2015 CALCPA REAL ESTATE CONFERENCE: ARE WE IN A
BUBBLE? was given by Jeffrey S. Weil on October 27, 2015
Thank you for your very kind introduction and the opportunity to be here today. My mother, Lillian Weil, lived and breathed the CPA Society and was the first woman President of the East Bay Chapter. She was a Director of the California Society of CPAs, chaired the Awards Committee and the Lillian Weil awards are given for scholarships by the East Bay Chapter. She was also the second national woman managing partner of what back then was the Big Ten, managing the Oakland Siedman and Siedman office.
I have a fairly ambitious agenda to cover, starting out with how Northern and Southern California commercial real estate is doing in warehouse, retail, office, apartment houses and investments.
You should have handouts with links to hundreds of pages of substantiating reports, and by you being here, you get a free one year chance to ask me any questions – just email firstname.lastname@example.org and I will do my best to get you answers to whatever you need on commercial real estate.
I will briefly cover residential, real estate financing and also stick my neck out on Are We In a Bubble?
I’m going to spend a few minutes discussing the major population centers in California in regards to commercial real estate. Remember, there should be a link to all the stats and details in your handouts.
Starting with San Diego, some of the hot things going on include creative office development, where industrial buildings are being repurposed into multi-tenant, multi-media, tech, start-ups. Go Pro just took on 44,000 sf and I believe another 177,000 sf. San Diego has 300,000 sf of speculative life science space and their apartment rents are skyrocketing, with 2-bedroom units downtown going for $3,200 a month!
Los Angeles has many different submarkets with downtown now flat lined, Santa Monica has had a number of large out relocations, retail reports huge demand for restaurant locations, everyone is eating out more from Ruth Chris to Chipotle.
Industrial all over is tight, the Inland Empire has a sub-3% vacancy, Orange County lots of Industrial conversions into creative space, Netflix leased hundreds of thousands of feet in Hollywood.
Up in Sacramento, the overall office vacancy is 15%, there are no specific industries expanding.
Sacramento retail has improved with an overall vacancy of 10 ½ percent. Class A vacancy has come down, but Class C rental rate have brought the overall rental rate average to a monthly rental figure of only $1.34/sf. The Sacramento MSA unemployment rate is 5.7%, down from 7.4% a year ago.
The apartment market in Sacramento is strong, with market occupancy at over 97%. Average monthly rent is $1,082 and very little new apartment houses being built – multi-family permits for the last quarter was only 186 issued. The average cap rate on sales is 5.4%.
Fresno, which our folks there say can reach 98% of California overnight which makes it an excellent central distribution hub, has a lot of new warehouse space being developed. A few deals, Joanne Fabrics took 700,000 sf, BTS took down a million square feet. New projects are 36 foot clear height.
What has hit Fresno hard, with the year after year after year drought, is the impact this has had not just on the farming economy, but on all the businesses and industries that feed on farming. Big tractor sales are way down, and so is a lot of other related businesses – a farmer worried about hanging onto his farm might put off buying a new truck or big screen TV.
The California high-speed rail project is already impacting Fresno, with buildings being knocked down and lots of traffic disruption.
Oakland – wow, that region is on fire! The industrial market along the I-880 corridor has been tight for years, sub-5% vacancy, land is almost non-existent and too expensive for industrial. A lot of industrial product is obsolete, with 12 foot or 16 foot clear instead of the 30 and 36 foot clear clients are looking for.
Apartment rents in non-rent controlled buildings have shot up, and with Oakland office rents half of what San Francisco is, there have been a number of recent announcements of office relocations out of San Francisco to Oakland. The biggest was Uber’s announcement to move their 330,000 sf headquarters in 2017, and the Sierra Club just signed a 38,000 sf lease to move their head office to Oakland.
Oakland is almost out of decent office space, so the landlords in Pleasanton, Concord, and Walnut Creek expect to see the next wave reach them.
Let me touch on the Contra Costa and Tri-Valley commercial real estate markets. In the Pleasanton / Dublin / San Ramon region there are several million feet of vacant Class A office buildings, with Class A rents in the $2.35 to 2.85/rsf range, full-serviced. A few projects offer as much as 200 to 800,000 square feet at Class A office space. The overall class A vacancy rate is 14%. Other than huge expansions by Workday, we have seen large downsizing by SAP and Safeway and no influx, as of yet, from Silicon Valley or Peninsula Tech companies.
Retail is strong, and where out in Livermore, get this name the San Francisco Premium Outlets just expanded to 134 Factory outlet stores, TripAdvisor recommends you plan on spending at least 2 to 3 hours, and the huge parking lots fill up and it can take you a half an hour just to find a parking spot.
Retail in Walnut Creek is unbelievable, and the Broadway Plaza Shopping Center, which is undergoing a huge remodel, just this morning announced 45 stores. Downtown parking meters operate 10 AM to 8 PM seven days a week, and downtown prime retail space is leasing for $10 to 12 a spare foot net net net.
