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Approaching Fiscal Cliff Threatens Recent Gains In Real Estate

By Joshua H. Silavent - Staff Writer

November 6, 2012 - It is no revelation that job growth – rather than, say, debt or deficit reduction – is the greatest single key to a sustained economic recovery in the short term. With it comes movement in all sectors of the economy, and this is especially true when considering the real estate market. From home sales to commercial and industrial sectors, experts agree that unemployment is a major drag on the industry, inhibiting investment, business expansion and household discretionary spending.

There is a long road ahead before the nation’s jobless rate resumes a stable level – it currently stands at 7.9 percent. But positive trends in the labor market are emerging throughout California.

Construction continues on the third and final phase of The Promenade North
block, between Broadway and 3rd Street in Downtown Long Beach. Bike racks,
dog-friendly pathways and green spaces will round out the development, which
includes the Harvey Milk Promenade Park (not pictured) on its Northern end.
The project cost for the three-block redevelopment totals almost $12 million.
(Photograph by the Business Journal’s Thomas McConville)

The Golden State’s unemployment rate fell to 9.7 percent in September, down from 11.5 percent one year earlier. In Los Angeles County, the rate dipped to 10.2 percent in September, a 1.8 percent decrease from February. And in Long Beach, the rate dropped to 11.2 percent in September from 13.2 percent in February. (All aforementioned rates are non-seasonally adjusted).

“The labor market improved notably in these last couple of months,” particularly since July, said Robert Kleinhenz, chief economist with the Los Angeles County Economic Development Corporation.

Gains in the Los Angeles County labor market were made in the leisure and hospitality industry, private educational services, financial services, retail, professional and technical services, and trade and transport, among others. Most recent losses occurred in government and manufacturing, with a slight decrease in the healthcare industry as well, though Kleinhenz said this was likely just a hiccup. Finally, growth in the construction industry, obviously crucial to the real estate market, continued to remain weak or nonexistent.

One caveat to consider is that the labor force shrunk by more than the change in employment, Kleinhenz said. The county workforce in September was 4.8 million versus 4.9 million a year prior. Part of this is due to an aging demographic, Kleinhenz said.

Still, in September, Los Angeles County added jobs on a year over year basis at a rate of 1.8 percent, Kleinhenz said, compared with a 1.4 percent national rate (excluding job losses in government, private sector employment nationwide is faring better, with a 1.8 percent growth rate year over year). “I think it’s important for us to recognize whenever the local economy is outperforming the national economy,” Kleinhenz added. “That’s hopeful news.”

The momentum of the last few months, however, might be all for naught given the looming fiscal cliff and the potentially catastrophic breed of tax increases and spending cuts at the federal level come January 1.

“I wish I could say that we expect the unemployment rate to continue to edge down,” Kleinhenz said, but everything seems to hang in the balance at this time.

The end of the Bush-era tax cuts, the loss of the payroll tax cut for workers, $100 billion in spending cuts next year alone (to defense, social services and education, among others), a reduction in unemployment benefits and the elimination of some deductions, such as the mortgage debt tax relief, spell a volatile fiscal mix that could send the American economy reeling.

“One of the things that really concerns Southern California and Los Angeles County, in particular, is that set of defense cuts,” Kleinhenz said.

Moreover, all these wild cards don’t even take into account the debt issues facing many European countries and the weakened economies of trading partners in Asia, both of which could spill over and contribute to economic stagnation in the United States.

Congress will have to tackle the fiscal cliff during a lame-duck session between the presidential election and January 1, which is not exactly an ideal scenario for fixing the nation’s economic woes. “The can has been kicked down the road quite a number of times,” Kleinhenz said.

HCVT - Certified Public Accountants

So what does this all mean for the real estate industry? Uncertainty, above all else.

But that’s not to say that trend lines haven’t been positive over the last few months. Pent up demand, low inventory, cash investors, increased sales prices and a lack of distressed properties on the market are contributing to a healthier single-family market, said Gary Painter, director of research at the USC Lusk Center for Real Estate.

“We’ve seen about five or six months in a row of the right direction in the housing market,” Painter said. “My forecast is that you’ll see more of the same.”

The apartment and condo market has surged in recent months, essentially outpacing growth in all other sectors of the real estate industry. “Multi-family has been on fire for most of the year,” said Steve Warshauer, senior commercial advisor with First Team Commercial.

The commercial market also has seen positive movement. The local industrial sector has benefited from new projects coming online, such as the development of Pacific Pointe at Douglas Park by the Irvine-based Sares-Regis Group. And many owners-users are filling industrial space throughout the South Bay.

