Office Experts Discuss Market Cycle And Why San Diego Is A Smart Investment
Despite being in the late innings of the current market cycle, San Diego's economy remains robust, making the market a good place for investment, though there are challenges, office experts said at our San Diego office forum last week.
Moderator Martin Togni (left), a partner at Allen Matkins, opened the discussion asking presenters their thoughts on the status of the current real estate cycle. “Where we are in the cycle is kind of a timeless question,” said Newmark Grubb Knight Frank senior managing director Brunson Howard (far right, with Jason Hill), noting it’s a more interesting question today than in years past. “We’ve heard something bad is about to happen, we just don’t know what.”
Looking at the data, he said rents and values are robust—in some cases at peak or through peak. Absorption is flat, but deck capital is cheaper than ever before. There’s lots of good news in the macro economy, but also lots of consternation. “I don’t think you can throw a blanket on the market and say this is where we are today, even here in San Diego. We’ve got some green shoots and some challenges, but one thing that’s certain, we have a lot of uncertainty in the marketplace.
“The best characterization I’ve heard as to where we are in the market in summer 2016 is a ‘hung market,'” he continued. While sales volume dropped in the first two quarters, the data is skewed by the high volume of transactions in 2015, which was an outlier year. When you pull out unusually high sales volume, Brunson said, "the disparity doesn’t look near as bad."
“Rather the property sales market has leveled off; pricing is holding, but there isn’t the dramatically upwardly trending growth factor that we’ve seen over the last couple of years," he said. Cap rates are generally holding, pricing is flat—“but flat at a very high level. I think we have to wait and see what that means for the third and fourth quarter.”
“We’ve seen at the macro level in the United States, 55% price increases in commercial real estate, and we’re in a sixth or seventh year at the trough already, “so it’s tough to predict the kind of price growth moving forward,” said Hines director Eric Hepfer (snapped at far right, with Brunson Howard and Jason Hill on his left).
He noted his firm does a lot of trend-line analysis, looking at individual markets and evaluating where asset pricing is relative to long-term trends. “Looking at San Diego specifically, our view is pricing is just about at its long-term trend, or value. In other words, it’s intrinsic,” Eric said. “We’re not seeing assets as overpriced right now. We believe that there’s actually room to run, at least from a backward-looking data analysis.”
Murphy Development EVP Kaitlin Arduino (snapped here, with Mark Wayne on her right and Eric and Brunson to her left) says her company bases the market on “how many phone calls we get, and I can tell you the industrial market is still seeing a lot of great demand. I think we have a lot of runway there!” She noted, however, calls on the office side have slowed a bit, but pointed out that’s to be expected with the summer months.
“We still believe there is a good ways for rents to go along the I-15 corridor and in suburban markets,” Kaitlin added, noting her company doesn’t ask rents like in UTC and Del Mar markets. San Diego has healthy market fundamentals, she said. “We’re excited about the next few years and confident San Diego will do well.”
“It’s clearly choppy out there after a pretty good run through the end of last year,” said Cypress Office Properties principal Mark Wayne (pictured far right). He expressed confidence the market will become smoother or frothy, because a lot of capital will be coming into the market.
He said this cycle is nothing like the last one, which started with a slow pickup, went through the dot-com bust, then moved into a 2007 trajectory “when rents, capital and values went through the roof. This is an interesting time: there’s tons of capital still waiting to be placed and tons of capital being raised domestically and internationally. San Diego and the United States is a pretty attractive place to go park money.”
He contends there’s still upside and runway in the market. "We’re very actively acquiring opportunities in our market," Mark said. "We're looking for properties where we can go in and make a difference—transform, update and modernize—do things to make these buildings attractive to tenants who are trying to recruit talent."
Calling the current status of the market the “crazy phase," Hill Properties principal Jason Hill (pictured center) said, “There’s definitely a glut of capital that needs to get on real estate. We hear from capital partners in New York and Chicago all the time that want to deploy capital here. In the first quarter we hit a slowdown. It feels very flat right now, but I predict that prices are going to hit historical highs during this cycle.”
Jason said the sales market is a little bifurcate. He used two recent sales to explain. In marketing one asset in the $10M range, which appealed to the private exchange market earlier this year, “we got a full-price offer on day three of the marketing and closed relatively quickly.”
Another asset marketed in the $18M to $20M range, which appeals to the institutional world, was a disappointing experience. Jason said offers on this core-plus asset, which had a very stable profile, came in lukewarm. "There are two markets out there,” he warned, “so that is something to keep our eyes on going forward."
Martin also asked panelists to compare San Diego to six “gateway city” markets, and what makes it more or less attractive to investors. Brunson said there’s not much buildable land left, so the market will be constrained over time, and opportunities in San Diego are for redevelopment.
While companies have pulled out of San Diego, “I think there’s a silver lining to these corporate exits," he said, as vacated facilities provide opportunities for developers to come in and reimagine them for new tenants.
“As to how capital sees San Diego, my personal and humble opinion is that it will become increasingly more attractive than it is already,” Brunson said. “We know that going into gateway cities, particularly on the West Coast and Boston as well, yields are razor thin. I do think we need to offer capital a little bit more of a yield to come to San Diego."
He said San Diego doesn't have a CBD comparable to gateway cities just yet, but does have the macroeconomic drivers, such as a strong economy and low unemployment, to make a good business case for the city. "They get it quickly—it’s coastal and lots of barriers,” Brunson added.
Jason said San Diego has a "property-size problem." He said equity partners in New York and Chicago want to put out $20M equity checks at a time, which translates to a $50M deal. “But you only see two, three, four deals of that scale going down in a year here in San Diego, so it's been tough to attract capital here."
