Commercial real estate outlook in California a mixed bag

Multifamily and industrial are going strong, but other sectors slowly recovering

Commercial real estate outlook in California a mixed bag

The economic woes of California – the nation’s biggest state after Alaska and Texas, respectively – have been greatly exaggerated. That’s the contention of a new study suffused with optimism about the Golden State’s promise in the next few years.

The Summer 2022 Allen Matkins/UCLA Anderson Forecast California Real Estate Survey contends “…there is much more optimism about the next three years than the barrage of negative news about the economy might suggest,” according to its authors. Although analysts acknowledge past optimism expressed in last winter’s iteration of the survey predicting the office and retail markets would turn positive in the near term failed to materialize, optimism is still held for the sectors in the long term.

Greater optimism is shared for the state’s industrial and multifamily markets, albeit at a more tempered pitch than what was thought six months ago, analysts concluded.

The study is not new, but a biannual survey that’s been produced since 2006 with an aim of improving the quality of current information and forecasts of commercial real estate. Mortgage Professional America reached out to John Allen Matkins partner John Tipton (pictured) for more insights into the survey’s latest findings.

“I think if you’re hearing only doom and gloom about the California economy, that might be a little overwrought,” Tipton began. “The economy has been pretty good out here. The pandemic obviously just scrambled everything everywhere, and we’re still seeing that play out, certainly in the real estate market – although I think if anything it’s probably accentuated trends that were already happening over time as opposed to actually changing the trend itself. The possible exception to that may be office space which truly may have had a bit of structural realignment coming out of the pandemic.”

Read more: Housing woes yield bonanza for multifamily investors

The survey covered four main CRE markets: Office, industrial, multifamily and retail. Tipton addressed each segment during his interview with MPA.

Continued uncertainty dampens office market sentiment

The pandemic reared its ugly head across the office market, reversing an erstwhile optimistic trajectory given continual delays among many employees in returning to the workplace, according to the findings. Investors’ resistance rooted in pandemic-fueled uncertainty about near-term economic prospects contributed to a downturn in Southern California, with a more neutral view in the northern part of the state, analysts found. Sentiment about development remains slightly optimistic in the Bay Area – “…though there are not yet plans in place to increase the rate of development,” according to the survey.

The prevailing feeling is that pessimism will evaporate as companies increasingly put plans into place to return their workforce to office settings, which could usher in a need for new office development, according to the survey.

“This is the one area where there is still the most uncertainty,” Tipton conceded. “Before the pandemic hit, you already had firms that were doing a couple of things: One being a little more cautious with their space, and in some cases downsizing, but you also had more common amenities – places for people to gather and work together and be collaborative – so that was a general change in the design of office. The pandemic hits and you have several things come out of that. One was, gee, maybe people don’t want to be on top of each other quite as much as before. Two, you have that so many people have been working remotely, at least in part, for so long and gee, it actually seems to work pretty well for existing employees who know what they’re doing and now doing their job elsewhere. But you also have the fact that as things go on that way when you’re trying to onboard new talent it’s really hard if there’s all kinds of collaborative work, and learning the culture of the place and getting to know people.”

Multi-year optimism continues for growing industrial market 

At the other end of the spectrum is the industrial market, which has seen consistently high occupancy rates and superior rate growth over the past few years, the survey found. Such optimism continues with the latest CRE study, Tipton noted. The sector’s success is attributable to rapid industrial development barely keeping up with absorption – leaving plenty of demand for additional supply.

Consistently high occupancy rates and superior lease rate growth have kept the optimism high for all industrial markets, according to survey findings. The current survey predicts more of the same — that significant future increases in demand will outstrip planned and projected 2025 supply. This view of an even tighter market stems in part from the fact that demand in the last few years has driven vacancy rates to their astonishingly low levels, analysts found.

Read next: Multifamily sector is red hot for investors

Tipton shared the sentiment, crediting much of the bolstered pace of the industrial market to an increase in online shopping – a trend that is largely attributable to the pandemic and the attendant tactics of physical distancing to avert the spread of infection.

“You think about the acceleration of online shopping – crazy expansion,” Tipton said. Once resistant of such shopping options, he’s now a believer himself, he added: “I was not an early adapter, but I adapted. You simply have the dynamics that there is a lot of supply that’s being built, but it’s being immediately absorbed. Inevitably, things ultimately will come into equilibrium. But this has been a growth segment where the demand has stayed ahead of the supply, and it’s been go, go, go.”

Multiple factors fuel continued multifamily market expansion

Optimism looms for the multifamily market in California, despite the pandemic-induced demand for homes in the suburbs and a continued work-from-home culture, surveyors found. Market watchers are especially optimistic in terms of sector growth in the next three years, although slightly less than a year ago. Developments across California should mirror those being forecast nationwide positing that rental rates will increase faster than the rate of inflation while vacancy rates fall between now and 2025, according to the survey.

“Although the continued waves of the pandemic delayed some return to the office, the reopening of city amenities and the creative and social value derived from urban experiences are attractors that are expected to prompt increased multi-family living in urban areas, particularly among younger workers,” the survey’s authors wrote.

Tipton pointed to a number of factors that have helped to bolster the multifamily market. Foremost: “It’s really expensive to buy a house in California, so you have that underlying thing that’s always there.” A shortage of housing stock has also helped bolster the sector.

And in recent times – in another lingering remnant of pandemic-fueled change – state regulators have relaxed laws to make it easier to build multifamily projects, which should usher in bolstered construction activity: “It’s going to be interesting to see how those play out in the real world because they kind of bypass local building ordinance and restrictions,” he said, referring to the relaxed rules for building. “So it’s go-time for multifamily.”

Retail outlook continues slow rebound

So multifamily and industrial are going gangbusters. Retail? Not so much. “Despite a looming recession and continued economic uncertainty, retail sentiment continues to rebound from the bottom of the cycle,” analysts wrote. “The latest survey indicates optimism in most markets aside from San Francisco and Los Angeles, where pessimism continues due to many people continuing to work from home and a lack of foreign tourism.”

In the other markets, a limited return to the office has increased demand for retail in the core of each city, the survey found, while the building of new housing throughout California has created demand for new retail close to that housing.

Pundits also expect demand for reconfigured retail establishments to more open air – decidedly post-COVID if you will – concepts likely to attract consumers back to stores. Furthermore, a strong housing market is expected to continue generating demand for retail throughout the state – leading to an expected “turnaround” in retail development and a new retail building cycle expected to begin before the end of 2025.

“Industrial has been the A-plus student for a long time,” Tipton said succinctly.

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