Going Back to Cali

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Los Angeles, the land of sprawl and traffic jams, has made a serious commitment to expanding mass transit options. The Olympic Games, which the City of Angels will host in 2028, has been a major impetus, with Mayor Eric Garcetti pledging to complete 28 key road, transit and bicycle and pedestrian projects in time for the Summer Olympics. The “28 by 28” plan will be funded in part by Measure M, a sales tax increase passed by L.A. County voters last November that allocates $120 billion to transit projects over the next 40 years.

It can’t come too soon for a city that, once again, was named the worst in the United States for traffic, with commuters spending 102 hours stuck in traffic congestion in 2017 during peak hours, according to an annual scorecard by INRIX.

The continued expansion and creation of transit services will not only ease commuters’ pain, but will add to property values around transit options. As previously reported by Commercial Observer, the growing public demand to be close to transit hubs has given landlords the confidence to push rents higher.

In Hollywood, for instance, office rents have climbed 19.8 percent in the past two years because of access to talent, neighborhood amenities and transit, rising to $52.20 per square foot in 2017 from $43.56 in 2015, according to JLL research.

“Tenants are willing to pay a little bit more [because] if you’re thinking about how to keep your workforce happy or at least less stressed, one of the first ways you can do that is to eliminate some of the pain that comes with their commute,” Amber Schiada, a senior vice president and national director for JLL research in the Southwest, told CO.

Keeping workers happy—given negatives like a chronic lack of affordable housing in the Southland, is paramount for continued growth, she added.

To call the lack of affordable housing a crisis is not hyperbole. As the Los Angeles Times reported in an Op-Ed in January, when housing expenses are tallied with incomes, the U.S. Census officials estimate that one in five Californians live in poverty. Thus, California has earned the ignominious distinction of having the nation’s highest poverty rate despite having the sixth-largest economy in the world.

“We cannot sustain long-term growth if our workforce cannot afford housing,” Schiada said. “In Los Angeles, there is certainly a lot of housing development underway and density is no longer a dirty word, but it’s not enough. This will ultimately be what impedes long-term growth.”

If S.B. 827, introduced by San Francisco State Senator Scott Wiener on Jan. 3, is passed, it will address two important impediments—the statewide affordable housing crisis and residential zoning restrictions that can bog down commercial development in California’s urban centers. (See here for more on the bill.)

Multifamily

The recent federal tax overhaul is expected to benefit commercial real estate statewide in almost all sectors, according to The Winter/Spring 2018 Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey. The biannual survey compiles the views of supply-side participants—commercial developers and financiers of such development—to create a three-year outlook for industry sectors in major Southern California and Bay area markets for office, industrial, retail and multifamily development.

The most recent poll, taken this past December, indicates that the federal tax overhaul will probably moderately increase the rate on return on commercial real estate and make investment more attractive in all sectors except retail (see retail and e-commerce section below). The Tax Cuts and Jobs legislation disincentivizes homeownership in California by imposing lower limits on home mortgage interest and reducing property tax deductions.

Starting in 2018, homeowners can deduct interest on mortgages only up to $750,000. The previous cap was $1 million, with an additional $100,000 allowed for home equity loans. Interest on home equity loans and lines of credit will no longer be deductible. For the first time, homeowners also will face a $10,000 cap on what they can deduct on their state and local taxes, according to NPR.

As a result, the law should push up the demand for multifamily rental housing and the desirability of such commercial projects for investors.

The new tax structure changes how “pass-through” income can be taxed, with owners of pass-through entities eligible to claim a 20 percent deduction for business-related income. As the National Real Estate Investor reported, the change would mainly apply to individuals and family trusts investing in real estate through partnership entities, such as limited liability partnerships and private equity funds, as well as individuals who receive income from real estate investment trust dividends.

Matt Levis and Jack Levis, both in CBRE (CBRE)’s property sales division, said the multifamily market in Greater Los Angeles remains strong with high-net individuals looking for long-term investments, viewing apartment rentals as low risk. The brokers (and brothers) based out of CBRE’s South Bay office cited rent-control ballot measures (there are no such controls in place today) being proposed by tenant advocates for several SoCal cities, including Long Beach and El Segundo, as potential impediments for growth.

“Introducing rent control in the South Bay and Long Beach markets will impede industry growth every way possible. Landlords will have no incentive to invest in their property and velocity will slow down; over time there will be more dilapidated buildings,” Jack Levis said.

Not Your Father’s Office

Content is still king in Los Angeles and, with the emergence of new content creators, where companies and individuals are developing content that can be distributed across a variety of media platforms, such as YouTube, the demand for creative office space is sky high and shows no sign of slowing down anytime soon.

“Even companies whose main purpose is not content at all, are diving into producing or partnering for new content at a rapid rate,” said Jeff Vertun, a broker in CBRE’s downtown Los Angeles office. “Technology, media and entertainment-related tenants continue to attract impressive talent to fill those jobs,” Because of the enormous entertainment industry, Los Angeles is positioned as the ideal location for all content-related companies, which, in turn will lift the synergistic businesses with it.”

