Real estate markets will have varied levels of success and some struggles in 2018, depending on property type, location and shifting demands, according to Richard Green, director of the USC Lusk Center for Real Estate.
“On the [residential] rental side, we think there will be some gains in rents this year, but they will be muted compared to years past,” Green said. “The reason for that is the vacancy rates are still very low despite the fact that there is a fair amount of stuff coming online.”
Real estate experts project a strong year for industrial space but a difficult year for retail, as the model shifts to experiential shopping. Long Beach Exchange at Douglas Park is a 265,000-square-foot retail development that combines conventional retail with experiential concepts and is slated to open on May 12. (Photograph by the Business Journal’s Brandon Richardson)
Over the last several months, Green noted that overall rental rates in Southern California have fallen slightly, but that trend depends greatly on location. In areas such as Orange County, where inventory is low and new development is scarce, Green said he expects rental rates to continue to climb. However, in pockets of Los Angeles County, where development has increased greatly in the past several years, he expects rates to begin to soften or at least flatten out.
Green explained that it is unlikely for values of single-family homes and condominiums to keep rising. Home prices have surpassed affordability for the average Californian, causing more residents to rent. While home prices increased up to 7% last year, Green said he does not expect to see more than 2% growth in 2018.
“I think [commercial real estate] will be a lot like it has been in the last few years. We expect the industrial [market] to do very well. They just can’t build it fast enough and that reflects how the economy more broadly is changing,” Green said. “Retail I expect to continue to struggle. Office depends very much on location and type.”
The outlook for traditional office space is “ugly,” according to Green, with more and more businesses seeking alternative, creative space to conduct business. He explained that 15 years ago, the average U.S. employee occupied around 230 square feet, but today that number has dropped to around 160 square feet and is expected to continue decrease. Further exacerbating the problem is that job growth has not been enough to offset the decreased need for space, Green said, noting that automation is replacing people in many instances.
A shrinking middle class and a decrease in disposable income – as well as the popularity of Internet retailers like Amazon – has resulted in many stores, such as Sears and Kmart, to begin shuttering locations. Green explained that high- and low-end stores are surviving because those markets are increasing in population as the middle class dissolves.
“Beyond the fact that incomes in the middle haven’t risen, they are spending more of their income on housing, more of their income on health care and, with this new tax bill, the middle class is ultimately going to be spending more in taxes,” Green said. “That means there just isn’t money there to support these stores. People just don’t have money, and retail spending is about money.”
Editor’s note: The following are guest perspectives by industry executives on the outlook for real estate in 2018.
Office Space
Becky Blair
President, Coldwell Banker Commercial BLAIR WESTMAC
On the national front, 2017 experienced fewer tenant expansions and the supply growth remained unchanged, according to the most recent REIS report. Research from that same report of 79 metropolitan areas showed declining absorption. This is in turn making it hard for landlords to be able to raise rents. However, developers are being very cautious as to where and how much office product they build, allowing for a continued equilibrium of absorption this past year. The Long Beach area averaged about a 2% increase in asking rents and the 3rd quarter showed a 13.3% vacancy rate.
Because Long Beach is a small business market, there is a trend for some office users to purchase their own buildings as opposed to leasing space, which is also negatively impacting office occupancy. Although we are closing in at the top of the market for single-purpose building sales, this trend still has a strong following with business owners and could negatively impact office lease rates in 2018.
Another popular trend continues to be smaller businesses using less office space per employee as well as more creative, open-space plans versus private offices. Because of this trend, several office landlords I’ve talked with recently are renegotiating leases early to secure tenants for longer terms.
Most experts are predicting that office vacancies will remain at around 13% in 2018 or may even edge up depending on likely interest rate increases. Although the outlook may be slow to no growth, Long Beach is having its best development surge since 1990. With a new civic center, infrastructure projects like the Gerald Desmond bridge and major redevelopment and new mixed-use projects throughout the city. Long Beach could surprise the critics and surpass the regional anticipated growth in the coming year.
Dave Smith
Senior Vice President, CBRE
2018 should bring steady progress in leasing activity in both Suburban and Downtown Long Beach. In Downtown Long Beach, recently renovated buildings such as 211 Ocean, The Hubb and One World Trade Center will benefit from their ability to deliver the type of space and amenities that tenants are seeking. With few large blocks of available space, there is very little chance of one or two large transactions substantially impacting the market. Most buildings should see modest improvement to their relatively healthy occupancy. One World Trade Center presents the best opportunity for a large company with the recent renovation of the project and availability of over 200,000 square feet. A steady stream of new companies should be expected to flow into Long Beach, following those from 2017 that included Pacific6 and Altech Electronics at 211 Ocean Blvd., The Children’s Institute at 1500 Hughes Way, and Expeditors at 4900 Airport Plaza Dr.