Meanwhile, the office space sector experienced positive absorption in both the downtown and suburban Long Beach markets in the third quarter. And big moves, such as the Port of Long Beach administration’s likely relocation to 4801 Airport Plaza Dr., are expected in 2013, which will have a positive ripple effect on the entire sector. (The Long Beach Board of Harbor Commissioners was scheduled to vote on the proposal November 5, after the Business Journal’s press deadline).

Finally, the retail sector has been slow to recover. With more and more Americans shopping online and less and less land space available to develop new shopping centers, mom-and-pop stores are likely to continue leading the way in the retail market across the South Bay.

Of course, prospects for even better results in 2013 hinge on whether the fiscal cliff is averted.

“If we fell over the fiscal cliff in its entirety,” Kleinhenz said, “we would probably be looking at a recession in the first half of next year.”

Single-Family Homes: A New Market Emerges

“All of the historic definitions of market are off the table,” said Phil Jones, managing partner with Coldwell Banker Coastal Alliance.

Indeed, the single-family housing sector in the Long Beach area has a strange look to it these days as median sales prices recover while inventory has fallen to nearly unprecedented lows.

A market in balance, Jones said, would have about six months supply of inventory. But in September, inventory stood at less than two months, and even that had improved from a low of 1.1 months in August. Moreover, inventory is down 59 percent year over year, said Tammy Newland, operating principal with Keller Williams Realty in Los Alamitos. “We have gone overnight to a seller’s market,” she added.

The extreme shortage of homes for sale is driving an increase in multiple offers for listings, and cash investors are flooding the market.

“The other thing we are seeing in the market that is fascinating is the influx of investment money . . . some of it foreign, some of it not,” said Geoff McIntosh, owner of Main Street Realtors in Long Beach. “I’ve never seen this much cash in the real estate market before.”

Moreover, McIntosh said that almost 70 percent of current sales are equity related, with about 15 percent being REOs and the remaining being short sales. “That’s a phenomenal change from where we were at a year ago,” he added.

Meanwhile, median sales prices in the local market increased to $400,000 in September compared with $365,000 a year prior, Newland said, primarily as a result of shrinking inventory.

There has been a lot of talk in the real estate industry recently about a “shadow inventory” of distressed properties not currently available and whether this is somehow suppressing the market’s true nature.

Newland said these bank-owned properties are skewing the numbers to a degree, as about four million homes are currently in the foreclosure process and 11 million more are underwater across the Golden State. “We’re going to be in an artificial market until they release their inventory,” she added.

Foreclosure filings did fall more than 25 percent in the Los Angeles metropolitan area in the third quarter, according to RealtyTrac. But the state still led the nation in new filings in September, with 37,917 (or 1 in every 361 housing units) new foreclosures – either a default notice, foreclosure auction notice or bank repossession.

“I think if we were in a true normal market we would probably be seeing more foreclosures now,” McIntosh said, “and that would ease some of the restrictions that we have on inventory.” It would likely take four or five years for a realistic level of inventory to hit the local market, he added.

Jones, a member if the Distressed Properties Task Force at the California Association of Realtors, said there is little risk of home sales prices plummeting because he doesn’t expect banks to deluge the market with REOs in the coming year. He said banks would systematically release properties in order to maximize returns.

However, the gains in sales prices seen across the state this year as a result of declining inventory might be an over-correction. Uncomfortable with this dynamic, “My fear is prices will increase too quickly” in 2013, Jones said, potentially producing a new bubble in the market.

Jones highlights the 90803 zip code and Belmont Shore neighborhood as a prime example. In a normal, stable market, he said, prices would have appreciated between 5 to 7 percent in this neighborhood, when in fact they have soared beyond 20 percent this year. This growth simply cannot be sustained. “It’s such an unconventional market,” Jones said. “It’s hard to define.”

Despite the mixed bag of signals in the housing market, trend lines are proving positive, and Newland expects this to remain true in the New Year. The luxury market, in particular, is recovering well.

McIntosh said he doesn’t expect interest rates to remain at historic lows through 2013, which could have some affect on buyers’ habits. But with the housing market showing some modest improvement, the trickle-down effect on the economy could be prove beneficial. “As demand increases for housing, suddenly the construction industry kicks back in,” he said.

Jones said there is a lot of uncertainty with regard to the fiscal cliff and prospect for tax increases and spending cuts at the federal level come January 1. “We want to believe that it will get done,” he said.

Apartments: Better Than The Rest

More than any other sector of the real estate industry, the multi-family apartment market is surging. The National Association of Home Builders reports that the Multifamily Production Index has improved for eight consecutive quarters, posting its highest level in September since the height of the housing bubble in 2005.

“Our market, overall, is ticking up,” said Malcolm Bennett, owner of International Realty and Investments and a past president of the Apartment Association, California Southern Cities Inc.