Last year alone saw streaming giant Netflix fully lease 415,226 square feet of office space between the ICON and CUE buildings on the Sunset Bronson Lot at 5800 Sunset Boulevard at an estimated rent of $4.75 to $5 a square foot per month. Entertainment Weekly is slated to relocate its headquarters from New York to 11766 Wilshire Boulevard in L.A. in March.  Meanwhile, Facebook opened its second L.A.-based location at 8500-8550 Balboa Boulevard in Northridge, in the once-uncool San Fernando Valley.

The recent expansion in interactive gaming—including live eSports tournaments—will also add to the race for suitable creative space around town.

According to Vertun, companies looking to attract and retain top talent have turned to properties that have souped-up amenities including wellness programs, and companies looking for flexibility have sought out coworking solutions.

“We’ve witnessed not-so-small companies take full floors of coworking space,” said Vertun, citing Heineken and Sketchers, which are utilizing WeWork, as examples of the trend.

The Los Angeles office market remains strong with moderate growth and Vertun’s outlook continues to be cautiously optimistic. He pointed to an 11 percent year-over-year increase in asking rates, though there is rising concern that an influx of new construction may lead to a glut in the market.

While the L.A. office market closed 2017 with rents and vacancy holding steady, downtown fared worse as vacancy rates there spiked, according to Colliers (CIGI) International’s fourth-quarter 2017 report.

The area’s 1.7 million square feet of office space under construction is far higher than the amount seen in the two other Greater Los Angeles submarkets the brokerage tracked with 80 percent of that space still available.

The strongest markets for rent values continue to be West Los Angeles, where average rents are currently over $5 per square foot, an 8 percent year-over-year increase, the Colliers data indicate. Downtown Los Angeles, meanwhile, has a high average rent of $3.51 a foot. Of note, the Arts District is commanding rents that rival the Westside.

Cushman & Wakefield (CWK) also projects that this year non-central business districts downtown, including the Historic Core and Arts District, will account for 1.6 million square feet of new supply.

Justin Weiss, a vice president of brokerage at Kennedy Wilson, and an expert on the Downtown L.A. market, concurred, saying both the Arts District and the once-sleepy Bunker Hill, where Frank Gehry’s mixed-use Grand Avenue Park is set to break ground this fall, are areas to watch.

In one of the largest office lease transactions of 2017, anchor tenant Bank of America extended and expanded its lease at its namesake plaza at 333 South Hope Street in Bunker Hill, growing within Brookfield Property Partners’ 55-story, 1.4-million-square-foot property to 218,000 feet from 164,000, according to an official company statement. Though neither BoA nor Brookfield would disclose financial details of the lease, a spokeswoman for Brookfield said the lease was for more than 10 years.

The South Bay

Geographically, the continued influx of media, digital and high-tech players to the Westside of Los Angeles in Silicon Beach—which stretches from Santa Monica south to Venice and Playa Vista—has led to greater interest in the nearby South Bay market for office property. Vacancy rates have been dwindling and square footage has become costlier by the minute. (Google, Facebook and Snapchat are among the biggies who have set up shop in the area.)

According to CBRE’s fourth-quarter 2017 report, institutional investors have turned to suburban markets such as the Tri-Cities (Glendale, Pasadena and Burbank) and El Segundo in the South Bay as a more economical option for their offices.

CBRE’s Vertun said the average asking rates for office space in the South Bay was $2.59 a square foot. (In comparison, asking rates for West L.A. ARE $5.02 a square foot.)

Institutional investors including Brookfield, J.P. Morgan and Blackstone Group were new to the market in 2017.

One of the biggest deals last year was Blackstone’s acquisition of a group of Southern California warehouses in the South Baby and San Gabriel Valley and related properties from Principal Real Estate Investors for $448 million in October, according to Tina Arambulo, the industrial research director for the Los Angeles Basin at C&W. Another indication of the sector and area’s growing appeal was Starwood Capital’s acquisition of Pacific Corporate Towers in El Segundo for $611 million, or $385 per square foot, in late October.

Retail and e-commerce

Like elsewhere in the nation, brick-and-mortar retail in California has taken a hit, particularly as big-box and mall-anchor mass retailers including Macy’s and Toys “R” Us dramatically scale down operations.

Though the tax overhaul in D.C. was supposed to create higher returns of investment throughout the commercial real estate sectors, in retail that is not the case, the Matkins/UCLA Anderson Forecast found. Panelists in each of the six California regions surveyed were more pessimistic than before the tax bill passed.

In the Bay Area, none of the survey’s panel of retail developers started a new project last year, and very few are planning on doing so this year. In Southern California, just over half of the panel began new retail projects last year, while only a third plan to develop retail in the next year.

Despite the market apprehension and general sentiment that retail is overbuilt, CBRE found that, in Greater Los Angeles, the retail market concluded 2017 with stable and optimistic fundamentals. The brokerage’s fourth-quarter report analyzed all retail centers of 50,000 square feet and greater.

