Will L.A. Investment Stay Strong in 2017?

LOS ANGELES—In the first half of 2016, the Los Angeles market saw $10.4 billion in real estate transactions, a 17% increase from the first half of 2015, according to a new capital markets report from CBRE. This is the strongest increase the L.A. market has seen in three years. To find out about the investment trends this year, what to expect in the second half of 2016, and where we are headed for 2017, I sat down with Maximilian Saia, senior research analyst, and George Entis, capital markets research analyst at CBRE, for an exclusive interview. Here, we talk about the fundamentals of the market, investor returns, cap rates and the make-up of the investor pool.

GlobeSt.com: Why is L.A. an attractive market for investors?

Maximilian Saia: CBRE's 2016 Americas Investor Intentions Survey found Los Angeles to be the most desirable metro in the Americas for investment. The performance of the local economy is one of the main drivers of investment activity in the region. The Los Angeles economy has a diverse employment base and job creation across most industries, with rising household incomes and one of the lowest unemployment rates since before 1990. Investors see long-term stability and less risk in the Los Angeles economy, with returns still well above long-run trends.

GlobeSt.com: Do you expect investment volume to continue this upward momentum through the end of 2017?

George Entis: Upward momentum is likely to cease but a large pullback in investment volume seems unlikely. There is still strong investment interest from foreign and domestic buyers across asset classes and a number of large assets are currently for sale. Commercial investment activity in L.A. bucked the national trend in 2016, and we believe the fundamentals that drove that divergence are still in place heading into 2017.

GlobeSt.com: How does L.A. compare with national trends in investment volume?

Maximilian Saia: Nationally, $188.5 billion in commercial property changed hands through the first half of this year, a decrease of 11.7% from last year. Over the same time period, investment activity in Los Angeles actually increased 13.9%, or $1.8 billion. Commercial vacancies have been edging down, pushing prices up and forcing investors to reach deeper for yields, bringing a growing share of capital flows to stronger performing CRE markets and assets that assuage investors of recession fears.

GlobeSt.com: Investment volume has increased, but the report also shows softening investor returns. What does this dynamic say about the L.A. market?

Entis: Investors are paying top dollar for exposure to the L.A. commercial real estate market. With pricing and cap rates at or near record levels, average returns are likely to be slightly diminished. In the long run commercial real estate has been an extremely well performing asset class and has many features that currently make it an appealing investment in such a low-yield environment.

GlobeSt.com: It was especially interesting to see that office is outperforming other sectors, even more than industrial and multifamily, which are typically hailed the “darlings” of CRE. Was this surprising to you as well? What is driving office investment in a market with a 14% vacancy rate?

Saia: Office usually holds a top spot in terms of investment volume primarily due to the size of the transactions. But simply put, for 2016, The Qatar Investment Authority (QIA) had a lot to do with it. So far this year, QIA has teamed with Douglas Emmett to purchase $1,713,025 of office product from Equity Office. That alone accounts for 21.2% of the transaction volume for office properties in L.A. this year. More broadly, investors realize that even in a market with 14% vacancy they can charge premium rents for creative office product with extremely strong demand from tenants at this time.

GlobeSt.com: Tell me about the investor make-up and how it has changed. There is clearly a strong foreign investment presence here. How does that compare to domestic investors?

Entis: In 2016 through the third quarter, private domestic buyers are the leaders in the current market, capturing a growing share for the third year in a row and accounting for almost half of all investment. Investment from cross-border capital sources has also been trending up, grabbing an 18.5% market share year to date. This is the highest proportion of foreign to domestic capital on record, notably higher than the U.S. share of foreign capital, and is expected to grow further as a lot of global liquidity finds its way to the U.S. Meanwhile, institutional investors have had a less pronounced presence over the past few years.

GlobeSt.com: Cap rates are so low. Do you expect that they will continue to compress, or have they bottomed out?

George Entis: Cap rates can still go lower, but not much lower. It's true that we are at or near historically low cap rates for most assets but risk spreads are still favorable and commercial real estate remains a very in demand asset class. Expect some continued decline in the short term before cap rates level off.