There are several factors at play that explain this growth: low interest rates, a slight easing of financing restrictions and a limited amount of inventory, said Steve Bogoyevac, a broker with Marcus & Millichap.

Moreover, investors have flooded the market, often paying cash, because apartment and condominium communities present a viable investment alternative to the less stable single-family housing market.

“It’s very attractive, in terms of yield,” Bogoyevac said, adding that economic uncertainty and potential for inflation makes apartments a solid investment opportunity, or hedge, against such market forces.

The market also is stable for renters, many of whom prefer short-term options while waiting for the housing market to fully rebound. “I think there’s a large age cohort of renters that don’t have the desire to own a home,” Bogoyevac said. “It’s just a different era. Owning the home with the white picket fence is not the end all, be all.”

Moreover, as a new generation desires more flexibility in where they work and live, renting is a suitable lifestyle choice that frees up some discretionary spending, Bogoyevac said.

Renting, currently, remains a more cost-effective living option to a mortgage, Bennett said, even if rates have seen a slight increase as a result of shrinking inventory in the single-family market.

Meanwhile, low-income housing options – such as the recent opening of an affordable community at 425 E. Carson St. in Carson – account for most new construction and rehabs in the South Bay. Senior living options also are springing forth.

Barbara Irvine-Parker, a realtor with Coldwell Banker Coastal Alliance, is seen
here inside the penthouse condo on the 23rd floor of the HarborPlace Tower in
Downtown Long Beach. Condo sales at the tower have increased each quarter this
year, she said. (Photograph by the Business Journal’s Thomas McConville)

Though low inventory kept sales in the condo market relatively flat during the third quarter, the upside is an increase in the number of offers made on individual listings, Barbara Irvine-Parker, an agent with Coldwell Banker Coastal Alliance, said in an e-mail. Though multiple offers tend to drive up rates, the market remains primed for buyers, she added.

This is evident at HarborPlace Tower in Downtown Long Beach, where condo sales have increased each quarter in 2012, with five closings in the third quarter and three already in the fourth quarter, Irvine-Parker said. Most were standard sales rather than short sales.

“I am very optimistic about the first quarter of 2013,” Irvine-Parker said. “The election and the holidays will be behind us. Buyers will be ready to take advantage of the low interest rates and sellers will be poised to benefit from the slow inventory and pent up buyer’s demand.”

The local apartment market, however, is likely to see less certainty in the first half of 2013, both Bogoyevac and Bennett said. But this sector is expected to retain its recent recovery even if a few bumps in the road emerge, which bodes well for the local, regional and national economy.

“I’ve been in this business for 38 years,” Bennett said. “You cannot have an economic recovery without a strong rental and home-buying market.”

Office Space: Holding Steady

It might not be a leading indicator of the nation’s economic health – as is the case with the housing market – but the office space sector reveals a lot about the most important aspect of a recovery: job growth. And given the relative weakness of employment levels in the last few years, anything but a downward trend is, perhaps, a positive sign.

“The market is still holding steady,” said Robert Garey, senior director at Cushman & Wakefield. “When there’s job growth, it creates demand for office space.”

According to a third quarter office space report from Cushman & Wakefield (C&W), there was positive absorption of office space in both the downtown and suburban Long Beach markets, with significant lease and sales transactions during the third quarter. For example, Parsons Brinckeroff leased more than 10,000 square feet at 11 Golden Shore, and the 3900 Cover St. building at Douglas Park sold for close to $1.6 million.

Though there was less than 4,300 square feet of positive absorption in the downtown market, according to the report, the trend lines remain positive as inventory hovers around 20 percent – not too low, not too high.

“The downtown climate is changing,” said Shaun McCullough, a broker with Lee & Associates, adding that about half of the downtown towers have sold, are for sale or are currently under contract.

The suburban market, meanwhile, posted nearly 50,000 square feet in gains, according to C&W, with the Bixby Knolls and Long Beach Airport area submarkets leading the way. Additionally, the available sublease inventory increased by more than 37,000 square feet.

With the passage of the Affordable Care Act and the fact that many of its provisions take effect in 2014, healthcare providers are ramping up across the nation, and Long Beach is no different.

“The healthcare industry is still kind of chugging along and moving in that positive direction,” Garey said.

For example, Molina Healthcare is backfilling sublease space at the ARCO Towers downtown, which is good for the market, Garey said.

The Port of Long Beach is poised to relocate its administrative offices to 4801 Airport Plaza Dr. (The Board of Harbor Commissioners voted on the proposal November 5, after the Business Journal’s press deadline). The relocation will have a trickle-down effect on the entire market, McCullough said. “It’s only going to do good things for us,” he added. “It affects everybody in that marketplace.”