Vacancy rates remained unchanged throughout 2017, standing at 5.2 percent at the year’s end and anticipated to hold in the low 5-percent range through 2018, according to CBRE. Leasing momentum remained positive with 231,104 square feet of positive net absorption by the end of 2017. Average asking rents further increased by 9.3 percent year-over-year, ending the final quarter of 2017 at $2.71 per square feet.

Alex Kozakov, a senior vice president at CBRE, said that the ongoing growth in online shopping will ultimately reduce the brick-and-mortar footprint of retailers, while increasing the demand for warehouse and industrial space.

Greater Downtown ranked the highest in vacancy rates at 11.1 percent in the final quarter of 2017, according to CBRE, which the firm attributed to numerous smaller spaces becoming vacant versus major move outs. Fitness, grocery and discount tenants were among the notable retail categories in the region. Kozakov said the strongest markets and neighborhoods for retail include West Los Angeles, Hollywood, Silicon Beach, Santa Monica and Culver City, all of which are due to their good average household incomes and abundance of jobs, amenities and density, which together enable and encourage consumer spending.

Rents in some of the best retail markets in West Los Angeles ranged as high as $10 per square foot and cap rates of 4 percent in the fourth quarter of 2017, Kozakov said.

In response to rising rents, retail tenants with existing locations in Greater Los Angeles slowed expansions, hoping that a slowing cycle will lead to vacancy increases and eventually some rent relief, according to CBRE.

On the flip side, the ongoing growth of e-commerce has fueled an increase in industrial property values. As demand outpaces supply, rents for Class-A properties will continue to escalate and lead occupiers to consider functional Class-B warehouses, according to Ryan Foley, a senior associate at CBRE. (Current Class-A asking rates are in the upper $0.80s on a triple-net basis, pushing low $0.90s on a triple-net basis on brand new construction. Class B asking rents, meanwhile, are in the mid $0.70s. Both class rates are almost double what they were in the recession.)

Tina Arambulo at C&W agreed, saying that Class B properties which five years ago may have been considered obsolete will continue to be sought after in in-fill markets.

“Greater Los Angeles continues to have the lowest vacancy of any major industrial market in the U.S. with vacancy of just 1.3 percent,” she said.

The need for industrial property is also fueling the continued rise of the Inland Empire, which CBRE labeled its own “North Star” in its fourth-quarter 2017 report. A sizable portion of activity came from pre-leasing activity earlier in the year, while demand for industrial space smaller than 300,000 square feet did the rest.

Real estate investment trust Liberty Property Trust started 2018 with a move that confirms the overall trend: It purchased a 400,169-square-foot Class-A industrial building at 5959 Randolph Street in the city of Commerce for $92.7 million. The fully leased building is among three other major industrial properties Liberty purchased at the tail end of 2017.  These include the acquisition of a 702,668-square-foot Class A building at 1221 N. Alder Avenue in Rialto for $94.2 million, a 210,710-square-foot property at 16325 Avalon Blvd. in Carson for $46.3 million. In all, Liberty has nearly doubled its footprint across Southern California in the last year, investing a total of $176.3 million in 2017 in acquisitions and development in Southern California, and the portfolio now includes 3.7 million square feet, according to an official company release.  A Liberty Property Trust spokeswoman told CO that at the end of 2016 the company owned 2.1 million square feet in SoCal. Today, that stands at 3.8 million, including what is currently under development.

Foreign Capital

The Golden State is, well, golden in the eyes of foreign investors as L.A. moved ahead of New York for the first time in terms of the volume of foreign capital it attracted in 2017, according to research released by JLL last month. While London still topped the list—despite Brexit uncertainty—attracting $33 billion in foreign capital, L.A. shifted up to second place in the top 30 with $23 billion and New York dropped to third with $21 billion. The research from JLL references 300 global indices and benchmarks that assess the relative performance of cities. The most recent study found that while the global investment landscape continues to be dominated by the “Big Seven” cities, which include London and New York, “contender” cities like L.A. have attracted investors because of a lack of product and high pricing for prime assets in the core seven.

The 26th annual survey from the members of the Association of Foreign Investors in Real Estate (AFIRE) also back up L.A.’s growing draw as the City of Angels tied with New York for the first time as the top U.S. city for foreign real estate investment. (London took the top spot as the reigning global city for real estate investment.)

In last year’s survey, L.A. ranked second among U.S. cities and fourth globally. AFIRE members are among the largest international institutional real estate investors in the world and have an estimated $2 trillion or more in real estate assets under management globally.

“With the growth of on-line shopping, foreign investors continue to rank industrial/logistics properties as their No. 1 investment opportunity,” Jim Fetgatter, chief executive of AFIRE, said in an official release.  “The cargo coming into the Port of Los Angeles represents 43 percent of all cargo coming into the United States. Respondents also say online shopping is likely to have the biggest affect on real estate over the next five years. With these as benchmarks, it’s easy to see why investors would be bullish on Los Angeles.”