Authors: Arlyn Stoik, Principal and Jerry Holder SoCal Region Lead, Innovation & Insight, AVANT.
A Southern California Overview
As we enter 2023, the commercial real estate world continues to prove it is not one story, but several unique narratives based upon geographic location and product type. While we all attempt to underwrite the markets based upon detailed analytics using the best information we have, like all asset classes, real estate is subject to many external factors that often cloud our crystal ball. The only real constant is change.
As we think of the complex web of factors at play in our market today, there are several influences and shifts that come to mind as we enter 2023.
Flexible workplaces are here to stay. We will continue to see the resistance of many to return to the office as we still have not found equilibrium. This has created an uncertain picture of our office market going forward. And our downtowns are suffering because of it.
We are still uncertain about a recession, and if it will be short and shallow like many are predicting. Or are we in for a period of monumental headwinds.
The rise and uncertainty surrounding the pace of inflation has caused many to take a “pencils down” approach, slowing, pausing or stopping deal-making, growth, capital investment and development. We expect to see a continued slowdown in new development in most asset classes.
The tech industry has been experiencing significant layoffs and resulting in unprecedented office sublease space coming back to the market. Tech has been a significant driver of the office market especially in Southern California. We have yet to see how things will play out in the sector and if companies will require employees to return to the office.
The supply chain continues to attempt to find equilibrium and sort out the challenges that have caused a shortage of many goods and subsequently sharp increases in prices. Will slowing consumer demand offset these challenges?
The continued importance of ESG. For many organizations it has become a must-have to compete successfully in the marketplace.
The flight to quality and the ability to secure flexible and more affordable office space opportunities for many groups. The office environment will play a more important role than ever in bringing people back and competing for best-in-class talent.
The resilience of the American consumer.
Housing market affordability in southern California is always top of mind. Are we in for a major market correction?
Southern California
With a focus on Southern California on a more granular level, the commercial real estate market has begun to plateau this year. The level of deal activity was inconsistent in 2022. The first half of the year was robust, while the second half of 2022 slowed down as interest rates increased. Unemployment in Southern California remains low, but it is important to highlight, that job creation has been uneven – leisure and hospitality jobs are still underwater, for example. The bright spot is that high-value-added jobs in a broad range of sectors such as aerospace, scientific research, medical products, and pharmaceuticals development, continue to grow, This bodes well for the region.
According to Avison Young’s Q4 Insights reports, below are a few key market highlights/indicators:
Retail – Tenant demand has surged, construction has picked up, absorption will remain positive, lease rates will continue to increase, vacancies/availability will decrease, and investment sales should continue to increase.
Office – Investment sales retreated in 2022 as interest rates increased and office workers were reluctant to return to the office. We should see construction slowing, more negative absorption and increases in vacancies/availability, and very little if any lease rate growth as companies “right-Size” their space requirements going forward.
Multifamily – new construction projects will continue to break ground, absorption will remain positive, asking rents will begin to flatten out after years of double-digit growth, vacancies/availability will increase, and investment sales activity will return to normal levels.
Industrial market – we’ll see construction activity slow down, absorption will be positive, capitalization rates will increase, vacancies/availability will begin to increase from the record lows we’ve seen recently, lease rate growth will return to single digits and investment sales activity will come back to normal levels.
Based on the current environment and what we have learned over a number of economic cycles, we believe that 2023 will see leasing demand that is below the 10-year average. Lease rates showing signs of stabilization after setting all-time highs in the first half of 2022. Vacancies are rising slightly from the record low levels over recent past quarters, and we are also observing that for the first time in a long time, development is outpacing absorption which is not a bad thing being that for so long demand outpaced supply which was the catalyst of the aggressive rise in pricing. It is notable that land is becoming harder to find. As a result, we will have increased developer competition for available sites, and subsequently upward pressure on land pricing.
From a capital markets standpoint, we anticipate that sale transactions will remain at similar levels in 2023 as compared to the second half of 2022.
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