Our annual forecast for the commercial real estate market in Southern California – here’s where our heads are at as we look at 2019.
First, Happy New Year to all of you from all of us at the Zehner Davenport Industrial Group.
2018 passed by in the blink of an eye and here we are looking ahead to another year that looks to be much the same in terms of the Southern California industrial property market.
Vacancy remains bottomed out in the 2% range and we expect that to keep sales prices and lease rates moving higher, but at a slighter slower pace in 2019. Tenants and buyers have become more focused on quality and getting what they truly need to be more productive in return for paying the premium landlords are sellers continue to insist upon. As a result, time-on-market for available properties has begun to increase, so in some instances we are now measuring marketing time in months rather than days or weeks.
Landlords are pushing hard for longer leases and stronger credit because they know that the supply/demand balance still tilts in their favor, and they are anxious to strengthen their rent rolls as a way to weather a potential market correction.
Sales prices moved sharply higher in 2018 and $300 per square foot is becoming the new $200 per square foot, especially for smaller buildings.
The rise in interest rates in 2018 sent occupancy costs higher for owner/user buyers, but did little to dampen demand, and the lack of construction activity continued to force buyers into older, less functional properties. So, unless there is an external shock to the local economy, we expect our supply-constrained market conditions to continue.
However, we do feel compelled to express our own concerns over some macro-economic issues that could throw a broomstick in the spokes if they persist. Politicians of all persuasions are ratcheting up the rhetoric and the fringes at both ends of the political spectrum have become more disruptive, making it more difficult to find middle ground on anything. Hot button issues like immigration reform, a physical barrier at the southern border, further tax cuts, healthcare and even calls to impeach the President, have the media whipped into a frenzy.
All that plus the uncertainty over the slowdown in global markets and trade tensions with China, has more business owners wondering if the nation’s robust GDP growth will be negatively impacted.
The federal deficit is expected to top $1 Trillion again in the current fiscal year, in part due to lower revenues resulting from the tax cut legislation, and the national debt clock is ticking toward $22 Trillion. Add another $50 to $100 Trillion in unfunded federal entitlement liability, depending on who is doing the counting.
And then there’s the flattening of the yield curve, (the spread between the yield on the 2-Year and 10-Year Treasury issues). That gap has been narrowing for more than a year, falling to just 19 basis points in the middle of January, raising concerns over an inversion (when the 2-Year yield is higher than the 10-Year yield), which has preceded 7 of the last 7 economic recessions.
This fact is not lost on our central bankers at the Fed, and their rhetoric has shifted to a more cautious approach to more interest rate hikes in 2019. However, there are no indications that the current $20 billion per month reduction in its $4+ trillion balance sheet (aka Quantitative Tightening) will change this year. The resulting impact on liquidity could alone drive borrowing costs higher this year.
The collective weight of these looming issues could impact business decision-making, including future commitments to acquire new facilities.
So far, Southern California has shrugged most of it off, but at some point it will impact the commercial real estate market.
Let’s all hope that cooler heads prevail.