Q&A: The Future Of Los Angeles With Walker & Dunlop's By Cartmell
Large office absorption rates, a bifurcated retail market and an exploding multifamily scene all affect what is going on in Los Angeles real estate. Bisnow chatted with By Cartmell of Walker & Dunlop Los Angeles to discuss the past, present and future of commercial real estate in LA.
Bisnow: What major trends are you seeing on the ground in Los Angeles office, industrial and retail? How do they contrast with what you are seeing in the suburbs?
Cartmell: Industrial is by far the biggest commercial real estate segment in the greater LA area, with over a billion square feet. In the last five years, industrial rents have gone up almost 50%. The vacancy rate is now 1% to 2% — there is an extreme shortage of industrial property. Land in San Fernando Valley is going for what buildings cost to build. If you get down by the port, there is practically unlimited industrial demand. This is causing a lot of the bigger industrial users to change: They’re outsourcing to a lot of third-party fulfillment type operations in the Inland Empire. In all areas of the LA market from Valencia [to] Oxnard and Pomona, there’s a 1% to 3% vacancy rate in industrial.
Landlords are also starting to see rents paid on a fully triple-net basis versus industrial gross where the landlord pays taxes, insurance and the tenant everything else. The story of LA office rents, on the other hand, is one of constant stagnation. Office rents have been stuck in the $2.50 to $3.50/SF full-service gross range for 30 years. A two-story walk-up apartment in West LA 30 years ago was $800 a month. Now it’s $2,800.
On the plus side to the office market, there’s still a ton of absorption; in the last quarter of 2016, we saw absorption of 2M SF. That’s the first time that’s happened since the early 2000s. The office vacancy rate in LA used to be 16% to 17%, higher downtown; now it’s closer to 12%. There’s a fair amount of construction going on, about 2.25M SF of office in LA, but it’s extremely segmented in just three markets. There’s 400k SF going up downtown, primarily for a big Korean airline project; 600k SF in Hollywood; and 1.25M SF in Santa Monica and Playa del Rey.
Retail is a very bisected market between the West side and downtown versus the suburbs. Rental rates have held up pretty well for retail. Five years ago, the average rent was around $2.10 to $2.20/SF NNN; now it is about $2.50. Nevertheless, there’s a difference between the single-story and ground-floor retail stores below office buildings. Tenants prefer single-story developments on Main Street, Hollywood, everywhere. That’s where LA wants to eat and shop. With the exception of Downtown LA, people’s first choice for entertainment is not the ground floor with office or apartments above it.
Bisnow: Would you say you have noticed a change in the risks public and private lenders are willing to take in the developments they are financing?
Cartmell: Absolutely zero. The one change is that lenders have slowly accepted today’s lower cap rates. Lenders still want a big chunk of borrower cash in front of them and settled in valuing property’s cash flow with a 6% cap rate. They are willing to accept this because they are lending 10-year money at 4.5%. On new construction, every bank we know is still requiring 35% cash up front, and only with very highly qualified credit-rated tenants. Restrictions placed by Dodd-Frank have really taken hold, and you have to bring in a lot of cash.
Aside from downtown LA, there are very few construction projects in Los Angeles County. Urban infill is the majority of the construction market in LA for the foreseeable future. If something one story is being torn down, they’re putting up four- to five-story apartment buildings in its place. There’s a lot of stuff going up downtown, but a big chunk of that is foreign, particularly Chinese investments.
Bisnow: JLL points to cyclical lows in office vacancies despite historically high deliveries in 2016. What is going on?
Cartmell: The absorption data ... was just a whole bunch of big tenants who take a long time to make up their mind. Once they decide to go on a big project, it’s big news. Google knocks off spaces in increments of 200k SF to 300k SF, absorbing a lot of vacancy.
One of the big factors — particularly downtown — has been the conversion of millions of square feet [of] old, barely functional office into residential units. I had great fun in the early '80s financing a lot of industrial building conversions into artist lofts. That was the key to turning around downtown LA into a place for people to live and shop. Downtown LA after 5 p.m. was a ghost town in the '70s and '80s. None of the construction happening downtown would be going on if the city had not allowed developers to convert industrial buildings into AIR (Artist in Residence) zoning in the '80s. Then the city put that adaptive reuse ordinance in the '90s that allowed nonfunctional office buildings to became converted to residential in the downtown office core. We had 14,000 apartments and 5,000 condos converted from old office space, so many of those tenants had to go someplace else.
The West side has been a magnet for tech companies, as they view office expense as a minor hindrance to access the engineers and talent near where that talent wants to live. Snapchat just signed for 200k SF on the West side of Santa Monica; they’ve been spending a lot of money converting old industrial into their campus on Venice Boulevard. As Yahoo shrinks, Snapchat is quickly absorbing their space. There’s another 200k SF old industrial being converted there; guessing I wouldn’t be surprised if a big name came in.
Bisnow: First Tuesday predicts that the next influx of renters and buyers in 2019-21 will be key to increasing the number of real estate professionals and, in turn, moving the housing industry back to pre-recession levels. Do you agree?
Cartmell: I think we’re already there at pre-recession levels. When you go out to the Inland Empire and you’re driving around — in 2009, '10, '11, you saw just whole tons of empty office buildings; single-family construction had completely collapsed, bringing down with it endless numbers of loan brokers and title people and all the attendant industry that occupies office space.
The construction in LA is primarily going infill rather than building new subdivisions; there just isn’t as much land to build that kind of stuff. People are going to be building up. There’s going to be a lot more of that. Santa Monica just rezoned sections of downtown and Lincoln Boulevard to convert single-story into five-story retail and multifamily above. That requires a lot of people — architects and such. I think there’ll be continued construction of single-family in LA, but there’ll be much more multifamily.
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