The office space market remains strong for buyers, McCullough said, and he doesn’t expect that to change much in 2013.

But like all real estate sectors, there is some uncertainty about how the presidential election, the looming fiscal cliff and the European debt crisis will impact the industry next year. “These factors will hold down the global economy,” Garey said.

Moreover, a continued slow recovery could stagnate the commercial real estate market, which already tends to lag behind the general economy, Garey said.

Steve Warshauer, left, a senior commercial advisor with First Team Commercial, and
Ed Spotskey, owner of Spot Lighting Supplies Inc., show off the company’s
10,400-square-foot industrial property at 1200 Oregon Ave. in West Long Beach.
The building was formerly owned by Jesse James of West Coast Choppers and
purchased by Spotskey. (Photograph by the Business Journal’s Thomas McConville)

Industrial: Choppy Waters Ahead

Though positive trends are emerging, the local industrial sector continued its back-and-forth march in the third quarter, according to local experts.

“Some areas are picking up,” said First Team’s Warshauer, “and some are still a little quiet.”

Brandon Carrillo, an agent with Lee & Associates, said activity had picked up in the third quarter after a drop-off in the second quarter. But with the fourth quarter typically a slower season in the market, he expects sales and leases to remain choppy heading into the New Year.

However, activity in the sublease space is burgeoning, and vacancies are slipping in the Long Beach area, especially compared with the broader Los Angeles market, Carrillo said. Moreover, class B and C space remains primed for buyers.

“So now you have people that were on the sidelines for so long just trying to wait things out finally jumping back in the game,” Carrillo said.

Warshauer said he has seen increases in sales and leases on the Westside of Long Beach, bleeding into San Pedro and Torrance. Many buyers are purchasing with cash and are owners-users of industrial properties, rather than investors. Warshauer has managed transactions for several small users within a range of needs: for example, a dry cleaning supply company, a wholesale lighting contractor and even a wealthy businessman needing a place to store his cars.

The Sares-Regis Group, based in Irvine, has been a major player in the local industrial scene over the last year as it develops Pacific Pointe at Douglas Park. The group recently purchased the Boeing 717 facility, which includes two hangars totaling about one million square feet on 52 acres of real estate, to add to its portfolio.

Pacific Pointe North, which includes four buildings, is now complete and grading for Pacific Pointe South is underway.

Peter Rooney, president of the commercial investment division at Sares-Regis, said the buildings offer a nice mix of consolidated uses, providing both office and industrial space.

Warshauer said he doesn’t expect to see much improvement in sales prices in the industrial sector until mid-2013 given the uncertainty of the presidential election and the potential for tax increases and spending cuts as part of the fiscal cliff.

“Every time you hear about another tax, you wonder, ‘How many more businesses are they going to drive out of California?’” he asked rhetorically. “And, on a national level, every time you hear about another tax you wonder, ‘How many jobs are they going to drive completely out of the United States?’” But, Warshauer added, the uncertainty isn’t enough to keep earnest buyers at bay.

Carrillo said that because access to capital remains difficult to come by, he expects the market to remain herky-jerky in the beginning of 2013.

Doug Shea, co-owner of Inco Commercial, stands outside the Circle Marina Center
retail outlet at Pacific Coast Highway and Ximeno Avenue. The center currently
has two units ranging from 6,000 to 12,000 square feet available for lease.
(Photograph by the Business Journal’s Thomas McConville)

Retail: Hard To Find In Long Beach

Activity in the local retail sector ticked up in the third quarter, especially with mom-and-pop stores taking advantage of low interest rates and refinancing options, said Doug Shea, co-owner the Inco Company. But stifling regulation has kept credit lines nearly frozen, he added, which inhibits expansion, remodeling or opening large retail stores for many businesses.

Shea did point out that an investor is doing a complete remodel of a long-vacant building at Peter’s Landing Marina in Sunset Beach. But such projects are difficult to come by in Long Beach.

“Long Beach is so, so behind on retail,” Shea said, pointing to the city council’s nixing of the proposed Seaport Marina Hotel expansion as an example. “If the city doesn’t support retail, you’ve got to go out of town to buy.”

And not just out of town, but also to the web. Internet sales are predicted to rise again this year during the holiday sales season.

Of course, the restaurant industry in Long Beach accounts for a large share of retail-related business, and while rent and lease prices are holding steady, they remain too high, particularly in a neighborhood like Belmont Shore, Shea said. “I think the retail market has been over-inflated for the past five years,” he added.

Whit Latimer, an agent with Bancap, said Alamitos Bay Landing and Alamitos Bay Marina Center are 100 percent occupied. “This end of town, and waterfront retail, always is in high demand,” he added.