The management shakeup at Molina Healthcare led to significant layoffs and retrenching of their office footprint. Molina’s downsizing presents near term challenges to the market, but over the long term, it will lead to a healthier and more diversified market.
Rental rates should continue their steady increase across all classes of buildings. Rates will remain well below levels that would justify new development so it is unlikely there will be any significant new construction over the near term. There is continuing demand from small companies to buy their own buildings so smaller developments of product for sale, similar to The Terminal at Douglas Park, is the only type of development that would make economic sense.
Continuing diversification of the tenant base and ongoing improvement in building and market amenities should make 2018 a good year for the Long Beach office market. It will also continue to provide the building blocks for a healthy market over the long term.
Residential Real Estate
Leslie Appleton-Young
Vice President & Chief Economist, California Association of Realtors
With the economy expected to grow at a slightly faster pace and the labor market remaining solid, housing demand should remain strong. The question is where the supply will be coming from. This issue will not be resolved overnight and the California Association of Realtors (CAR) expects a tight supply condition in the coming year, as concerns about the demographic shift, property taxes and capital gains continue to be factors that prevent homeowners from listing their properties. While CAR expects the economy to have a stronger growth in 2018, tight supply conditions, low housing affordability, the likelihood of an interest rate hike and the ongoing uncertainty in the policy arena provide a less than favorable environment for the housing market. As such, CAR projects that existing home sales in California will have grown at 1.3% in 2017 and 1.0% in 2018.
Home prices also are forecasted to grow next year, as supply shortage and strong housing demand continue to dictate the market and exert upward pressure on prices. Housing affordability will be negatively impacted as a result and could be a force to counterbalance the price appreciation created by the market competition. The tug of war between the two forces will elevate the statewide median home price to a higher level but keep price appreciation under control. CAR is expecting the state median price to have grown 7.2% in 2017, and will continue to rise at a more moderate 4.2% in 2018.
With home prices growing faster than income, housing affordability continues to deteriorate, and fewer Californians are able to make the jump back into owning their own homes. The supply constraints have created an excess-demand situation that is putting further upward pressure on home prices as the economy creates more jobs and incomes start to rise. As interest rates are also expected to rise in 2018, the cost of carrying the typical mortgage will increase, thereby reducing affordability even more in the upcoming year. As such, homeownership may get worse before it gets better.
Steve Bogoyevac
Senior Vice President Investments, Marcus & Millichap
Long Beach has seen tremendous growth in rents and values in recent years. Local private investors have pushed Class C apartment returns to sub-three percent yields, with the average price per unit over $200,000 per door. Developers are underway on nearly 2,500 new units, most of which will come online during 2018. This increase in inventory will influence rates and vacancy in 2018. Long Beach’s vacancy rate rose 50 basis points over the past 12 months to 2.9%.
However, relative to other submarkets in the Los Angeles area, Long Beach rent remains affordable despite a 7.3 percent bump in monthly rates.
Velocity may be a future indicator of how the market will react in 2018. In the last market cycle, 2004 presented us with the last clear peak in velocity. This was followed two years later, in 2006, by the last peak in all four pricing indicators: price per square foot, price per unit, cap rate, and GRM. We saw a small decrease in velocity in 2017 from previous years and will be tracking this and its effect on values closely in 2018.
Investors should keep in mind that we’re now on Year 11 of the real estate cycle as measured from peak to present. In the hockey world, we’d be in overtime.
The present real estate market is significantly different than the last cycle, however. While interest rates have increased slightly, there is still ample lending for the foreseeable future, and there is plenty of capital available for investment via exchanges and money looking for competitive returns.
Furthermore, apartment values could be significantly impacted if the California Legislature votes to repeal the Costa-Hawkins Act, as proposed in a bill introduced in early January. If Costa-Hawkins is repealed, cities will be authorized to permanently control the rent of all properties. We caution investors to keep in mind that even if Costa-Hawkins is repealed, cities would still need to have their own votes in order to enact rent control ordinances.
