The Market's Back—After Growing Pains

IRVINE, CA—Labor shortages and rising construction costs are some of the concerns panelists at RealShare Orange County here last week have as we move further into the recovery. The after-effects of the recession are being felt across the region as the market revs up again.

“Local Leaders Power Panel” moderator Kurt Strasmann, senior managing director of CBRE, said 6% of all retail sales are conducted via the Internet, a number which is expected to grow to 30% by the year 2030. Peter Rooney, president, commercial development division, Sares-Regis Group, said Amazon.com is the biggest player in the world, and e-commerce is changing the way retail is happening. While bricks-and-mortars are shrinking their footprints, retailers are adding on to their distribution centers to accommodate e-commerce.

While larger distribution centers are located in the Inland Empire, Orange County tends to be more of an infill market, Rooney said. Lesser-known names are occupying buildings of 10,000 square feet that have a newer office component of up to 30%.

Shifting to the office sector, Bill Halford, president and CEO of Bixby Land Co., pointed out that creative office is an overused term. “Most product is not well-defined as creative office. It really refers to unique architecture, use of outdoor space and tenants who don't use the space as a commodity, but to recruit and retain talent.”

Halford said people want better, more-interesting product that's designed in a thoughtful way, and the demand is well in excess of the supply. He also said the capital markets view this type of space more valuable, even if it may look “rough” with exposed beams and concrete floors. “If somebody wants to pay more for ripped jeans than new 501s, then the ripped jeans are worth more.” Steve Briggs, principal with LBA Realty, said amenities are hugely important in office, and tenants want free Wi-Fi, flexible conferencing areas and great food options.

Rooney spoke of the problems developers are facing as the market revs up, including a shortage of skilled and low-level labor since many workers left the state during the recession. “There's no one to do the framing” for development projects, he said, so the market had to raise wages in order to attract labor again. “The market's back, but there were a lot of growing pains in 2013 with labor and material shortages.”

Subcontractor prices have risen to increase their profit margins, and the housing market hasn't really come back, Rooney added. “Construction-cost increases keep me up at night.”

Halford said value deals are more sought-after in the market than core deals because the yield is so much better, and the way to win a deal is simply to pay more than the other bidders at the auction. “It's very competitive and the margin of error is getting narrower.”

With regard to cap rates, Briggs said he believes there's some invented rent growth in the market, so there's room to run. “Also, liquidity is a big factor in the movement of cap rates, and there's a lot of liquidity in the market right now.”

Eric Ruehle, SVP for Sitex Group, added that the tipping point is coming with regard to cap rates, and Rooney said he's seen sub-5% cap deal with the right type of lease terms, “but not a lot is for sale.” He also said he deals with a lot of all-cash buyers, but there's nothing to buy, so interest rates are not likely to rise, which should keep cap rates low because of the competition.

In terms of areas of opportunity, Ruehle said he likes to go a little off the fairway, often going after the worst building on the best block, and he tries to pick up a lot of off-market deals. Briggs said the infill user market is very strong, while Halford said, “Century City sucks, but Playa Vista is on fire. That's where people want to be.” He maintained that as far as the West goes, the California real estate market is in increasingly good shape and quite strong, while markets outside of the state are somewhat less strong.