San Diego Housing Bubble News and Analysis

This is a pay site, so I didn't read the whole article. However, I have seen anectdotal evidence of a glut of commercial properties lately. Last week I was driving around carlsbad near the airport and saw approximatly 20 "for lease" signs in a two block area. These were 5000 to 12000 sqare foot buildings for lease in the palomar triad area.

I have also heard recently that about 2 million square feet of commercial real estate is coming online in southern California in the next 18 months and that there isn't anywhere near that much demand.

On a national level, I've seen compelling evidence that commercial real estate construction spending trails residential real estate spending by about 3 years.

Commercial real estate is probably headed for the same cliff.

Commercial RE is actually my thing; I only dabble on the edges of the residential side of my business.

There is such a glut of office and warehouse space in Carlsbad (as well as So. Vista/San Marcos) that it's ridiculous. I don't know who convinced these banks that there was sufficient demand for these units, but several somebodies (including appraisers) were telling whoppers and they should be punished for it.

There are other areas in the region with similar gluts, like E. Chula Vista and Temecula/Murietta. And they're all going down, just as surely as the SFR market. The difference between commercial and residential is that commercial buildings can't be filled simply by dropping the price. There has to be a business, and that business has to generate sufficient profits to support the building they're in.

That's why I think the "commercial correction" will come on even faster than the residential correction.

Bugs
I am in a light industrial facility in Miramar area - Nancy ridge, renting it from the owner directly 3500sft, as I am needing more space, I am trying to work with the landlord in exiting the lease and getting into a bigger space, My realtor is telling me that I should have no trouble finding a tenent to sublease the space in 2 to 3 months at around 1$ a sq foot and most light indistrial in that area are renting for 1 to 1.25 a sft.

I am finding it hard to believe the above as I got into the lease around 1.5 years ago when the vacancy rate in the area was as low as 3% and I got this space for 90 c a sq foot, when CRE is tanking, how come my agent tells me that rents are up compared to a year ago. especially in a dump like miramar - nancy ridge. Well, it also happens to be an area of easy access for most of my employees who are unskilled and make a small fraction of the usual san diego 100 to 300k salaries.

Can you throw some light on the light industrail market in the miramar area. I would like to relocate the business to the east side of i15 around carrol rd, in the future

Also what is happening in the Rancho Bernardo area in the LI market
thanks

There are currently 41 listings in Loopnet of units from 2000-5000 SqFt in your zip area, with asking rents ranging from $1.00 - $1.20 or so. The adjacent 92126 zip area has another 38 listings. Lots of listings, relatively speaking. I even saw a few under $1.00.

That means that a few of them would probably settle for a skosh less.

Rco Bernardo (5 actives) and Poway (13 actives) have fewer listings and they're running about $.05/SqFt higher. THere will usually be a few more limitations about what types of businesses can operate there vs. miramar.

BTW, $100k - $300k is much more the exception than the rule in SD County.

A few comments and observations on CRE...

I was at a banking conference last week and there were three CEOs from California banks ("community banks" - $800 million to $6 billion in assets) on a panel discussing Southern California CRE credit trends. Here's a summary of their thoughts and observations:

- We're in the third or fourth inning of the downside of the (general) credit cycle; it will get meaningfully worse before it gets better.
- Bottom of the cycle/Recovery will be late-2009/early-2010.
- There's a notable bifurcation in the CRE market. In general, properties closer to the coast (10 miles) and/or surrounded by "established" neighborhoods are doing pretty well, although problems are expected to crop up. Properties further from the coast - Inland Empire, Murietta, Temecula, East SD County, East Chula Vista, etc. - are struggling and it will get much worse; it will be like the early-90s in these areas.
- CRE in the coastal/established areas will have problems but not as bad as the early-90s due to: (1) A more diversified economy - that is, we won't have the same proportion of people simply leaving the state as when the defense industry left the state in the early-90s, and (2) Less overbuilding this time around - the early-90s CRE meltdown was exacerbated by dramatic overbuilt conditions throughout SoCal.
- The CRE-oriented REITS with lots of exposure to Class A office towers in Orange County will have big problems as this market is in shambles due to all the high-end mortgage broker-related space available.

These three bankers were all operating their banks during the early-90s and survived without needing to be recapitalized. They are generally thought of as relatively conservative underwriters.

Now, there is a distinction that needs to be made between existing CRE and CRE that's under construction or recently completed and not leased up. Probably anything that's under construction or recently completed (and not leased up) is a bad deal for the bank, almost regardless of its location.

