Vision 2020: Office Will Continue to Drive ‘Safe Haven’ LA This Year01/06/2020
Cars still can’t fly and humans don’t have the ability to teleport, but at least 2020 will bring extended growth to the commercial real estate market. Industry experts and analysts told Commercial Observer this week that real estate in Los Angeles and the broader United States will continue to expand this year in almost every major asset type.
“It will be a good year, similar to 2019,” said Spencer Levy, chairman of Americas research and senior economic advisor at CBRE. “The economy is in a very good place, and I don’t see forces like rising interest rates taking us down.”
Levy said there are some “X factors” that could ease investor enthusiasm at the end of the cycle, such as uncertainty over trade negotiations, consumer confidence and low interest rates. CBRE analysts forecast “tempered growth” in the country’s commercial real estate market in 2020, and they cite weakness in manufacturing as well as the approaching presidential election as reasons why it isn’t growing faster.
Richard Barkham, CBRE’s global chief economist and head of Americas research, said in the firm’s forecast that 2020 will “bring deceleration on a few fronts,” but that it is still is an expanding economy and a “flourishing property market,” with a robust job market, solid consumer confidence and low interest rates.
Tim Lee is founder of L.A.-based Olive Hill Group, which acquires, repositions and manages creative office properties in Southern California. He told CO that L.A. will see another year of growth in the office sector with tech and media content creation as “the two pillars that office growth is based on in L.A.” The third, he said, is the professional services that work with the major industries, like law firms or accounting firms, which grow as the primary sectors grow.
Lee said L.A. will continue to see adaptive reuse projects as developers convert properties like the former Westside Pavilion, which is being transformed into two major modern office projects, one of which is was pre-leased to Google last year. Most of the growth is happening on the Westside, which is notorious for being restrictive to development, so adaptive reuse is the best strategy. Lee pointed to long-term buyers like Kilroy, which purchased the massive Blackwelder development in Culver City for $185 million.
“That’s a sign that even if there’s a blip in growth and rent, that the market would sustain,” Lee said.
Andy Lustgarten, senior managing director of Savills in L.A., told CO that he expects the office market throughout Southern California to remain fairly static this year.
“I don’t anticipate a significant cooling off, nor do I think we’ll see the same level of growth and expansion that we experienced over the past few years,” he said via email. “In light of the downturn by WeWork, flexible space providers have significantly scaled back growth plans, which represented a large part of Southern California office market growth. We’ll continue to see expansion from content creators, however, the FAANG (Facebook, Apple, Amazon, Netflix and Google) companies have already executed their big deals and taken expansion space in the past few years. Additional growth in this sector is likely to be modest relative to the size of the companies.”
Lustgarten said the creative office conversions and adaptive reuse projects are “here to stay” as they generate good returns for developers. He expects vacancy to remain static and absorption to decline slightly, bringing the marketplace more in line with the final quarter of 2019 instead of the first half of last year.
Lee said demand is increasing throughout the city, with vacancy rates for L.A. office decreasing last quarter to 14.9 percent. Almost 5.2 million square feet of L.A. office space is under construction or renovation, with about 43 percent of it pre-leased, according to Olive Hill Group. Lustgarten said pre-leasing will continue due to the short supply of large blocks, but he expects the pace to slow.
CBRE predicts flex office inventory across the country to grow to 87 million square feet by the end of 2020, accounting for 2.1 percent of the U.S. office market.
A decline in U.S. business investment and manufacturing, and lukewarm corporate profit growth in the third quarter of this year could raise fears of a recession, but primary real estate markets like L.A. have a “buffer” if a slowdown comes, Lee argued. He said L.A. is a “safer market,” and well-positioned as a primary target, which would help the city sustain itself if there’s a downturn or recession.
“If there is a downturn, L.A. would be the last place to feel it, as investors pull out of secondary markets and go into cities like L.A. and New York,” he said.
CBRE’s forecast said that the relatively low amount of office completions in L.A. will make it the nation’s strongest market for rent growth this year. Lee and Lustgarten said the submarkets on the Westside are in the best position to remain stable.
“Aside from coworking, most of the pre-lease agreements are with credit tenants, and I don’t think these tenants will walk away from their lease commitments. That said, a downturn or recession could lead to a large supply of sublet space coming to market, which would impact direct lease pricing and the overall market,” Lustgarten said.
Lee said Downtown L.A., which has a large amount of inventory and tenant turnover, might not be as well suited to weather a downturn. According to CBRE’s third quarter 2019 report on the Greater L.A. office market, vacancy rates downtown stood at 18.6 percent, which led all submarkets. For comparison, the vacancy rate in Burbank was below 10 percent with the figure expected to fall further by mid-2020 as tenants start to occupy leased space.
Global yields are expected to remain low and equity markets are expected to become more volatile, making stable returns from U.S.’s commercial real estate more attractive this year, according to CBRE’s forecast. Investment volume is set to reach between $478 billion and $502 billion across the U.S. in 2020, which is on par with the previous two years, and would make it one of the strongest years on record.
Levy said that while foreign investment was down in 2019, there were late surges from countries like South Korea, and he expects L.A. will have a slightly better year with greater amounts of international capital flows thanks to declining hedging costs. Indeed, Eric Melendez, vice president for the U.S. investment arm of South Korean-based Mirae Asset Securities & Investments, said during a panel discussion last month that the U.S. remains an attractive market for investors in places like South Korea who are feeling the effects of over-saturation on their home turf.
CBRE’s forecast shows overall foreign investment rebounding over last year due to lower hedging costs for major investor countries thanks to lower interest rates, particularly in “safe haven” core markets, like L.A.
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