Commercial Real Estate Expected to Keep Sizzling

By BOB HOWARD

Dec. 31, 1997 12 AM PT

SPECIAL TO THE TIMES

Virtually everyone agrees: 1997 was the best year this decade for commercial real estate in Southern California, and 1998 promises more of the same.

Having pulled out of its slump in late 1995 and hit its stride in 1996, the commercial real estate industry fairly roared in ’97.

“This was the best year in a long time,” said Jay Haskell, president of Seeley Co., a commercial real estate brokerage.

The only questions, according to Haskell and other experts, are whether the buying and selling of properties can continue at the sometimes frantic pace seen in 1997 and whether Asian economic troubles will affect this region’s commercial real estate markets.

But barring any unforeseen downturns or unexpectedly harsh fallout from Asia’s woes, real estate observers predict another solid year for those who own, buy, sell, lease and broker office, industrial, retail and apartment properties in Southern California.

A preliminary forecast by Hessam Nadji, a senior vice president at Marcus May & Millichap Research Services, says 1998 will register “the strongest overall property performance in nearly a decade.” He predicts that rents will continue to rise, prompting construction of office and industrial buildings. Investing will get trickier because rising prices mean buyers can no longer find the rock-bottom bargains of a few years ago.

The rising property prices are in large part the result of buying sprees by real estate investment trusts. Many in the industry consider 1997 the “year of the REIT,” and one factor shaping 1998 will be whether REITs invest in real estate as heavily as they did this year.

“I’m not sure the [REIT] activity can continue at the level it has for the past 12 months, but I would expect it to continue for at least the first six months and to slow toward the end of the year,” Haskell said.

Even if the REIT binge slows somewhat, other investors are expected to pick up the slack.

“Underneath the radar screen of the REITs is a whole new bevy of investors looking for properties that don’t fit the REIT profile,” said Mike Ibarra, a managing director with CB Commercial Real Estate Group. These other investors, ranging from individuals to Wall Street investment funds, are looking for properties that are either too small or for other reasons not attractive to REITs.

Since REITs have already bought many of the biggest properties and portfolios, Ibarra said, the main difference between 1997 and 1998 may be in the price of properties sold. “The number of transactions and the average size went up in 1997, but in 1998 we may see the average size decrease even though the number of transactions will probably go up again this year,” Ibarra said.

Besides the breakneck pace at which REITs bought property in 1997, one of the most remarkable developments was the comeback in rental rates in the most sought-after business neighborhoods.

“All of a sudden, we have vacancy rates below 10% in most of the Westside markets,” said Howard Sadowsky, an executive vice president with Julien J. Studley Inc. in Westwood.

Rents, which have been rising steadily in Santa Monica, Century City, Beverly Hills and other popular Westside markets, jumped dramatically in just the last quarter, Sadowsky said.

Tenants held the upper hand in lease negotiations just a few years ago, thanks to a plentiful supply of office space, Sadowsky said, but conditions now favor landlords in those desirable markets.

“As the economy continues to improve, a number of industries have a greater demand for space, particularly the entertainment industry in our area,” Sadowsky said. “We will continue to see a tightening of the marketplace and fewer options for tenants.”

But those conditions won’t last long, according to Sadowsky, who expects new office buildings to be built and some tenants to leave more expensive Westside markets for places such as the Miracle Mile and San Fernando Valley.

“The real question is how much of the space being spoken about will be built,” Sadowsky said. “If a lot of it gets built, then rents will not go up as fast. If very little gets built, then rental rates will increase considerably.”

If new space isn’t built soon in some markets, according to Ibarra of CB Commercial, leasing activity will slacken.

“Once space becomes really constrained historically, what usually happens is that the markets slow a little bit until the next construction boom begins. We have not hit that construction boom yet, meaning there will not be huge blocks of space available in some markets, so the pace may slow a little bit in those places,” Ibarra said.

But any such slowdowns will be temporary, observers say. Among the markets expected to remain soft is Los Angeles’ Mid-Wilshire district, which Sadowsky said will remain a tough sell for landlords trying to rent space.

On the other hand, Sadowsky said the long-languishing central business district in downtown Los Angeles is finally showing signs of recovery, albeit much weaker signs than those on the Westside.

The contrast between the strongest and weakest markets makes it tough to generalize about the future of Southern California, where some areas can sizzle while others fizzle.

But a preliminary Grubb & Ellis Co. forecast says rents in general will rise throughout the region as the amount of empty office and industrial space declines during 1998. The national brokerage firm foresees construction in places where demand is strongest, but it suggests the construction “will not significantly alleviate the space crunch until 1999.”

While the experts foresee growth in demand for both office and industrial space, they do raise “the Asian question” regarding industrial space.

“Everybody has been saying one of the reasons L.A. will continue to do well in light-industrial and warehouse space is its connection to the Asian markets,” Ibarra said. “It will be interesting to see if the problems in Asia have any impact on the demand for space here.”

In general, however, the forecasters expect the improving Southern California economy to carry the commercial real estate markets along with it. That includes the apartment market, which has improved as rents have increased and vacancies declined, according to Marcus & Millichap.

“Record-low vacancies and rent hikes in the San Francisco Bay Area, coupled with the recovering markets of San Diego, Orange County and Los Angeles, have elevated the California market to a top performer in the past 12 to 18 months,” the Marcus & Millichap forecast says.

Although they speak confidently about the prospects for most kinds of commercial real estate buildings, forecasters say the outlook isn’t quite as clear in the retail segment, which hasn’t improved as dramatically as the other sectors.

“Retail is still a question mark,” Ibarra said. “Theories on what’s going to happen in retail range from the major mall as we know it is dead because people are going to do everything electronically in the future, to just the opposite--that human beings by their nature are social and they still want to shop in person and gather together.”

One result of this wide spectrum of theories is hesitation on the part of developers, who are building some retail space but are generally being much more cautious than they were in previous boom times, Ibarra said.

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Vanishing Vacancy

A look at year-end projected vacancy rates in Los Angeles and Orange counties:

Los Angeles County:

Orange County:

Office Vacancy Rates

‘98**

Los Angeles County: 15.1%

Orange County: 5.8%

Industtrial Vacancy Rates

‘98**

Los Angeles County: 7.6%