The main thing that separates CRE from SFR is that, ultimately, there's gotta be a debt coverage ratio when the loan is underwritten, generally between 1.1x and 1.2x (now it's almost exclusively 1.2x because banks are tightening up on underwriting). And the minimum LTV has generally been 85%, even during the boom times, although cap rates have been very (re: too) low. BUT, the debt coverage ratio puts a cap on how much the bank is willing to lend regardless of what value gets generated from the cap rate. So, things got crazy in CRE, but not nearly as crazy as SFR, because there is real income involved (although it will certainly decline for the next few years) and there is real equity involved (again, this too will almost certainly decline in aggregate).

So, my guess is that we'll see the coastal/established properties, in aggregate, lose some tenants and have to re-lease at lower rates, plus cap rates will inch up and net/net many of these properties will be underwater for a couple of years, but not REALLY underwater. Most will continue to make their interest payments, some loans will need to get restructured (with attendant losses for the banks) and some will get foreclosed, with larger losses for the banks. But - and I could be wrong - while I see impending pain and discomfort, I don't foresee a total disaster in this property type.

But the stuff in the Inland Empire, East County, etc... that will be a bloodbath largely because the customers (the people who are in foreclosure and/or never moved into their homes) simply aren't there to support the businesses.

What are your thoughts on some of this Bugs?

I don't believe in market bifurcation regardless of location or property type. I believe it's all connected - some more directly than others. The house in Rancho Santa Fe cannot stabilize at $3+mil if a comparable house in Fairbanks stabilizes at $1.5mil, and the Fairbanks home can't stabilize at $1.5mil if the Carmel Valley home ends up at $800k. And so on. Eventually, you can connnect the dots between the beater properties in Barrio Logan and the mansions in La Jolla because there are always alternatives. Premiums (and discounts) are based primarily on advantages (or disadvantages), and over time they're always proportional.

If a Class A office building can't get $3/SqFt in rents (under Gross terms) then how can it justify a sale price in excess of $400/SqFt? Over the long haul I don't think it can. Sooner or later the mortgage interest rates will come up, and cap rates will have to come up with them. We've seen cap rates that are lower than mortgage interest rates - there's no way that's sustainable unless pricing continues to INCREASE (and stabilization isn't increase). The most agressive investors don't buy to hold - they buy to flip; and the ones who do buy to hold are not as agressive.

Just like with the housing market, once there's no short term upside the hyper agressive investors will split and cap rates have to adjust up. As I'm sure you're aware, between rent concessions, increased vacancy rates and increased cap rates, a commercial building's income potential, and hence its value can decline pretty quickly.

Over the long term, I think there are some Class A tenants who would be willing to move to Class B space if the rent differential made it worth their while. And likewise as we move down the chain and outward in location. That's why I think an office or retail or industrial meltdown in the outlying areas will eventually make its presence felt in the more centralized areas.

The only question is whether the trends will hold long enough for that to occur. Reasonable people will disagree on that one, but I think the trend will definitely continue.

BTW, I've been wrong before about future trends, so it's entirely possible I'm wrong this time, too. So far, I've been wrong about the timing, not the direction or the consequence; but my timing sucks really hard so that calls all of my judgment into question.

I called the turn around in the mid-1990s early by 2 years, and more I called the turn around in the residential markets early by 2 years. So I'm an idiot and nobody should listen to me on timing.

what are the options of converting warehouse space into dual commercial/residential?

what are the prospects for buying a smaller warehouse and moving into it?

I basically agree with you Bugs. When I use the term "bifurcation" I use it in the sense that "everything will suffer, but to varying degrees." Perhaps I wasn't clear on that point.

To use the residential market as an example, if the median peak-to-trough decline in SD County ends up being 40% - just to pick a number - there will be certain areas (think Chula Vista, Imperial Beach, etc.) that will decline by 50% and other areas (think La Jolla and RSF) that will decline by 20%. We have seen similar outcomes in previous downturns. ("Location, location, location" won't save anyone from a decline, but it may save a lot of folks from the dramatic declines witnessed in other areas.)

I think we will see something similar on the CRE front going forward. All will suffer, but to dramatically varying degrees. But I could be wrong.

"Over the long term, I think there are some Class A tenants who would be willing to move to Class B space if the rent differential made it worth their while."

Funny you mention that Bugs. Right now I am negotiating a new lease for a business my wife owns. She is finishing up a 5 year term in class A space and we are searching in some class B/B+ space which should reduce our rent by close to 50% with very little loss of business. Our landlords in the current class A space refuse to budge on base rent price and it is also a NNN lease. Most of the class B/B+ buildings we are looking at are modified or full gross.

SD Realtor