Winter/Spring 2019 Survey

Allen Matkins and UCLA Anderson Forecast Partnerships

Welcome to the latest edition of the
Allen Matkins/UCLA Anderson Forecast

Trade wars, interest rate hikes, higher cap rates, falling equity values, and slowing employment growth all ought to affect the sentiment of developers as they consider new commercial real estate projects, particularly ones scheduled to open three years hence. In the latest (November/December 2018) Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey we again find none of these events have moved the needle from the November/December 2017 Survey. It seems clear that our panelists long ago discounted the uncertainty in the market, increasing cap rates, and slower economic growth, and although the last 12 months have been turbulent, they have not changed the panels’ views on California commercial real estate markets over the next three years.

Their perspective for CRE markets in California is simply that industrial space— warehouses in particular—will remain the hot market in spite of the fluctuations of the economy and the threat of trade wars. Similarly, the shortage of housing in California, even with a softening of the resale market, is such that multi-family housing remains strong. By contrast, the panels’ views of office and retail markets, while having specific niche opportunities, is that they have topped out for this cycle.

An important aspect of the survey is its ability to predict turning points in CRE markets. In a recent study of the indexes created from survey responses, this was demonstrated through two characteristics of the data.1 First, the prediction that optimism or pessimism as recorded by the survey indexes corresponded to higher or lower levels of development of new properties three years into the future. Second, trends in the survey data, to the limited extent the data can tell us at this point, indicate early warnings of directional shifts in the commercial real estate building cycle. In the current survey, those trends have continued to provide more confidence in the predictions of a decline in retail, the end of the boom cycle in office space, and the continued shortage of warehouse and distribution centers.

The Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey compiles the views of commercial real estate developers with respect to California markets three years hence. The three-year time horizon was chosen to approximate the average time a new commercial project requires for completion (though projects with significant environmental issues often take much longer). The panelists’ views on vacancy and rental rates are indicative of their own business plans for new projects, and so the Survey provides insights into new, not-yet-on-the-radar building projects and is a leading indicator of future commercial construction. For example, if a developer were optimistic about economic conditions in the industrial market of Sacramento in 2021, then initial work for a new project with an expected ready-for-occupancy date of 2021—a business plan, preliminary architecture, and a search for financial backing—would have to begin no later than early 2019. Although optimism does not always translate into new construction projects, this sentiment is a prerequisite for it.

Office Space Markets
Office Space Developer Sentiment Index
(>50 optimistic sentiment)
Office Space Developer Sentiment Index

Over the last year and a half, sentiment in four of the six office markets we survey has weakened. In the current survey, sentiment in the remaining two has dropped significantly. One of the highlights of the aforementioned analysis of the predic-tive capability of the survey indexes was that both the level of sentiment (positive, neutral, negative) and the trend in the in-dex are important. The survey now tells us that for California, office markets have peaked, and will over the next two years begin the more moderate part of the cycle.2

In the Bay Area, Silicon Valley is the only market exhibiting a clear trend. Though sentiment fell in both San Francisco and the East Bay, there is not enough data as yet to tell if this is statistically significant. The supporting data we collect—ac-tivity over the past 12 months, planned activity in the next 12 months, and weakness in leases—is mixed. Overall, Bay Area developers are not indicating an immediate cut-back in their development activity. In the East Bay, leases remain rela-tively firm while they are slightly weaker in San Francisco. And in Silicon Valley, the data indicates that the market has now topped out as the negative trend in sentiment continues and slow-walking and sublease activity picks up.

In the three Southern California markets surveyed, the pan-elists indicate increased weakness between now and 2021. Although actual and planned building is currently higher, in San Diego, Los Angeles, and Orange County developers see rental rates being eroded by inflation and vacancy rates in-creasing from today. Thus, even though office markets are relatively strong today, the responses by the panelists over the last two years has now signaled a slowdown in the office space markets.

Retail Markets

“In Los Angeles in general,
we're not seeing what other  
people are seeing right now  
in the retail market.  LA is a
healthy market.”

- Carine Mamann
Senior Director 
Cushman & Wakefield

The current survey extends the recent stretch of pessimism about future retail markets to two years. This has occurred in spite of good job growth, rising incomes, and more than three percent GDP growth. In the last 12 months, new projects were started by only 18 percent of our developer panel in the Bay Area and 38 percent in Southern California. Vacancy rates are expected to continue to deteriorate through 2021. While this is indicative of too much capital in brick-and-mortar retail in the aggregate, a bit over 30 percent of the panelists have found projects that will pencil out and are planning new develop-ments in 2019. New retail for housing, office, and hospitality projects provide niche opportunities in this space.

The recent holiday season has been good for some retail-ers and less so for others; particularly old-line mall anchors.3 Overall retail sales in the U.S. have increased at a 5.3 percent annual rate for the past year, but net store closings and tradi-tional shopping mall stress remain prevalent characteristics in this space, as they have for some time. This is, of course, be-cause of the shift away from brick-and-mortar to online shop-ping, resulting in too much aggregate space in retail markets.

