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This has been the kind of year that when greeting an acquaintance with, "So, how's business?" you know it is a safe question. It’s the equivalent of "Are you having a nice day?"
Most will reply that they are having a nice day. And most in the real estate business in San Diego had a good year, thank you.
Predictably, the forecasting field is now crowded. Everyone is jumping on the prognostication bandwagon, not just the usual few, brave and misquoted. This is because the activity level of 1997 was so frenetic that making a 1998 prediction is comfortable.
It’s easy, and not a little bit self-serving, to suggest that the coming year will be even better. After all, wanting it to be so in this industry is tantamount to making it so. Keep the faith, baby. The market will stay solid.
And it probably will. The year 1998 marks the second full year of prosperity in the local economy and hence the local real estate industry. We are in the frenzy-building portion of this economic episode:
•We haven't seen much overnight camping at new home sites. But in 1998, we probably will.
• We have seen selective increases in housing prices, although not yet across the County. But in 1998, we probably will.
• We have seen a precipitous drop in the vacancy rate in the commercial and industrial sectors, but not huge increases in lease rates. In 1998, we probably will.
It’s 1987, 10 years later. A turn toward prosperity gives the impression to many misguided souls that it will last forever. It probably won’t.
What this new found prosperity also means to me is that we will see new mistakes by new players in a real estate industry that attracts newcomers every 10 years. I feel downright old, remembering the last peak of 1989, and how many practitioners of that era thought it was going to last forever. Some are back again, hopefully lecturing the tenderfeet that markets are cyclical. Alas, others will learn it the hard way.
Let this article serve either as a primer or a review, depending on your rank:
Upward Movement in Housing Prices
Home sales are very strong. This is a direct function of the strength of the economy, reacted to by households moving in, up and around the community. "I do not believe low interest rates are the primary motivator for home sales," suggests Mark Goldman, an independent mortgage broker. Yet, interest rates are low, and may continue to decline into the first quarter of 1998.
The residential market should get stronger. I have continuously contended (most recently in my October, 1997, San Diego Metropolitan article, available on this magazine's Website) that we cannot possibly build enough homes in the county to match demand. While this year we have constructed and sold more homes than any single year since 1990 (maybe as high as 10,000 units when the dust settles), the demand significantly outstrips supply. This is a recipe for increasing housing prices.
The year 1998 should see a steep upward curve in housing prices. The push will be felt, as usual, at the middle and lower end of the market where first time buyers congregate. It is they who are most vulnerable to a housing shortage.
And there will be little relief in the rental market, although 1997 was a banner year for apartment starts. The problem is that these units are mostly at the high end of the rent market, and with a vacancy rate effectively under three percent, it will take more than a few thousand apartment units to satisfy the demand of a population expected to grow by 45,000 persons this year.
Office Market Tightening
Ditto that with commercial offices, which in certain of San Diego’s hottest markets, are nearly fully occupied. Curiously, while La Jolla Village/UTC, Mission Valley and the larger suburban markets are fully occupied, the downtown market is still hobbling at around 15 percent vacancy, a victim of changing rules of businesses that don’t unilaterally value a Downtown location as they once did. While Downtown will stay pretty much where it is in 1998, perhaps gradually improving, the occupancy in other commercial nodes has transformed into construction, particularly along the North City Coastal corridor. Look for additional construction in those sub-markets during the coming year and significantly increasing lease rates, as many contracts are up for renewal next year.
Industrial Market
Breaking New Ground
A market still on fire in 1997 saw a dramatic increase in industrial construction, particularly along the North Coastal Corridor. Look for industrial development to spread throughout the county, including Poway, Rancho Bernardo, and even heretofore sluggish Otay Mesa. Land is increasing in value because of tremendous absorption and there is a fair amount of speculative land transaction, better known as "flipping" hot industrial property from one owner to the next, without doing more than holding on to it a bit. That's a true sign of scarcity. And it exists uniquely in the industrial/R&D and corporate land market.
Commercial Pockets Of Opportunity
The hotel market also was strong last year, and should stay very strong through 1998. Six large hotel properties were sold in 1997 at a total value in excess of $500 million. That is a sure sign of increasing hotel room rates, as well as new construction activity. With expansion of the convention center possible, this market should stay strong next year and beyond.
Retail shopping centers have been undergoing dramatic transformations, with the push toward entertainment or activity-oriented sites, in an effort to attract shoppers in an increasingly competitive retail environment. This year we have seen a great deal of change with the expansion of Fashion Valley (which was brilliantly accomplished) on the heels of Mission Valley's upgrade. Smaller and older centers also have engaged in adaptive reuse, such as Clairemont Town Square. Now since that that environment extends to the Internet, there will be a reshuffling of consumer activity leading to more experimentation by local retailers and shopping center owners.
Be Careful Out There
What worries me most in the real estate market is the potential for too much money chasing too few deals. Money has been flowing to Southern California in the form of real estate investment trust (e.g. Wall Street) dollars and abundant availability of debt financing. This started about a year ago and now the money is chasing the deals. Good product (real estate priced to produce adequate yields) is hard to find. But the market is hot because of full buildings and increases in rents. Some stumbling and bad results are inevitable along the way.
This is the long-delayed boom we have been counting on. It will last for the remainder of the decade. San Diego’s economy is making its move into the 21st century. We have healed from our shift in employment profile from defense contracting and aerospace to high-tech. Those who were displaced have adjusted — moved out of the area or retrained. Those who are left are moving in and up. Business is good. And most everybody is having a nice day.
Gary H. London is president of The London Group Realty Advisors Inc., a La Jolla real estate economic advisory firm. He can be reached through his Web site at www.londongroup.com
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