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Perhaps it is an historical coincidence, but the San Diego real estate market has peaked in the last year of each decade the past 40 years. And it appears that this year will not be an exception, although we have reached what more accurately might be termed a plateau. While the frenzy experienced for 18 months through the first half of 1998 has slowed to merely a robust market, we are still in a positive place in the cycle.
Entering the third year of the cycle, there are clouds on the horizon. But they have to do with the general economy and not necessarily with real estate. Reports suggest that the global economic crisis is now beginning to be felt in California's technology industries and that slowdowns are coming in aerospace and financial services.
Yet, real estate fundamentals remain quite strong.
TURI Commercial Services reports that the San Diego County office market is now at 92.4 percent occupancy, and new leases are at decade highs. Projections suggest the current inventory of 60 million square feet of office will grow to 75 million square feet by the year 2005. Most of the growth so far has been in the suburbs, and none has been Downtown.
The industrial market is very strong, experiencing the addition of more than 5 million square feet in the past year, bringing the total to 109 million square feet and a very high 95.1 percent occupancy. That should increase to an inventory of more than 120 million square feet by the year 2005.
Housing developers added 2,900 apartment units in 1998, the biggest year since 1986. But that year we added 15,000 units. Apartment rents are high (can you believe approaching $1,500 a month for a two bedroom apartment?) and vacancies are as close to zero as one can measure. Nearly 26,000 homes were sold in 1998, with about 12,000 being new housing units. The supply of new homes, however, is not meeting the demand made by a populace that is adding 50,000 to 70,000 persons in any good year. Although nearly 100,000 units are planned in the coming years throughout San Diego County, they will take many years to earn the necessary government and financing approvals. By the year 2005, South County will increase its housing base by 36 percent, pushing it past North County as the region's highest growth market. (North County in the next five years will add 16 percent to its much larger base.)
Housing prices in San Diego County have now reached an average of $252,000, with new homes now averaging more than $310,000. Mortgage rates have slipped well below 7 percent for 30-year fixed, the lowest of our generation. It is possible that 1999 will mark the first year we achieve a $1 million price tag for a single family home in a tract development. While this will be a big home, and not far from the coast, we are talking about a tract home, not custom, without a particularly outstanding vie nor a large lot.
Maintaining A Cycle Of Prosperity
Each sector of the real estate economy has been fully engaged in a cycle of prosperity. Here are some highlights:
- Carmel Valley upsurge: The region's office market has had one outstanding success story during this past year and that is North City's Carmel Valley market, a suburban corridor stretching a short way along the east side of Interstate 5 on El Camino Real and High Bluff roads. Now boasting the highest lease rates in the county — about $2.35 per square foot, per month — this classically suburban office market has grown more than 1 million square feet in the last two years. Its strength is location north of the much-maligned Interstate 805/I-5 merge, easing the commuting burden of many San Diego executives.
- Manufacturing: the future of manufacturing and industrial development in San Diego County is unlikely to emulate the past. Most of the industrial inventory added has primarily been in Sorrento Valley, Poway and Carlsbad, principally in the South Poway Business Park and the Palomar Airport area. Manufacturing and industrial are likely to shift to available South County and other in-fill locations. But the real action may be in new style quasi-industrial demand — including corporate offices, research and development and mixed corporate facilities — which may be accommodated Downtown as a part of the East Village redevelopment, or in places such as Rancho Bernardo and Sorrento Valley as buildings shift "vertical" after a generation of construction of "horizontal" industrial projects.
In fact, Kearny Mesa is a prime example of the phenomenon of a traditional industrial area that is going from "horizontal" to "vertical." The old General Dynamics site is the latest example, now that it has been purchased by Lennar, of the promise of a more intensive land-use application. Yet this does not mean the loss of jobs. Rather, there will be jobs on this site that reflect a shift in the nature and output of companies now expanding and moving to our region.
There is a blurring in the distinction between what once was clearly office or industrial space. A look at the manufacturing sector over the past couple of years suggests that San Diego is fast removing itself as a traditional manufacturing base, turning instead to buildings and campuses that are a blend of research and development, assembling and showcasing products. When there is manufacturing, there often are robotics involved, such that the traditional industrial spaces are no longer required. This opens up new development opportunities in nontraditional locations and may very well ultimately be the resuscitator of other urban, in-fill locations.
- No condos: In virtually none of the planned residential inventory do we see the development of condominiums. This is owed to an imposingly deep line of construct defect liability for any developer, subcontractor or consultant who dares participate in the development of a condo project. The result is the elimination of the traditional "starter home" for young, upwardly mobile San Diegans. More than any other factor, this has the effect of bidding up apartment rents as these same young, affluent persons take a much longer time to save for the daunting, large down payment required to purchase a single family home. Apartment rent levels will remain high for the foreseeable future until condominiums are built again. The crisis is in entry-level housing, not necessarily in lack of apartments.
No Overcapitalization
In this column 12 months ago I warned of the danger of overcapitalization because I believed that the Real Estate Investment Trusts would overpay for offices, hotels, shopping centers and apartment projects. However, the stock market drop eroded the REIT treasure chests with the result that they and other investors cooled their purchase activities. As 1998 progressed, the number of these kinds of transactions declined markedly. This unexpected slowdown stabilized the real estate market, such that the kind of trouble I thought we were going to get into seems to have been avoided.
The loss of appetite for product gives the market time to catch up. When this same product eventually is sold to investors it sells for the value which can be supported by the revenue of the asset, not on its prospective revenue. That's what always kills a project and causes a cycle of investment failure as the market turns down. We may very well have avoided that calamity this time around. It looks like we can steer clear of a crisis of real estate bankruptcy at the level of what happened in the first half of this decade.
Another reason to be optimistic about the real estate market is that although the pent-up demand, which was the lasting residual of the early 1990s, may now be close to being satisfied, the growth of the market remains strong. San Diego added 65,700 residents last year, primarily fueled by job growth, a phenomenon that will continue to create demand this year.
Managing The Growth
Ultimately the positive psychology of the market will change, through no fault of the real estate sector. When the local economy does falter, it will not be the major episode previously experienced. Economies cycle, but not all cycles are created equal. This one will be mild, and San Diego can escape much of the bad stuff. Our prices across all sectors are rising, but we are relatively cheap by comparison to California's other major coastal metropolitan markets. That makes us perennially attractive to expansion-minded companies.
In the face of this growth, the pressure is increasing for a managed solution. In the November 1998 elections, San Diegans approved three developments in the North City, which in time will add 15,000 housing units. The completion of one new freeway (State Route 56) to connect I-5 and I-805 will bring some temporary reprieve from the growing traffic problems. But the real answer to traffic woes lies in the employers' and employees' willingness to figure out how to stay off of the freeways during the impacted six-hour commuting window. Variations in work shifts as well as implementing incentives to put more people in a single car take us some of the way.
But the real answer may lie in something gleaned from a recent study I conducted: Nearly 50 percent of the heads of households purchasing a new home during the past year commute to the same or the adjacent zip code. In other words, people are simply choosing to purchase a home near their jobs. We can only hope that this trend continues as these new homes are built.
Stay Liquid
Somewhere between now and the Y2K crisis there lurks a market peak, to be followed by a slowdown. The gutsy strategy for investors is to lower your greed factor and sell now, preparing for buy opportunities during the next episode. If our major systems start failing after midnight on Dec. 31, it may be prudent to be liquid anyway. Stashing some cash under the mattress is a smart strategy. Who knows what bargains lie ahead?
Gary H. London is a real estate strategist and economist. His firm, The London Group Realty Advisors, publishes real estate information on its Website at www.londongroup.com.
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