The future of San Diego County’s commercial real estate investment market is somewhat uncertain.
According to John Busse, senior vice president of the investment group in the San Diego office of real estate services company Grubb & Ellis, the number of deals that closed in the third quarter reflects deals that were being negotiated in the second quarter and early in the third quarter , before the terrorist attacks of Sept. 11.
“The empirical data doesn’t support anything other than things are going well,” Busse said. The total number of sales remained steady in the third quarter. Figures for the fourth quarter of 2001 will be a much better indicator of how Sept. 11 and the downturning economy have affected local investors, he said.
“To say that Sept. 11 didn’t have an impact on the market wouldn’t be completely true,” said John Walz, senior vice president and manager of real estate finance at San Diego-based Burnham Real Estate Services.
“There’s just a little more caution in the wind now,” Walz said. “So far this year, we’re above 2000 in all product types. Because of Sept. 11, we lost 30 to 45 days. Deals in the works before then will close.”
According to Grubb & Ellis’ statistics, the number of sales worth more than $1 million totaled 575 in 1999, 622 in 2000, and 589 as of the end of the third quarter of 2001.
Office transactions total 127 so far this year , 14 more than in 2000. Industrial transactions total 141, just eight fewer than last year. There have been 96 retail sales this year, compared with 109 in 2000. Apartments sales total 225 so far this year, compared to 251 for all of 2000.
“My sense is that there were a lot of deals that were being discussed, where people decided to put it off (after Sept. 11),” Busse said. “Many investors are saying they want to wait and see if prices are going to drop in the near future.
“If prices dropped, I think you’d see there is a tremendous amount of capital available for investment activity. There’s definitely funding for investors who have big down payments.”
The money behind local transactions is coming mostly from life insurance companies, which have been less active in financing real estate over the last 10 years, according to Busse. But, commercial mortgage-backed securities appear to be picking up the slack, and some local banks have been behind recent transactions.
Most investors right now appear to be large institutional investors, such as pension funds, and exchange buyers, Busse said.
Institutional investors may slow their real estate investment. Walz said most of them have to keep about 10 percent of their portfolio in real estate investments.
However, with the stock market declining over the last year, the value of their stock portfolio has gone down, so the real estate portion of the portfolio is valued at more than 10 percent of the total.
Exchange buyers, who are selling properties in order to purchase more valuable properties, are still looking around the market. Busse said some investors are looking to get out of the multitenant office market in exchange for single-tenant buildings where the tenant has good credit.
“We’re finding if we can put together a nice package on a reasonably well-located property, investors are willing. Investors across the board are still willing to invest in all product types,” Puttkammer said.
– Investment Slows After Peak Last Year
Local investment activity appears to have peaked around the second quarter of 2000, according to John Cona, research and financial analyst at Marcus & Millichap Real Estate Investment Brokerage Co.’s San Diego office. The peak may have been even earlier, but buyers’ exuberance kept investors from realizing it.
“In the last three months, we’ve seen a decrease in commercial real estate confidence for the first time,” Cona said. After employment growth slows, it takes a while for commercial real estate to slow down, because of the positive momentum building in the marketplace, he said.
According to economists interviewed by Cona, the economy is expected to begin its rebound in the middle of next year. The still-low unemployment rate in San Diego County would help prevent a lengthy recession, the economists said.
Busse said as the economy deteriorates and people spend less money, apartment tenants may move back in with parents, or double- or triple-up in apartments. However, apartments continue to be a strong investment, in light of the area’s shortage of affordable housing.
Apartment investment is still a limited risk, even with high-end properties. “If you don’t have tenants, all you have to do is lower your rents and you can continue your revenue stream,” Walz said.
– Apartments Still in Demand
He said there is still a long way to go before San Diego County apartments become so expensive that tenants stop renting and investors stop buying.
“One thing that’s kind of unusual is at some point, though the prices are high (for buying apartment properties), since they’ve lowered interest rates, that gives investors a cushion. For each point mortgage rates go down, they can afford it if rents drop by 15 percent,” Cona said.
A year to a year and a half ago, Cona said developers were optimistic about San Diego’s apartment market, investing up to $100 million in a project, based on high rents they expected to receive.
“Now across the board, we see a spike in rent in the market, higher than the norm. There’s 8 percent rent growth, up to 15 percent, then it goes down,” Cona said. However, the developers have a hard time filling apartments at the higher-than-average rents they told investors they’d be able to get, he said.
“More or less, the original investors are not getting the original return on their investment,” according to Cona. Investors in high-end projects can still make money on high-end apartment investments, if they capitalize their income, he said.
Retail investment can pay off for investors in certain types of properties.
Investors who are buying retail properties are most interested in neighborhood shopping centers anchored by grocery stores. However, those properties come up for sale so rarely, that there haven’t been many of those properties sold lately, according to Busse.
Eric Puttkammer, senior vice president and manager at Burnham, specializes in retail properties. He explained that San Diego County does not have much land zoned for new retail development.
Most new retail projects are in master-planned communities, like the Otay Ranch housing development in Chula Vista. “From a retail standpoint, to find 10 acres along a freeway, it just isn’t there,” Puttkammer said.
Big box shopping centers with large national tenants, and build-to-suit single-tenant properties are also high on retail investors’ lists, according to Puttkammer.
Smaller strip shopping centers without large anchors are still desirable, but mostly for local, smaller scale investors, who will add value to the property and sell it in two or three years, he said.
– Subleasing On the Rise
Because of the amount of sublease space that has come on the market, investors may be more cautious about office property investments.
“We had convinced companies in San Diego that we’re running out (of space). High-tech companies that had plans to expand took more space than they needed,” Walz said.
Rising office vacancies experienced in the eastern United States have now hit San Diego, but the vacancy rate has more or less stabilized, Walz said.
“It happened later in San Diego, and not in as big a way,” he said.
However, Cona said if investors aren’t shying away from office properties, they should be. There is quite a bit of new physically vacant space and sublease space, which is being paid for but is sitting vacant, he said, especially in the Sorrento Mesa area.
“When you start seeing subleases, it’s a sign the economy’s weakening,” Cona said.
Industrial properties are just as risky, he said. However, industrial tenants using their space for manufacturing still need the same amount of space for producing their products, even if demand falls and fewer employees are making the products, Cona said.
Industrial properties do have a more stable tenant base than office, Busse said. Office building tenants are more service-oriented. When new ones move in, they need more extensive improvements to their space compared to industrial tenants.
San Diego-based Business Real Estate Commercial/NAI reports that office, industrial, and research and development properties selling for more than $3 million total slightly more than $838 million in sales in the first three quarters of 2001, compared to just less than $838 million in 2000.
About 64 percent, or $533 million, was invested in office properties. However, according to BRE, fewer square feet were sold this year as the average price per square foot has risen from $145 in 2000 to $174 in 2001. Industrial sales dropped from $196 million in 2000 to $140 million so far this year.
