Sizing Up a Not-So-Vacant Look at Retail, Industrial Office Space

By BOB HOWARD

Jan. 2, 2001 12 AM PT

SPECIAL TO THE TIMES

Optimism is the operative word among those assessing the outlook for Southern California’s commercial real estate markets in 2001--despite reports of a slowing U.S. economy.

Consultants, developers, builders and brokers who track the regional markets for office, industrial and retail space believe demand will continue to grow this year, albeit at a slower pace than in recent years.

And even if growth slows more than expected during the coming year, experts believe, the consequences will be relatively mild because the construction surge of the late 1990s has been considerably saner than the overbuilding free-for-all of the late 1980s and early 1990s that exacerbated the region’s economic downturn.

Real estate demand will slacken a bit in Southern California, said Martin Griffiths, partner in charge of the Pacific Southwest real estate practice at Arthur Andersen, though not as much as in other parts of the country.

“We’ll probably see more slowing during the first quarter as people try to figure out where the market is and where the economy is going,” Griffiths said, “but after that, I think optimism will set in during the second, third and fourth quarters.”

The consensus among Griffiths and other observers is that there will be only a slower rate of growth--not a decline in demand for commercial space.

Such a slowing is to be expected in a cyclical industry like commercial real estate, they say, adding that 2001 will seem slower only because demand has grown dramatically every year since the real estate recovery began in about 1996.

“Our view for 2001 is that the pace of growth in the commercial real estate markets as a whole will be slower than what we’ve seen in the last five or six years,” said Brett White, chairman of the Americas for CB Richard Ellis, “but to keep that in context, those years have seen record growth.”

The growth has been reflected in many facets of the commercial real estate industry: rising demand for office, industrial and retail space, more work for architectural and design firms, higher rents for most types of space, and a growing list of construction projects for developers.

Whittier-based Oltmans Construction Co. will enter the 2001 fiscal year April 1 with a backlog of at least $250 million worth of commercial construction projects and possibly as much as $290 million, said John Gormly, vice president.

The 2001 backlog will be up from $220 million at the beginning of this fiscal year, Gormly said, noting that Oltmans’ backlog has grown steadily every year since 1996. Oltmans’ business has expanded through new construction projects as well as a steady stream of renovations and upgrades, like remodeling jobs and earthquake retrofits.

“If you asked me to pick a market segment that was weak,” said Gormly, “I don’t know what it might be.”

Despite the steady increase in construction during the past four or five years, “At this given moment, supply and demand are pretty evenly matched,” said broker Chuck Hunt, a managing director with Cushman & Wakefield.

Hunt outlined a pair of hypothetical scenarios, however, in which Southern California could face localized gluts of office or industrial space: Between 3 million and 3.5 million square feet of new low-rise, or ‘flex-tech” space has been proposed and authorized in Orange County, he said, so that market could find itself oversupplied if demand cools and all the proposed space is built this year.

The other potential for overbuilding lies in the Ontario industrial market, where developers in recent years have added millions of square feet of huge warehouses--in most cases filling them with tenants soon after completing construction.

If building continues at the same pace as recent years, and if demand declines, Ontario could face an oversupply.

But Hunt and others don’t expect to see overbuilding because lenders are being too cautious to allow it, requiring developers to demonstrate that demand exists for a project before agreeing to finance it.

“The capital that’s fueling new construction today is smart,” said CB Richard Ellis’ White. “We’re not seeing projects getting built in soft markets.”

Another reason experts believe the soft landing will be even softer for Southern California’s real estate markets is that growth here hasn’t depended as much on “dot-com” companies as it has in other parts of the state and the country.

“There are a few pockets with some high-profile dot-com tenants, but they really don’t make up a very large percentage of the market,” White said. “Even in a place like Santa Monica, there are plenty of bricks-and-mortar tenants to take up any space that the dot-coms vacate.”

Said Doug McEachern, partner in charge of the Western Region real estate practice for Deloitte & Touche, “I don’t see a whole lot of impact from the dot-com space that’s being offered up. It’s a blip that will get absorbed fairly quickly.”

The dot-com shakeout, however, could provide unexpected benefits for some real estate markets, according to Andersen’s Griffiths. He thinks more Internet firms may turn to cheaper space in downtown Los Angeles, now that investors have tightened the purse strings.

“Some of these [dot-com] companies might be asking themselves what costs they can reduce,” Griffiths said, “and if they realize they can get space for half as much downtown as they would pay on the Westside, you might see some of them making the move.”

Downtown Los Angeles has struggled, despite the steady improvement in almost all other Southern California office markets. It still has a relatively high vacancy rate of about 20%, blamed in large part on corporate consolidations that have emptied floors and floors of office space.

But Griffiths believes 2001 may be the year downtown gains some real momentum, economic slowdown or not, and that 2002 will be even better.

“How many more corporate consolidations can there be?,” he asked rhetorically.

What happens downtown may depend in part on what strategies are adopted by large users of office space.

“We have consolidated all of our space here [downtown] and have some smaller, outlying drop-in offices,” McEachern said, “but other accounting firms have adopted a different philosophy. They have larger offices in the outlying areas.”

Despite the plentiful office space in central Los Angeles, economic development officials have long bemoaned the shortage of close-in sites on which to build new industrial buildings demanded by companies that provide what are often described as “high-tech, high-paying jobs.”

By contrast, one of the few places in L.A. County with land to spare is the Santa Clarita Valley, where about 1 million square feet of new industrial space is being filled each year at Valencia Business Park, said Thomas Lee, chairman and chief executive officer of Newhall Land & Farming Co., the park’s developer.

“The shortage of good quality manufacturing space in Los Angeles County is one of the reasons we see the prospects in our area as being pretty good,” Lee said. He expects the demand for industrial space, will continue in 2001.

Lee is less sanguine about the development of office space in the Santa Clarita market, explaining, “Office has not done as well as we had hoped, although I do think we’ll see more office users come up here in the not-too-distant future.”

Although Princess Cruises has taken a substantial amount of office space in Valencia, Lee said, “There’s been a fair amount of spec office space brought on line up here in the past few years, and it hasn’t leased at the pace we all had hoped it would.”

So as the new year begins, experts believe Southern California’s real estate industry is much better prepared for an economic downturn than it was in the early 1990s--both because this downturn is expected to be much milder and because the real estate industry apparently has forsaken its reckless ways.

“Of course,” said White of CB Richard Ellis, “All bets are off if we hit a recession.”

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Commercial Market Unbowed

Real estate professionals predict growth in Southern California will slow somewhat in 2001, but expansion will continue. A handful of major office projects are under construction, even though substantial vacancies remain in some existing buildings.

Significant Projects Under Construction

Building: 2400 Empire Ave.

Submarket: Burbank-Mediab District

Square feet: 405,000

Percent vacant: 100%

Completion date: April 2005

Building: Lennar Warner Center

Submarket: Warner Center

Square feet: 356,000

Percent vacant: 0

Completion date: November 2004

Building: 6080 Center Drive