LOS ANGELES—In the first half of 2016, the Los Angeles market saw $10.4 billion in real estate transactions, a 17% increase from the first half of 2015, according to a new capital markets report from CBRE. This is the strongest increase the L.A. market has seen in three years. To find out about the investment trends this year, what to expect in the second half of 2016, and where we are headed for 2017, I sat down with Maximilian Saia, senior research analyst, and George Entis, capital markets research analyst at CBRE, for an exclusive interview. Here, we talk about the fundamentals of the market, investor returns, cap rates and the make-up of the investor pool.

GlobeSt.com: Why is L.A. an attractive market for investors?

Maximilian Saia: CBRE's 2016 Americas Investor Intentions Survey found Los Angeles to be the most desirable metro in the Americas for investment. The performance of the local economy is one of the main drivers of investment activity in the region. The Los Angeles economy has a diverse employment base and job creation across most industries, with rising household incomes and one of the lowest unemployment rates since before 1990. Investors see long-term stability and less risk in the Los Angeles economy, with returns still well above long-run trends.

GlobeSt.com: Do you expect investment volume to continue this upward momentum through the end of 2017?

George Entis: Upward momentum is likely to cease but a large pullback in investment volume seems unlikely. There is still strong investment interest from foreign and domestic buyers across asset classes and a number of large assets are currently for sale. Commercial investment activity in L.A. bucked the national trend in 2016, and we believe the fundamentals that drove that divergence are still in place heading into 2017.

GlobeSt.com: How does L.A. compare with national trends in investment volume?

Maximilian Saia: Nationally, $188.5 billion in commercial property changed hands through the first half of this year, a decrease of 11.7% from last year. Over the same time period, investment activity in Los Angeles actually increased 13.9%, or $1.8 billion. Commercial vacancies have been edging down, pushing prices up and forcing investors to reach deeper for yields, bringing a growing share of capital flows to stronger performing CRE markets and assets that assuage investors of recession fears.

GlobeSt.com: Investment volume has increased, but the report also shows softening investor returns. What does this dynamic say about the L.A. market?

Entis: Investors are paying top dollar for exposure to the L.A. commercial real estate market. With pricing and cap rates at or near record levels, average returns are likely to be slightly diminished. In the long run commercial real estate has been an extremely well performing asset class and has many features that currently make it an appealing investment in such a low-yield environment.

GlobeSt.com: It was especially interesting to see that office is outperforming other sectors, even more than industrial and multifamily, which are typically hailed the “darlings” of CRE. Was this surprising to you as well? What is driving office investment in a market with a 14% vacancy rate?

Saia: Office usually holds a top spot in terms of investment volume primarily due to the size of the transactions. But simply put, for 2016, The Qatar Investment Authority (QIA) had a lot to do with it. So far this year, QIA has teamed with Douglas Emmett to purchase $1,713,025 of office product from Equity Office. That alone accounts for 21.2% of the transaction volume for office properties in L.A. this year. More broadly, investors realize that even in a market with 14% vacancy they can charge premium rents for creative office product with extremely strong demand from tenants at this time.

GlobeSt.com: Tell me about the investor make-up and how it has changed. There is clearly a strong foreign investment presence here. How does that compare to domestic investors?

Entis: In 2016 through the third quarter, private domestic buyers are the leaders in the current market, capturing a growing share for the third year in a row and accounting for almost half of all investment. Investment from cross-border capital sources has also been trending up, grabbing an 18.5% market share year to date. This is the highest proportion of foreign to domestic capital on record, notably higher than the U.S. share of foreign capital, and is expected to grow further as a lot of global liquidity finds its way to the U.S. Meanwhile, institutional investors have had a less pronounced presence over the past few years.

GlobeSt.com: Cap rates are so low. Do you expect that they will continue to compress, or have they bottomed out?

George Entis: Cap rates can still go lower, but not much lower. It's true that we are at or near historically low cap rates for most assets but risk spreads are still favorable and commercial real estate remains a very in demand asset class. Expect some continued decline in the short term before cap rates level off.