Apartment rents in this area are now hitting $3,900 for two-bedroom units in the new complexes, there are seven apartment over retail projects currently under construction, and apartment house cap rates can be as low as 3 ½ percent!
Downton Walnut Creek Class A office rents are in the $3.50 to 4.00 a square foot range, while five miles north in Concord they go for $2 to 2.35 a square foot.
Santa Clara and Silicon Valley expect to lease combined warehouse, flex and office in 2015 of over 25 million square feet of deals, which is huge. Tech is still the major driver, but Tesla Motors just by themselves leased one million square feet of research and development, office, and industrial space.
Apple is taking a 760,000 sf planned office development from Wolfe and Central, super cool architecture, on top of their 2 million foot spaceship headquarters which will be done by 2017. Google has a 2.5 million foot Shoreline development and another 2 million feet at Moffett Field. LinkedIn at Mountain View took 400,000 sf and will build 1.6 million feet. Facebook bought a third huge campus and will have employee housing as a component to attract and retain its workers. Palo Alto Networks is building one million square foot data storage facility. Who says California is too expensive?
San Francisco is the epicenter in the entire world right now, with many of the top tech firm headquarters – Salesforce, Twitter, Instagram, on and on, currently over 5.2 million square feet of new office buildings being built; most of this is preleased, and almost 18 million square feet of additional office development pending. However, San Francisco has a Prop M growth moratorium which starts next year and will limit new development to 850,000 sf per year, and there are political forces trying to shut down development, increase rent control and otherwise stifle growth.
Traffic is ridiculous, and the commute now begins at 4 AM. Bart is packed, San Francisco downtown parking is $35 a day or more and even the sidewalks are filled to capacity with pedestrians.
Apartments are renting, two bedrooms for $6,000 a month, more expensive than even New York, and people are doubling up, renting out closets for bedrooms – they have 280 square foot micro-condos for $400,000, but it comes furnished with a Murphy bed that converts to a dining room table.
Many millennials in San Francisco are attracted by six-figure starting salaries, don’t own cars, use Uber and local bus and Bart, eat out a lot, and don’t have home ownership on their wish list – and they are having the times of their lives, working hard and playing twice as hard.
An article by Michael Storper published on October 23 of this year titled “Why San Francisco’s way of doing business beat Los Angeles”.
From 1910 to 1970 greater LA multiplied its population 21 times, and was the center for movies and aerospace. Since 1970, when San Francisco was ranked #1 and Los Angeles #4, today the five-county Los Angeles region is ranked 25th on the income scale while the 10-county Bay Area region remains No 1. Per capita, workers in the Bay Area make 30% more than those in greater Los Angeles.
Biotech, Amgen was established in Thousand Oaks while Genentech started in South San Francisco. By 2010 there were 214 biotech start-ups in the Bay Area compared with 55 in greater LA. $8 billion in VC financing vs. $551 million in greater LA.
The overall vacancy rate for retail in the Los Angeles Basis has dropped to 6%. Unemployment for LA is 6.9% as compared to Orange County of 4.5% and the Inland Empire, at 6.8%. For product types, single tenant buildings had vacancy rates of 2.6%, super regional malls of 4.3%, and neighborhood shopping centers at 8.6%. Industrial space within the Los Angeles County region is down to a miniscule 1.6%.
It is interesting that in our global economy, where many millions of jobs have gone offshore to India, the Philippines and elsewhere, where you can get programmers in foreign countries at a fraction of the cost of US workers, and even in the US, where cities in the Midwest and South will almost pay your company to move, they will train your employees, give amazing tax breaks and incentives to entice California companies to leave California – heck the average price of a house in the US, according to the Huffington Post, is $189,000, but there are dozens of states where the average price is under $150,000, and yet Californian big tech companies for the most part are buying and leasing huge office campuses, right now, to house new employees. As I mentioned, Apple is building a 2.1 million foot headquarters and Apple, Google, Facebook, Salesforce, LinkedIn and many many others have purchased or leased tens of millions of square foot office campuses, or, in the case of Salesforce, Class A high-rises.
Our California infrastructure is so so far behind our current job and housing growth, it is ridiculous! We have roads and bridges literally falling apart, we are adding thousands of new housing units and millions of feet of new office space in a number of subregions, yet no new mass transit, freeway, parking lot infrastructure plans are in play to keep up. Yes, the Bullet train may be coming, but at least in the Bay Area our daily commute now starts at 4 AM, Bart trains are at capacity, and in some cities, like suburban Walnut Creek, public parking is five years behind development.
Cities, counties and the State are collecting billions of dollars in windfall property tax due to the crazy sale prices we are experiencing, and this won’t last, but this is when government should be investing big-time in major infrastructure upgrades for the long-term and not wait for the economy to slow down and these bonus revenues to dry up.
For VC funding nationwide California totally dominates. The San Francisco Bay Area alone accounts for 48% of all funding, followed by New York City with 12%, New England with 8%, and Los Angeles/Orange County with 5%.