Phil Jones
Broker/Owner, Coldwell Banker Coastal Alliance
Forecasting the real estate market leaves much to chance and resembles the polling of who will win a Presidential election. Having said that, let me begin by addressing a frequently asked question, is the housing market in a bubble? There really isn’t any evidence to support an argument that it is, when looking at the highly regarded Case-Shiller index. As a matter of fact, the index reflects that the last six years appear to be very normal relative to the previous 40 years, with very steady growth in the market between 4% to 7%. None of the factors that contributed to the Great Recession, including liberal loan underwriting standards or double-digit appreciation are present in the market.
What will real estate in 2018 be like? Most real estate economists believe we will see elements in the market that closely resemble those of last year’s. The dominant factor remains the very restricted inventory. Currently, the Greater Long Beach market has approximately a two-month supply of residential properties for sale, when the norm is considered to be a six-month supply. This, of course, puts considerable pressure on buyers, particularly first-time consumers. It also creates a dynamic where home prices continue to appreciate, currently about 6% to 7% year over year, which is relatively moderate given the strong demand. Finally, interest rates have been holding in a stable range, between 4% to 4.5%, although the expectation is that there will be gradual increases throughout the year.
The trends of 2017 reflected a decrease of listed properties of 6.7%, closed transactions were down 2.2% and inventory dropped 13.9% as compared to 2016. Overall, a reasonably steady marketplace.
Steve Warshauer and George Bustamante
Vice Presidents, Coldwell Bank Commercial BLAIR WESTMAC
The outlook for 2018 multi-family commercial real estate remains optimistic, with caution. There are several positives for the economy coming out of 2017. Most evident from last year is that unemployment hit new lows and the stock market hit record highs.
Looking ahead, we have good reason to remain optimistic. Real GDP appears likely to expand close to 3% in the coming year, which is a big improvement over the 2% growth seen in 2015 and 2016. Tax reform is complete and businesses will reset, causing the economy to continue to see continued growth in 2018.
The fundamentals for multi-family investments are still tied to supply, demand, costs of capital and income levels. The persistent supply/demand imbalance remains intact for 2018. That means continued low vacancy rates (sub 4% for Long Beach), landlord pricing power and tenants’ limited supply for affordable rental housing. Interest rates remain at historic low levels but are expected to climb slowly as the economy improves.
The investment market appears to be peaking based on the most recent CoStar reports, showing a slowdown in the sales activity and bottoming out of CAP rates for the last quarter of 2017 in Long Beach. Investors and lenders are expected to closely monitor property fundamentals in the markets and property sectors they invest in for 2018, as the U.S. economy continues its extended recovery and the Fed continues to increase rates.
Despite record low unemployment, increased consumer confidence and a strong stock market, many in the industry see slower growth ahead for rent increases and property prices. As the capital market moves later into the current real estate cycle, financial services firms are maintaining an optimistic outlook for the U.S. economy, although many are also recommending a cautious approach.
Industrial Real Estate
Brandon Carrillo
Principal, Lee & Associates
Incredible demand has outstripped the limited supply in the Long Beach industrial real estate market. Market signals shows us that this trend shall continue into 2018. The direct industrial vacancy rate in the Long Beach marketplace is hovering around historic lows of 1%. Rents have increased around 10% since the 1st Quarter of 2017. The vacancy rate this time last year was 0.7%, which, despite the numerous construction projects in the pipeline and those delivered into the marketplace, have not had an effect on the vacancy rate. Sale volume has increased immensely throughout the year from $76.8 million in the 1st Quarter to $316 million for the 3rd Quarter. Lack of land sites had an effect on development activity in the LA/Long Beach region with 1.1 million square feet (SF) under construction, down from the previous quarter of 1.8 million SF. Cap [capitalization] Rates continue to be pushed downwardly as investors clamor for limited quality investment projects in the area.
Rexford Industrial acquired Rancho Pacifica Business Park, one of the largest industrial parks located in the South Bay. Rexford’s investment flexibility allowed them to close the 1.17M SF Class A project in 13 days for $210.5 million. Toyota’s Headquarters in Torrance consisting of 110 acres of industrial, office and land was sold to Sares-Regis for $270 million. Looking forward, small and medium sized businesses will continue to get squeezed by historically high lease rates. The demand for buildings continues to grow and shows no signs of leveling off. This trend should continue, and be a great opportunity for property owners to capture these historically high values. Low interest rates will continue to encourage business owners to take advantage of the favorable market conditions. As seen in 2017, industrial property for lease or sale will continue to be difficult to find while new facilities will be built to support ecommerce fulfillment centers and the shift towards electronic retailing.
