Whether it is military downsizing, sequestration or a “fiscal cliff” that is fast approaching, it is already having an impact on commercial real estate.
That was the conclusion reached during a roundtable discussion at The Daily Transcript offices last week sponsored by CohnReznick.
Stuart Tanz, Retail Opportunity Investment Corp. (Nasdaq: ROIC) CEO, said that the Maryland-based Corporate Office Properties REIT (NYSE: OFC) had planned to construct millions of square feet in defense properties in that part of the country, but placed those plans on hold months ago due to fears over sequestration.
David Crabb, a CB Richard Ellis senior vice president, said whether it has been concerns about sequestration or an ongoing downsizing of the military, defense contractors have generally been holding off on leasing new space for about the last two years now.
Some are doing more than holding off, they are shrinking.
“Lockheed Martin has gotten rid of a lot of space,” said Jay Arnett, Colliers International senior vice president.
Gary London, The London Group’s president, seemed less worried about the strength of San Diego’s military contractors and their ability to fill space.
“We are the No. 1 defense contractor. We are the (unmanned aerial) drone capital of the country,” London said.
While much has been written about what would happen if all the Bush-era tax cuts were allowed to expire and budgets from the military to entitlement programs were slashed, London said that’s not what concerns him most.
“What bothers people more than taxes is uncertainty,” London said.
Perry Dealy, Dealy Development president and CEO — who is overseeing the Manchester Pacific Gateway (Broadway Complex) mixed-use development — said while the revenue per available room (RevPAR) for hotels continues to improve, the prospective lenders are holding onto their wallets due to what may happen after the first of next year.
“You can’t borrow any money,” Dealy said.
Dealy did say he doesn’t expect the situation to last forever, and suggested a lot more about the economy will be clear by early next year.
“I am optimistic we are going to get there and we’re going to see ground up development,” Dealy said.
In the meantime, Crabb said he is encouraged by the fact there has been 12 straight months of positive net office absorption. About 80 percent of this net absorption has been of the Class A variety. Arnett has also noticed this dynamic.
“Ordinarily, large blocks of space tend to be cheaper than smaller ones, but now they are more expensive,” Arnett said.
Arnett said the Class A vacancies are sufficiently low in some parts of the county that the American Assets Trust (Nasdaq: AAT) is considering developing new speculative office buildings in its Torrey Reserve developments in the Del Mar Heights area.
Arnett said whenever these new buildings are constructed, they will need to command rents of more than $4-per-square-foot per month to pencil.
Gregg Bloomberg, a partner with the CohnReznick accounting firm, said “a lot of private equity firms from the East Coast have been trying to find Class A office buildings.”
The 553,715-square-foot Columbia Center office building was picked up by a unit of Emmes Master Services LLC of New York City for $135 million in late November. Emmes specializes in turning troubled properties around. Columbia Center, which was built by now U-T San Diego publisher Doug Manchester, is about 30 percent vacant.
As for office buildings of the Class B and Class C varieties, London suggested they too may continue to struggle despite their lower rents.
“There is a 120 million-square-foot office market here. The problem is that 80 percent of it is in B and C product,” London said.
This fact may mean some major upgrades will be necessary to keep the B and C buildings competitive. Dealy said that doesn’t just mean cosmetic improvements, but wiring the buildings to make them technologically competitive, as well.
These aren’t the only changes landlords need to worry about. Along with keeping tenants who are repeatedly being lured somewhere else, London said tenants simply don’t need as much space as they may have needed in the past.
“The amount of square feet has shrunk from 250 down to 125 square feet per employee because we don’t need file cabinets anymore,” London said.
Jonathan Freeman, a Cassidy Turley chief operating officer, gave another reason for a smaller footprint: the lack of the corner office.
“We’re moving toward much more collaborative space,” Freeman said.
On the subject of what is happening with retail space in the era of e-commerce, Tanz said it is impossible to deny that electronic retailing is having an impact on the demand for space. That said, he suggested that people will still want to go to the malls for the experience and can’t try on clothes via the Internet.
And while retail stores may be shrinking (some have stores within stores now), Tanz said companies still have to put the merchandise somewhere.
“Amazon is going to be building a lot of warehouses in the state,” Tanz said. “Before, it would take two or three days to get a book. Now, it may take two or three hours.”
Gregg Bloomberg, Partner, CohnReznick (sponsor)
David Crabb, Senior Vice President, CB Richard Ellis
Perry Dealy, President & CEO, Dealy Development Inc.
Jonathan Freeman, COO & CFO, Cassidy Turley
Gary London, President, The London Group
Stuart Tanz, CEO, Retail Opportunity Investment Corp.