Between the last two surveys, internet sales have grown at a 10.7 percent rate, twice that of total retail sales.4 As such, a net 2,900 store closings nationwide occurred in 2018.5 From the survey results, this is a phenomenon likely to continue in California for at least the next three years. A case in point is the recently announced conversion of the West Side Pavilion Mall in Los Angeles from retail to an office campus for Google.

Retail Developer Sentiment Index
(>50 optimistic sentiment)
Retail Developer Sentiment Index
Industrial Space Markets

“The industrial market is undersupplied today with the lowest vacancies we've ever seen in California history.”

- Darla Longo
Vice Chairman, Managing Director

Of the three major non-residential real estate markets, only industrial space is still trending upward. This is of course a mirror image of the decline in retail and it is bolstered by a continued increase in imports. Since industrial space is now dominated by warehousing and distribution centers, it is more sensitive to the continued growth in consumption. While the UCLA Anderson Forecast outlook for the economy is for GDP growth slowing to one percent nationally in 2019, real per-sonal income growth in California is expected to hold up and support the current expansion in industrial space.

In the East Bay, sentiment with regard to rental rates and va-cancy rates has been optimistic for the past 18 months. In ad-dition to robust demand for online consumption requiring dis-tribution centers to serve seven million Bay Area residents, the ports, serving a wider geographical area, have experienced increased traffic in the second half of 2018. Since our last survey, seaport traffic in the region has increased at an annual rate of approximately nine percent, and air cargo at Oakland International Airport and the two Sacramento airports, Sacra-mento International and Mather, increased at an annual rate of 3.4 percent through November. With low vacancy rates and increasing freight movement, it is not a surprise that our panelists are optimistic about the next three years in the East Bay, and San Joaquin and Sacramento counties. As evidence of this, 80 percent of the panelists started a new industrial space project in the four-county region last year and 80 percent will begin at least one this year, with three-quarters of them plan-ning for more than one new project.

The same optimism is present in all three of the Southern California markets surveyed. Over the last three years the panelists have viewed these markets as playing catch-up with demand, and the expectation is that this will continue through 2021. Continued growth at the ports and strong consumer de-mand nationwide is adding to demand, particularly in the In-land Empire. Over this time there has been an increase in new projects started by our panelists. During the last 12 months, a larger proportion of them began new projects than they origi-nally anticipated in last year’s survey. It is estimated that 15 million square feet of new industrial space is under construc-tion in the Inland Empire, and that absorption will take it off the market rapidly.6 Absent interruption in imports due to national trade policy, the industrial space market in Southern California ought to remain strong.

Industrial Space Developer Sentiment Index
(>50 optimistic)
Industrial Space Developer Sentiment Index (>50 optimistic)
Multi-Family Housing Space Markets

“We're seeing a mixed bag in California with
respect to commerical real estate. 
Industrial markets continue to do well.
Office markets seemed to have topped out.
Retail is still hurting. The housing markets  
remain tight in California so multi-family 
will continue to do well over the next
three years. 

- Jerry Nickelsburg
UCLA Anderson Forecast

The multi-family market sentiment is decidedly mixed. In the Bay Area, occupancy rates are expected to creep down over the next three years and rental rates are expected to outpace inflation, though not by much, in the same time frame. Overall, three quarters of our panelists plan on starting new projects in 2019 and over half expect to start multiple projects. However, the expected slowing of job growth coupled with new building signals the end of increasingly tight Bay Area housing mar-kets, but not an end to the relatively high cost of housing.

In Southern California, three-fourths of the panelists are once again planning new projects, with about half expecting to be-gin more than one multi-family development. The panel’s expectations are that rental rates will continue to rise faster than inflation and that occupancy rates will remain high. The implication is that even though job growth in Southern Califor-nia is expected to slow, the building process will not keep up with the growth in demand. This is consistent with the UCLA Anderson Forecast7 projections through 2020 and with a sep-arate analysis by Fannie Mae8 economists.

Multi-Family Space Developer Sentiment Index 
(>50 optimistic)
Multi-Family Housing Developer Sentiment Index (>50 optimistic)
The Survey in Perspective

The Allen Matkins/UCLA Anderson Forecast CRE Survey and indexes provide a window into the evolution of California’s CRE markets. The latest survey shows no significant impact of the headwinds to the economy from policy in Washington with respect to changes in the tax laws, trade policy, Fed policy, and gridlock. The underlying fundamentals, strength in housing and warehousing, weakness in retail, and a slowing of office using employment, as they reflect on future demand for CRE, have been unchanged through 2018. As divided government and trade negotiations with China take us into 2019, it is not expected that these trends will change signifi-cantly, though unexpected economic news may exacerbate or moderate them.

UCLA Anderson Forecast