James Flynn
President, The Carson Companies
The 2018 outlook for industrial real estate is very strong; in fact, it is the strongest I have seen in my 34-year career.
There is a perfect storm of demand drivers for industrial real estate. Manufacturing is returning to the United States; E-commerce is expanding rapidly, moving goods from traditional retail stores back to logistics centers; and finally, the consumer, driven by a very strong economy, is quite active.
The difficulty finding infill sites suited or zoned for industrial property in the Los Angeles market is creating a critical shortage of space for companies to expand or locate in the Los Angeles area. The vacancy rate in Los Angeles is approximately 1%, an all-time low. As a result, rents and industrial sale prices are increasing very rapidly. By our estimate, rents in the South Bay area of Los Angeles have increased 17% in 2017 alone. Los Angeles is a very difficult environment to get entitlements and permits to develop or redevelop property for an industrial use. Unless the Los Angeles area addresses these difficulties in permitting industrial uses, there will continue to be a critical shortage of space for companies with an industrial use in the Los Angeles area.
Carson Companies, which originated from a Spanish land grant in the Carson area in the 1700s, now operates in Southern California, Pennsylvania, New Jersey and Houston, Texas. The demand drivers for industrial space are consistent throughout all of these markets as well as much of the nation. Due to the difficulties in permitting and finding industrial land sites in the Los Angeles area, most of our new activity is outside of the Los Angeles area and the State of California.
Retail Real Estate
Scott Burnham
Founder and Chief Executive Officer, Burnham USA
While the new tax reform has caused some to pause, there is actually much reason for commercial developers to be optimistic in 2018 and beyond. Economic optimism in the economy was generally felt this past week when the DOW closed for the first time in history above 25,000.
We have good economic momentum as we roll into the new year with both consumer spending and investment steadily growing.
With the passing of the new tax reform, consumers will have more disposable income to spend on retail purchases, which will generally help support an otherwise ailing retailing industry-in-transition. Business is also now incentivized to spend more on equipment. At the same time, corporate taxes will be reduced and will play a positive role on employment within the greater U.S. economy, with the creation of more jobs.
The corporate tax rate changes should also attract more foreign investment in U.S. commercial real estate, driving demand; and at the same time, the tax changes will discourage corporate inversion and the moving of dollars abroad, which are now more likely to stay in the U.S.
Pass-through entities that are prevalent ownership structures in commercial real estate will also benefit with lower taxes, while like-kind 1031 exchange laws will remain intact.
Overall, the tax changes in 2018 are a very good thing for our commercial real estate industry and will encourage more U.S. investment and incentivize the real estate industry itself to invest and build more.
Together with job growth, the industrial and office sectors will continue to experience improved occupancies, and the retail sector will continue to evolve with the collapse of the older retail models such as Macy’s, J.C. Penney, etc., while consumers demand a better and more improved shopping experience.
All in all, the outlook for 2018 looks bright!
Doug Shea
Partner at Centennial Advisers
We must look globally to predict what is going to happen locally. A couple of trends that we must look at for 2018: new tenant makeup and the downsizing or closing of some big box retailers.
Mall owners are shrinking apparel users as the majority of tenants in a mall. As early as eight years ago, the tenant makeup of apparel to general was 70/30. It is now down to about 50% regionally and I predict will be down to 40% by 2020. The landlords are changing as they see the number of apparel shops closing. According to IHL Group, a global research and advisory firm for the retail and hospitality industries, the sector is set to lose 3,137 stores like the ones we have seen for 2017 – American Apparel, Abercrombie & Fitch, Gap, The Limited, Rue21 and Wet Seal, to name a few.
What does this mean for Long Beach and the surrounding cities? Existing malls and potential new malls will need to incorporate more restaurants, entertainment, service, fitness and other new uses. It is about the experience as much as the retail purchase, if not more.
The big-box department store closures will total approximately 400 stores this year. The retailers are Sears, Kmart, Macy’s, and J.C. Penney. How much longer will the Sears and the Super Kmart on Bellflower Boulevard survive? The full notification of all of the locations has not been released yet. These closings will affect Southern California and Long Beach in a number of ways. There will be changes of use that were not even considered before.
Good examples of the change will be self-storage, medical and dental, residential, office, hotel, entertainment (theaters) and educational facilities. All of the aforementioned will create new opportunities to the surrounding neighborhoods.