Recession Furthers Downward Spiral of Some CRE Sectors

SAN FRANCISCO—In the wake of the pandemic-induced economic recession, there is uniform pessimism and a drop in sentiment for developers across all commercial real estate spaces. The biannual/summer Allen Matkins-UCLA Anderson Forecast California Commercial Real Estate Survey projects a three-year-ahead outlook for California’s commercial real estate industry, and forecasts potential opportunities and challenges impacting the office, multifamily, retail and industrial sectors.

Survey panelists see office market demand decreasing due to work-from-home policies, industrial only moderately decreasing due to the shift to online shopping, retail continuing its downward spiral and multifamily only moderately decreasing due to the continued shortage of housing across the state.

“Overall, although it’s not surprising that people are more pessimistic than last survey, there are some silver linings in areas such as multifamily and industrial,” John Tipton, Allen Matkins partner, tells GlobeSt.com. “I look forward to seeing where things are at the end of the year when we survey again. We’re certainly rooting for the optimistic outcome.”

Given the continuing pandemic, there is much uncertainty about how working from home will affect today’s office space market. The panelists’ shared sentiment is about as gloomy as it was in December 2008 during the height of the last recession. This time with rising vacancy rates and downward pressure on rents forecast for the next three years. This is consistent with UCLA Anderson Forecast’s projection that a rapid return to pre-recession/office-using employment is not likely.

The implication of the drop in sentiment is, as in 2008, a continued decrease in new office construction during the ensuing three years. Although half of the Bay Area and Southern California panelists said plans for the coming 12 months were unaffected by the pandemic, one-third are pulling back development by more than 15% from previous plans.

For the third that will engage in some new development, the panelists in each market believe that land, building materials and labor costs would be more favorable. Given the uncertainty about office space demand, these responses seem reasonable and indicate growth in development beginning in late 2021 and a slow return to pre-recession levels.

Although there has been consistently high occupancy and rate growth in the industrial market during the past several years, the deep economic recession has caused sentiments in the latest survey to drop precipitously in all markets except the East Bay. However, the panelists’ actions also indicate that they do not feel as pessimistic as the overall index suggests.

Specifically, 60% of panelists in Southern California and 43% in Northern California are planning at least one new development in the next 12 months, and 39% and 29% are planning multiple projects respectively. When one considers that this is in the middle of a recession with a great deal of overall economic uncertainty, these numbers are quite telling.

With an increase in household savings, a recession and a continued trade war with China, there will be near-term downward pressure on rental and occupancy rates. However, this is from a very high level. If the demand for warehouse space and the stock of warehouses are increasing at about the same rate as projected, then 2023 will see a mild erosion of rental rates when adjusted for inflation with a possibility of some erosion in occupancy. However, that does not mean that industrial space markets will be depressed. Rather, they will not be as imbalanced as in recent years, according to the survey.

The current recession has tripled down on the struggles retail already faced during the previous economic expansion. First, household loss of income and shelter-in-place policies reduced current demand for brick-and-mortar retail. Second, the inability to physically frequent many retail establishments created a new set of online shoppers. Third, increases in the savings rate on the part of households in response to the recession portends less consumption. To be sure, some activities will return, particularly personal services and experiential retail. However, marginal properties will not find tenants willing to pay sufficient rent to keep those properties in the retail space.

The pessimism expressed by panelists from the Bay Area and Southern California in the latest survey is an extension of the trends from the past three years. The current view is that retail properties will be generating significantly lower returns in 2023 compared to the middle of 2020. In the Bay Area and Southern California, two-thirds of panelists will not develop any new properties in the coming 12 months. Approximately the same percentage expect difficulty with current leases and plummeting property values.

Though the pessimism that has come with this recession has hit each of the multifamily markets in the state equally, the view that rental and occupancy rates will not continue on the same trajectory has not affected the rate of activity by developers.

As the economy grows, the demand for housing in the Bay Area and Southern California will grow alongside it. Though the UCLA Anderson Forecast is looking at a 30-month recovery in the state and there remains a great deal of uncertainty with regard to the current public health crisis, it is likely that the market for multifamily housing will remain robust. Indeed, in spite of the turnaround in sentiment from each of the six panels, almost three-fourths of the Southern California panelists and two-thirds of the Bay Area panelists have stated that the pandemic has either not changed plans for future activity or increased it. Thus, the findings indicate a quick turnaround in this sector’s sentiment with the December 2020 survey.