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California CRE to Expand in 2022. © Allen Matkins/UCLA Anderson

California’s Economy Reawakening Tentatively Signals the Beginning of a New CRE Cycle

Continued growth expected for industrial and multi-family housing; possible turnaround predicted for office and retail

Published on July 22, 2021

The Summer 2021 Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey shows that Californians have a palpable urge to return to normal, as survey respondents’ expectations for the next three years are decidedly less pessimistic than in the last survey. Although both office and retail development plans have been cut back, panelists predict that the current pessimistic cycles for both sectors have hit their respective floors and that those markets will soon turn because of increasing demand. Meanwhile, multi-family housing and industrial space remain in the growth portion of their business cycles.

The semiannual survey polls a panel of California real estate professionals to project a three-year-ahead outlook for California’s commercial real estate industry and forecast potential opportunities and challenges affecting the office, multi-family, retail and industrial sectors.

Office Developers Signal an Upward Turn in the Market

While the question “What is the future of the office building?” is still on the minds of everyone who owns or develops office space, it has become clear that the latest return-to-office activity has our panelists becoming less pessimistic. In Northern California, our panelists forecast that, by 2024, demand will have grown at least as fast as the new supply, in part because fully one-third of the panelists have cut back on their plans for new development. In Southern California, where panelists’ views are similar, 40% have cut back on development plans for the coming three years. Although the office sector sentiment in the most recent survey remains negative, it is becoming less so, and it appears that this sector has bottomed out and is ready for a possible upturn. The current lull in office construction could be short-lived as the demand for office refitting, low-rise office buildings and growth in employment increases over the coming year. The survey reflects that developers are taking less of a wait-and-see approach, signaling an early turn in the market. As workers return to the office, the demand for the amenity-rich office should push construction activity higher than the sentiment indicates.

Pandemic Fuels Continued Growth of Industrial Market

Industrial markets over the past several years have seen consistently high occupancy rates and superior rental rate growth. While sentiment in the June 2020 survey dropped precipitously, it immediately rebounded and has continued to improve. In the latest survey, overall sentiment about the coming three years soared to its highest level since December 2015. In both Northern and Southern California, developer sentiment indicated the current increase in rental rates would continue to exceed the rate of inflation, and the already low vacancy rates of 4% to 7% are expected to be even lower by 2024. Behind this sentiment is a view by the panelists about online shopping-induced demand for industrial space, and the expected increase in the supply of that space.

Multi-Family Market Optimism Prevails Despite Pandemic-Related Disruptions

Despite the move to the suburbs and falling rental rates, panelists are bullish about the coming three years in the multi-family housing space. Rental rates are forecast across the board to increase faster than the rate of inflation, and vacancy rates are expected to fall between now and 2024. This optimism is caused by both the reopening of city amenities that attract people back to city apartments and the beginning of the return to the office. Multi-family housing close to employment centers is, for many, an attractive alternative to a long commute from the outlying suburbs.

Declining rents in the last year have not had much impact on the actual level of building for multi-family developers, as they have declined from very high levels. While nearly 70% of Southern California panelists will begin one or more multi-family projects this year, the number is just under 50% for panelists in Northern California, where lower rents and higher vacancy rates in the Bay Area have panelists waiting to see how the return to the office translates into core city demand.

While Still Pessimistic, Retail Outlook Begins to Rebound

Following a continued decline into pessimism, retail may be coming back from the bottom of the cycle. The employment data reflects a rebound in retail employment, particularly in the inland regions of the Inland Empire and Sacramento. The Bay Area and coastal Southern California regions, impacted more by work-from-home orders, have seen substantial employment gains in spite of pandemic restrictions, but have further to go.

The current view is that retail properties will be generating lower returns in 2024 compared to the end of 2021, but it does not mean the absence of solid targeted opportunities. New housing developments, whether they are multi-family or single family, generally require nearby retail. The booming housing market will continue to generate this demand. Though the survey responses on the surface suggest a continued decline in new retail property construction, the trend has indicated a possible turnaround and a new cycle beginning before the end of 2024.

Finance Reporter