Southern California’s Recovery Attracts More Real Estate Investment Capital
By Brad Hall and Richard H. Klein
The Los Angeles basin is experiencing an economic recovery with significant impact on the commercial real estate markets. What’s different this time around is that the flow of capital into real estate is led by institutional investors and pension funds.
Domestic and foreign pension funds, real estate investment trusts (REIT’s), and mutual funds are looking for opportunities to make equity investments in Southern California real estate. Insurance companies and banks are interested in debt financing, as are Wall Street firms through securitization and conduits. And opportunity funds want a piece of the action through participating and mezzanine debt financing. The targets of these diverse investors and lenders include single assets, portfolios of assets, real estate operating companies, small REITs, and real estate owned (REO) – assets taken over by lenders as the result of foreclosure proceedings or borrowers deeding the properties to lenders.
With the increased ability of real estate companies to raise capital in the public and private capital markets, more capital has become available for investment in Southern California and other commercial-property markets around the country. Recent capital markets transactions illustrate this trend:
– Essex Property Trust received a $40 million capital infusion from Tiger/Westbrook, which Essex Property will use to reduce debt and acquire properties in Southern California and selected West Coast markets.
– Spieker Properties LP (SPK) received a $200 million investment in medium term notes from Fitch Investors Service, thus enabling SPK to repay debt and acquire and develop new properties.
– Carr America Realty Corporation announced a plan to make a $200 million public offering to repay indebtedness and facilitate acquisition of office properties.
– Security Capital announced plans to raise $250 million in an equity offering, for purchasing up to $132 million of shares in Regency Realty Corporation. Regency will use the funding to finance acquisition and development and investment opportunities, which is expected to include California.
– TriNet Corporate Realty Trust, Inc. 1996 raised its California portfolio to 18 properties by acquiring a four building, R & D facility and a second office R & D property, both in Silicon Valley.
Geographic Markets
In Southern California, the hottest geographic markets for investment include West Los Angeles, Century City, Santa Monica, Marina del Rey, and Beverly Hills; the Tri-Cities (Burbank, Glendale, and Pasadena); Woodland Hills, and Orange County.
Property types
Industrial
Among property types, demand is strongest for warehouse and distribution properties. An oversupply of this type of space is abating. Owner/user prices remain higher than investor prices in most markets. REITs are actively pursuing development as well as acquisition opportunities. Institutional debt sources will lend at competitive rates on well-established industrial properties. Limited speculative development is occurring in Orange, San Bernardino, and Riverside counties.
Competitive industrial prices will continue to attract investor interest because of Southern California’s growing trade with the Pacific Rim and increased investment in port infrastructure. Approximately 30 percent of the $400 billion economy of metropolitan Los Angeles depends on global trade. The ports of Long Beach and Los Angeles plan to invest $4 billion on expansion programs over the next 25-years, the largest such investment in the nation. Increased trade through the ports will create additional 700,000 jobs in Southern California by 2020.
Suburban Offices
Prices of suburban office prices have begun to recover, mainly because of increased demand from the entertainment industry, a prime space user in certain locations. The largest increases in prices and rents have been in Beverly Hills, West Los Angeles, the Tri-Cities and other markets that are leading the recovery. In some markets, however, investors continue to find opportunities to acquire properties for substantially less than replacement costs. Institutional capital is seeking investments in higher quality suburban properties. Limited capital is available for investment in lower-quality properties, but yield requirements remain high.
Apartments
Apartment prices have begun to recover slowly from the depressed levels of the mid-1990’s, when a glut of apartments taken over by lenders as REO were on the market. Investors will continue to be attracted to newer apartments (those built since 1985) in larger complexes (of 200 or more units) and in middle-class suburban markets.
Hotels
Southern California’s hotel market, which was harder hit by the recession of the early 1990’s than any other regions, has begun to recover. Average daily room rates (ADRs) and occupancies are expected to continue increasing in most markets including West Los Angeles, the Los Angeles airport area, Long Beach, and Orange County. Investments below replacement costs are generally available.
For Southern California’s real estate markets, the recovery of the region’s economy is not a rising tide that will lift all boats. The performance of individual real estate markets will vary dramatically by location and product type. Assets that can meet the investor’s criteria will be in the best position to attract investment capital.
However, the return of institutional investment to California will not be frenzied. While investment capital will be readily available, investors will be highly selective. They will emphasize current returns (vs. capital appreciation), look for opportunities in value-added redevelopment or repositioning, and tie the compensation of operators, advisors and property managers to asset performance.
Brad Hall is National Director of Pension Consulting for E & Y; Kenneth Leventhal Real Estate Group. Richard H. Klein is a Partner with E & Y; Kenneth Leventhal specializing in REIT advisory services, corporate workouts, restructuring and insolvancies. The E & Y; Kenneth Leventhal Real Estate Group is the preeminent provider of real estate advisory services, with more than 2,500 real estate industry specialists located in over 75 markets across the country.
##
Why is Capital Returning to California?
The rest of the country is talking about California in a new context, based on the state’s fundamental strengths and improvements to its economy.
– Many people were concerned that the state’s high-priced jobs in defense and aerospace would be replaced with low-wage, low-skilled positions; they have been proven wrong. California has created jobs in education, technology, motion picture production, engineering, management service and international trade, as well as new jobs for lower-skilled people.
– If California were a separate nation, its economy would rank seventh in the world. California’s current gross state product is about $700 billion in 1987 constant dollars. More than 25 percent of Southern California regions’ economy is tied to international trade, primarily with Asia.
– Based on personal income, California’s share of the U.S. economy is about 12 percent, or roughly one-eighth. The state has one of the most diversified economies in the nation, in fact, in the world.
– The film and television industries, which account for $36 billion of Los Angeles County’s annual economic output of $275 billion, added 25,700 new jobs in the year ending July 1996 – an increase of 18 percent – according to the Economic Development Corporation.
– Los Angeles’ hotel occupancy rate has climbed to 71 percent, the highest rate since 1989.
– California consistently leads the U.S. in farm production. Out-of-state agriculture provides about 400,000 jobs, and makes a significant contribution to the state’s economy.
– On the real estate front, home sales in California rose more than 31 percent in the second quarter, the largest quarterly increase in nearly 10 years, according to the California Association of Realtors.
– Funding for California construction projects in August totaled $951 million, up 13.7 percent from $836 million in July, according to Data Quick Information Systems. Lending rose 25 percent.
– Finally, to confirm it all, in August, Standard and Poor’s raised its rating on California’s $18.2 billion outstanding debt, upgrading it from A to A+.
