Industrial and Multifamily Boom in the Southwest as Some Retail Lags

Between wildfires and the COVID-19 pandemic, it’s been a dynamic two years for Southern California and the Southwest. Partner Insights spoke to Matt Felsot, Southwest regional manager of real estate banking at JPMorgan Chase (JPM), about how commercial real estate is faring in the area.

Commercial Observer: What has been the biggest shift in commercial real estate in the Southwest region since the beginning of the pandemic?

Matt Felsot: We’ve seen a remarkable acceleration in the e-commerce space since Los Angeles and Long Beach, Calif., are home to massive ports. Together, they handle 40 percent of U.S. imports, so the increased activity and supply chain disruptions have caused increased demand of the existing surrounding warehouse stock. In October 2021, there were 900,000 TEUs [twenty-foot equivalent units, which is a measure of cargo capacity] of industrial cargo moving through. That’s the highest ever in October. So, the ports are fueling all the industrial properties in the area and keeping vacancies at 50-year historic lows. (Source)

The trend has been at the expense of older Class B and C retail malls. Developers are now shifting their focus. Multifamily has fared well, especially in the suburbs, as populations migrate out of higher-cost, dense city centers into less populated, spacious garden-style apartments.

How has the pandemic, including the emergence of working from home, affected multifamily and office in the region?

For office properties, the physical occupancy is gradually coming back, but still well below pre-covid levels. That’s created a lot of uncertainty about older commoditized office buildings, resulting in a demand shift to newer properties with robust amenities. For example, some office properties in Orange County are including swimming pools to promote healthy lifestyles, a factor that’s also a major differentiator. If developers have access to enough land, they’re electing to build to a lower density, as employers are pivoting away from higher-density configurations.

For multifamily, people want an environment where they can spread out. Multifamily developers are creating not just extra bedrooms, but an actual dedicated office or alcove, sometimes with touchless tech and work-from-home support. We hadn’t seen that before.

How is the multifamily rental market there comparing to the market for sales?

It comes down to affordability. We have a very high median home price in Southern California of around $800,000 and a chronic shortage of affordable housing in general. That and the difficult entitlement process for developers creates higher barriers to entry for home builders, which leads to a higher differential between cost-to-own and cost-to-rent.

For apartments, we’re seeing renters by choice move into highly amenitized, brand new Class A buildings because they’re well-located — they’re close to jobs. We’re seeing some former retail centers being redeveloped into multifamily, medical office and experiential retail.

Class B and C, which are typically workforce housing, have provided a durable cash flow through the pandemic. Preserving workforce housing is especially necessary in the region because building is so expensive, which leads to higher rents.

To what extent have your developer clients chosen to repurpose commercial properties as opposed to engaging in new construction?

The lack of well-located land is making repurposing older properties much more attractive. Properties built in the 1960s or 1970s, that maybe were anchored by department stores in decline, are some of the best “Main and Main” locations, surrounded by very strong demographics. But the problem is that e-commerce is putting pressure on older vintage retail centers. They view these parcels as prime redevelopment projects, but this doesn’t happen overnight. These sites need to be re-entitled. We also have NIMBYism [not in my back yard] from community opposition groups who worry about traffic and and environmental impacts to the neighborhood. So those approval processes can take years.

What are some of the ways you’re currently offering your services to clients?

We specialize in large loans. As property values have increased over the past couple years, we’ve seen massive amounts of liquidity in the market coming from domestic and international capital sources. Our ability to do large, complicated financing quickly, and to syndicate and bring in other banks, puts us in high demand right now.

How did the recent wildfires on the West Coast affect your business?

Given the tough entitlement process to build and redevelop, a lot of development is being pushed farther out, sometimes into sloped areas prone to fire danger. Thankfully, our clients haven’t had anything catastrophic, but it is a big risk, and it may become increasingly difficult and costly to obtain fire insurance. This could put even more cost onto housing.

How have JPMorgan Chase’s West Coast and Southwest offices worked to advance racial equity and inclusion through the CRE business?

First of all, I’m proud to work for a firm that makes DEI such a big priority. There’s a massive commitment from JPMorgan Chase — $30 billion — to close the racial wealth gap and drive economic inclusion, with a strong focus from our commercial real estate business. We have a community development banking group that is very active in supporting multifamily affordable housing development. Our term-debt business also provides competitive rates to our clients that preserve affordable units. My group is developing a rent-to-own pilot product that’s designed for people usually priced out of home ownership. The group helps residents get into a rental unit and save enough over time to buy that unit. That’s another way of making sure that home ownership is within the reach of people with lower incomes.

How well do you think the region’s commercial real estate will do in 2022?

We see an incredibly robust economy, including reports of strong job growth. As these economic fundamentals continue to improve, commercial real estate should continue to benefit. There are significant amounts of capital looking to enter this sector. That, as well as logistics, will continue to fuel the industrial sector here as jobs and wages, combined with the housing shortage, fuel the growth in multifamily. We also see pandemic-induced forced savings continuing to fuel experiential retail. The obsolete Class B and C, meanwhile, will increasingly be redeveloped into other mixed uses. Commercial real estate is also a great hedge against inflation, so we’ll see investment continue.