Dec

CBRE Northern California 2008 Outlook–LC’s Take

By LC

CB Richard Ellis is the largest real estate services company in the world, and each year about this time they hold a market outlook in various locations worldwide. The Northern California outlook was held on the evening of December 11, in Sacramento. Here are some of the highlights, with some comments:

Office: The State of California continues to support the downtown office market, with continuing expansion even in face of the budget deficit. The biggest deal of the year was the Department of Corrections expansion and relo.

The Roseville market is the largest trouble spot, with a staggering 250,000 square feet of sublease space available, with another 300,000 SF of space going vertical for 2008 delivery. The current vacancy is about 18% and climbing. 2008 absorption is expected to be down for the region, but stable to up for the downtown market.

Despite the oversupply in some markets, net job creation was still about 7,000 for the region, largely from the government sector. There are two problem areas, both real estate related-mortgage companies and homebuilder offices, both of which are largely vacant now. An exception is the reverse-mortgage business; Liberty Mortgage in Rancho is undergoing a huge expansion. The baby-boomers are retiring and reverse mortgages hold an appeal for us.

Elk Grove is not on the radar and has been largely discounted due to high costs, commuter resistance, and the availability of deeply discounted sublease deals in Roseville.

Housing: Good news and bad news. The bad news is that the region’s housing market values decreased by over 11% in 2007, and the current home values are around 2003 levels. 2008 is expected to take another hit roughly equal to 2007 due to excess inventory and variable loans converting to fixed rates at higher levels than the borrowers anticipated. The good news is that Sacramento has once again returned to one of the most affordable areas in California. Residential land for new homes has no market, but is expected to sell off to land bankers willing to hold for 2-5 years in 2008.

Apartments: Rent levels have not kept pace with construction costs, and the shadow market of speculator-held single family homes are further depressing rents. Clearly a renters market, 2008 will see some stabilization as speculator properties are transferred to owner occs and rental supplies decrease.

Industrial: Other than the small owner-user buildings for which there is little to no demand, industrial remains the bright spot in the region. While the Central Valley from Stockton south is a rapid growth area due to the proximity to the Port of Oakland and low cost, Sacramento has not been overbuilt for the 20,000 - 60,000 hi-cube properties which is traditionally our mainstay and demand is unchanged. The 7% vacancy factor in this market is the lowest of any sector.

Investments: Merchant developers who build to sell and didn’t peddle their projects in early 2007 will see price reductions of about 10% - 15% next year. While the investment specialist predicted an increase in interest rates, I disagree. I believe that while we do have inflation it is largely in the energy sector and that GDP will stagnate to the point that we will see rate cuts of at least 200 basis points under the current levels by this time next year. Concerned about defaults, debt investors are on the sidelines, and we may see A and B product in shorter supply, acting to stabilize values and pricing.

Retail: The retail sector was described as the good, bad, and the ugly. The good is the large lifestyle centers and power centers, with significant projects planned for Elk Grove, Natomas, Folsom, and Bradshaw/50. The tenants for these centers are typically rated and well financed. The bad is the plethora of strip malls. This sector has been overbuilt in Laguna West, Rocklin, Roseville, and Folsom. The properties on signalized intersections with residential backup continue to survive, but the misplaced midblock buildings with poor access and or visibility have failed. The ugly are a handful of very large unanchored strip malls with 60,000 - 80,000 SF which are projected to remain largely vacant for several years. The highlighted poster child for these centers is one in Elk Grove which has certainly been newsworthy recently. These centers should never have been built as they have never worked well anywhere, but the loose debt funds were out to cover the world with financing. Those days are over, thankfully.

General 2008 Outlook: CBRE feels that overall 2008 will be a year of transition. We’ve had 7 good years and the next year will be a churn of value added deals and a struggle to fill existing space. The prognosis was relatively upbeat, but I think the media presence may have tempered some dour comments.

Client Dinner: After the presentation, about 20 of us shopping center developers moved down to Morton’s for a client dinner hosted by the #1 retail leasing team in the US. We were all in good spirits and these are the places where you hear the stories and the real scoop. Many of the developers there I’ve known well since the early 80s, and we all agreed that this is our 4^th cycle and we will get through it like we have the others.

It seems the current trend is for retailers to complain about rents, regardless of their sales volumes or current rent levels. My story was of a tenant who recently asked for a rent reduction, to whom I replied that I would certainly look at their numbers and see if we can help on a short term basis. Their response was that their numbers were confidential, and my reply to that was that in that case, so was my decision. That got some laughs and nods. Several owners got letters from regional chain tenants asking for a 10% rent reduction without any justification. One mailed back an agreement form that stipulated a 10% increase in rents when their volumes increase in 2009. They didn’t hear back.

The good news is that absolutely no one is planning any spec building next year. We trashed the banks for lending to new developers with ill-conceived product, and agreed that although we should not have to compete with them their desperation still temporarily depresses rents. Good real estate survives any cycle, and most of us at that dinner do only A and B deals so we’re fine.

Elk Grove still has a tarnished reputation for perceived crime and housing over-supply, but the group agreed with my prediction that we’d bounce back as our excessive housing inventory will act to decrease values faster than in other areas in the region, that Elk Grove will again become the most affordable market in the region, and that with 43% government employment our workers are in the right industry.