of adaptive reuse projects remains a key challenge in 2024, we expect to see a growing emphasis on the conversion of office buildings to uses that better support local economies in the coming years, in California and throughout the country.”

Office development experiences steep decline

Amid ongoing discussions about the redevelopment of underperforming office buildings, panelists expect that the office sector will not fully recover until the end of 2026 as rental and occupancy rates weaken. As such, new development of office space continues to rapidly decline.

Respondents in Northern California anticipate no new development in 2024 as traditional office hubs such as San Francisco reach vacancy rates of 35.6%, whereas 20% expected to initiate at least one new office project a year ago. While 17% of respondents in Southern California expect to begin at least one new office project in the next 12 months, this figure is down from 29% in Q1 2023, with vacancies in the Greater Los Angeles area currently at 21.9%.

As corporate tenants evaluate their real estate needs, the office leasing process is becoming more complex. In the Winter 2024 Forecast, all San Francisco and East Bay respondents, 90% of Silicon Valley, Los Angeles, Orange County and San Diego respondents, and 85% of Inland Empire and Sacramento respondents observed increased subleases or slow-walking of the office leasing process.

Crystal Lofing, partner at Allen Matkins, said: “Office owners are eager to fill their buildings, and, as a result, we are seeing an increase in turnkey buildouts where landlords assume construction costs and risks that, traditionally, tenants taking a material amount of space would have been responsible for. The landlords that are more flexible and more willing to take on complex projects are best positioned to boost occupancies.”

Retail’s rebound begins

Following a period of cautious optimism about the retail market, the Winter 2024 Forecast finds that respondents are now bullish on the opportunity set for retail, with 80% expecting demand to grow faster than supply. This shift in sentiment is largely driven by limited new development of retail space over the last decade paired with growing retailers’ interest in expanding their physical footprint, ultimately increasing competition for space and rent costs.

As the retail market begins its resurgence, more than 50% of the Forecast respondents expect to initiate at least one new development project in 2024. Nearly half of respondents (46%) will prioritize residential-serving retail development in the coming years, especially as remote- and hybrid-work models drive demand for neighborhood-centric retail options such as grocery and convenience stores.

Jonathan Lorenzen, partner at Allen Matkins, said: “New retail development projects will largely be influenced by the end customer, with spaces designed to maintain consistent foot traffic and, in turn, drive tenant demand. Whether it’s an urban storefront or a suburban neighborhood shopping center, developers must closely consider how a project’s location and amenities will support a convenient shopper experience that drives repeat business.”

Industrial demand balances out

The Winter 2024 Forecast paints a mixed picture for the industrial sector over the next three years. Development activity remains strong, with 74% of Southern California panelists and 56% of Northern California respondents planning new projects in the next 12 months. At the same time, panelists expect supply to grow faster than demand, signaling that new development will eventually begin to cool.

Nearly half (49%) of respondents report e-commerce as the primary driver of new industrial development. The rising use of artificial intelligence (“AI”) and the corresponding demand for data center space is also beginning to influence new industrial development. Sixteen percent of Forecast respondents cite the AI boom and digital infrastructure as the primary driver of industrial development, ahead of cold storage and electric vehicle facilities.

“While industrial growth has slowed, the sector is expected to remain relatively healthy in the coming years with strong leasing activity and new construction,” said Drew Emmel, partner at Allen Matkins. “Emerging trends such as the commercialization of AI will drive demand in the industrial space, especially for facilities that meet the unique needs of digital infrastructure tenants.”

Multifamily begins to feel macroeconomic pressures

Despite California continuing to experience a housing shortage, in Northern California, 68% of Forecast panelists report no plans for new multifamily development in the coming 12 months, which can be attributed to high interest rates and rising construction costs.
Sentiment is more optimistic in Southern California, with 55% of respondents planning new development.

For new projects, multifamily developers are leaning into continued remote- and hybrid-work strategies, with developers listing in-home office and co-working spaces, as well as community-oriented spaces, as their top design considerations. Sustainability features are also top of mind for developers working on new multifamily projects.

“In recent years, the multifamily sector exhibited resiliency to many of the economic challenges impacting the broader commercial property market,” said Jennifer Jeffers, Senior Counsel at Allen Matkins. “However, in 2024, a significant decline in new construction activity is projected due to high interest rates, a scarcity of construction financing, and skyrocketing materials and labor costs. Although multifamily supply projections are very submarket specific, the overall demand for housing throughout California remains strong. As such, we expect to see construction levels begin to rebound in the next 12-18 months as supply and demand find equilibrium and as capital markets and interest rates ease.”

About the Survey

The Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey and Index 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.




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