Let’s talk about financing for a few minutes. There are billions of dollars looking to fund commercial real estate loans, but definitely more conservative and cautious than what we saw back before The Great Recession. Between this year and 2017 there is also over 300 billion dollars in Commercial Mortgage Backed Securities, or CMBS coming due, but most of these properties are not underwater and there should not be a refinancing problem.
Traditional commercial real estate loans require 25 to 30% down, are amortized over 25 or 30 years, and are usually due in 5, 7 or 10 years. The current interest rates are in the low 4% and can either be fixed or variable. Many commercial real estate loans these days can be non-recourse, and insurance companies and banks are eager to make new loans. After all, they pay their savings accounts almost no interest.
Two other key avenues for commercial real estate loans – one of the most popular ways for an owner/user to buy their own building, as long as they occupy 51% or more of the property, is SBA financing with as little as 10% down, and usually the tenant improvements can be rolled into the loan as well, 20-year-fixed term and a very popular way to go.
A third type of financing, particularly for high net worth folks, i.e., 10 million or more in investment accounts, is using firms like U.S. Trust, a division of Bank of America, which for its wealthy clients can go as high as 85% loan to value as long as there is recourse and cross-collateralization.
One of the more interesting components of what I was asked to cover in this morning presentation was the main title, “Are We In a Bubble”, The answer is definitely “yes, no, and for sure, maybe”.
In a recent Barron’s article titled “A New Real Estate Crash is Unlikely”, a number of reasons why this won’t happen, include the current housing supply, which is still not keeping up with US population increases. The commercial real estate market, where in most property type categories and regions rental rates are still far too low to support new construction, so there is no threat of overbuilding. Both residential and commercial lending today are far far more conservative than the crazy 100% loans which were done back before The Great Recession, and remember those days where you could make up your own income figures? Those who have financed or refinanced recently know how difficult it is these days to get a loan.
Warren Buffett’s advice is to be fearful when others are greedy and greedy when others are fearful.
An article titled “Top Reasons the Real Estate Market Could Crash Soon” cites the following things to watch out for:
– Rates are dropping because the economy is not cooking and not enough jobs are being created.
– Robots will continue to take over human jobs.
– FHA can do a 3.5 percent down with a 580 credit score.
– The stock market will slow, the value of stocks diminish, and folks won’t be able to sell stock to buy homes.
(This last article was written back in May 2014.)
The U.S. housing crisis during the Great Recession started when house prices peaked in 2006, and hit new lows in 2012. It is becoming distant memory, but I remember entire cities where one out of every three homes was in foreclosure.
In another article titled “Ten Reasons It’s a Terrible Time to Buy An Expensive House” Banks says a safe mortgage is a maximum of 3 times the buyers annual income with a 20% down payment. “Buyers are still borrowing 6 times their income. Salaries and rents prove that affluent neighborhoods are still in a huge housing bubble, and that bubble seems to be getting more dangerous by the day”. When interest rates go up, housing prices might fall and if you bought high, you’ll lose your equity, but not your debt.
Are we in a bubble and if so, when will it burst? In my opinion, the growth of tech at its current pace is simply not sustainable. However, this does not mean we will have a meltdown like in the dot-com days. Signs to look out for: Google stops hiring, Apple stops innovating, Facebook finally saturates the world, and tech companies start to put excess space on the sublease market.
Quoting Accounting web February 6, 2015:
“Many accounting firms have spent a fortune trying to attract and hang on to the next generation of top talent. They’ve invested in countless hours of staff development and training, offered an exceptional benefits package, encouraged work-life balance through options like telecommuting, and, possibly, even invested in the occasional office yoga class or 15-minute chair massage during busy season. But chances are they’ve entirely overlooked one of the most significant factors in determining workplace satisfaction: the physical design of their office space and the impact it has on their employees’ happiness, productivity, and loyalty.”
Office design is one area where smaller CPA firms can come out ahead as compared with the large firms.
Four key elements of great office design:
– Everyone does not work the same way. Some people thrive in open environments, others need privacy and quiet, and some like to have a choice during the day, collaborate with others, in group space, and later ‘heads down’ in a private quiet space.
– Have different zones throughout your workspace for collaborating, for solo work, for socializing.
– Make wellbeing a priority, offer standing desks, treadmill stations, and lounge furniture.
– Emphasize moving versus sitting, have walking meetings, reasons to get out of the private office and collaborate.
Have a work café, where you can eat, socialize and also get work done between meals. And even though accounting can be a serious business, consider making parts of the workspace ‘cool’ and ‘fun’!
In conclusion, we discussed the major California metropolitan regions, including San Diego, Sacramento, Los Angeles, Fresno, Silicon Valley, and San Francisco. We discussed commercial real estate financing, covered retail, warehouses, office and apartments, and touched on both sides of Are We In a Bubble.
All the reports and stats can be found at https://www.officetimes.com/2015-calcpa