Commercial Real Estate Forecast 2018

Presentation given at Scott’s restaurant by Jeffrey S. Weil, Colliers International on January 16, 2018

Referred Resources:

So what’s ahead for 2018 and beyond? – A lot! We’ll be discussing industrial warehouse space apartment house sales, reviewing all the new East Bay retail projects, touch upon the huge changes in the retail industry. We will take a peek at what’s been happening in the San Francisco office market and how it might affect us here in the burbs. We will examine Downtown San Jose and why what is going to happen there, and a lot of what will happen there, is good for us out here. We will also touch on the changing nature of office design, and how autonomous vehicles in the near future may totally transform our commute, our use of land, and our economic pocket book – all in a good way!

The handout goes to one website page with links to many of the articles I will quote or use as a resource, so, please keep this and take it back to your office with you. And as I always enjoy doing, we will be giving away two great bottles of wine at the end. Please note your questions on the back of the handout and we will have plenty of time for questions and answers when I am finished.

Ok, here goes …

What a year we had in 2017! Sure, we had some of the worst unimaginable natural disasters in history between hurricanes, catastrophic flooding, then the two horrific California fires, and now the devastating mudslides.

We also saw the stock market explode, going up 25 or 30 percent over the past year. We saw interest rates rise, but just by a little, and this had minimal effect on the commercial real estate market.

All of you who are home owners, for the most part, experienced big gains in equity, and most of you who are apartment renters, had continued sticker shock as rents soared.

Just about everybody has a job, and everyone they know has a job as well.

For the most part, our military fought without the devastating deaths and injuries of past years, but we are still fighting at least two wars.

There are a number of new retail projects either just completed or under construction in the East Bay.

The Veranda in Concord, a 375,000 square foot shopping center which replaced the 475,000 square foot Chevron office complex, features Cost Plus, Super Duper Burgers, TJ Maxx, Toys ‘R Us, 365 by Whole Foods Market, and a LUXE Cinema where you can wine and dine while watching on IMAX.

Broadway Plaza was renovated last year and has been as huge success – new restaurants, buy a Tesla or shop for clothes, and one of the hottest new Apple stores in the country will be finished this year. To give you a flavor of rents, the old Barnes & Noble two-story building on North Main Street is rumored to be getting $100 an annual square foot, including second floor space, net net net from Anthropologie.

Down at Bishop Ranch their new retail complex is under construction and will be completed this November. They will have 75 merchants, including 18 food service of which six will be sit-down restaurants, a health club and they have announced the signing of The Lot, a 42,000 square foot ten-screen all luxury seat movie complex with wine and dining at your seat.

Just listen to these factoids. Sixty four percent of U.S. households have Amazon Prime. In 2016 Amazon had 136 billion dollars in net sales, and last year Amazon dominated online sales with a forty-four-percent share of the total online market. However, for all of retail sales in the U.S., Amazon has only a 4% share – as of now …

It is no secret that the business of retail shopping is undergoing dramatic changes. Thirty years ago we had downtown shoe stores, women’s apparel, mom and pop variety sporting goods and every other category of retail – then along came Walmart, Costco and Sam’s Club, and in many regions across the country these mom and pops were decimated. One large Walmart could cause a hundred or more mom and pops to go out of business. Well, the same type of retail transformation is happening with Amazon disrupting the traditional retail business model.

There will be major shopping centers across the United States which will be obsolete or requiring repurposing. In our region, Eastmont Mall in Oakland has a police station, kidney dialysis clinic and a library. Other shopping centers have brought in major medical clinics, health clubs and entertainment to replace vacant stores. Macy’s and J. C. Penney among others are expected to shut down scores of stores. One article cited 10,168 store closures in 2017, and while there were 14,248 new store openings, the ones closing are a lot larger than the ones opening. It takes a lot of new Dollar Trees to replace one Macy’s.

“It has been three years since a major new shopping mall opened in the U.S. Of the roughly 1,200 spread across the country, less than half are expected to be in operation five years from now.”

Last Friday in the East Bay Times there was an article describing how a growing number of malls are building housing on top of their retail stores, and mentions Santana Row in San Jose and Bay Street in Emeryville. Hilltop Mall in Richmond will probably add housing, as will Bishop Ranch’s new retail development.

How is retail fighting back? It does so by blowing you away with off-the chart personalized customer service, getting you engaged with their products, the store, and giving you a memorable shopping experience. More retailers are adding cafes, and “the best of the national performers have picked up on a crucial strategy: Target your store’s selection of goods to the needs and interests of specific communities. It’s better for sales and for controlling costs. The savviest retailers know this and they’re using technology to help give them edge.”

It is also done by using analytics to know your customer, pinpointing and predicting what goods your customers will actually want, minimizing excess inventory and stocking only what your customers will buy.

Some online retailers are opening up small brick and mortar stores, some open pop-ups or seasonal locations.

Apartments, apartments, apartments. – There are thousands of apartment units under construction in the East Bay and thousands more in the pipeline. However, if you think this will ease the cost of East Bay housing, forget it. – According to The East Bay Times on June 2, 2017, “of the thousands of building permits Oakland approved last year, less than 2 percent were for affordable housing.” Walnut Creek has a number of new apartment house developments, several are already fully leased, with rents in the $3,500 for a one bedroom all the way to $5,800 for a two bedroom with Mt. Diablo views. Oakland and Berkeley rents for new product are also in the $4,000 – 5,000 per month range.

Apartment house investment sales are still a shadow phenomenon, with 80% of all sales being off market, meaning there are very few apartment houses officially listed for sale. Cap rates are still super-low, in the 4 ½ %range, even though interest rates went up several times in 2017 and are expected to keep going up this year.

There was a bill introduced to the California legislature last year that scares the bejesus out of every apartment house owner and developer. However, if you hate high apartment rents, it would probably make you happy, which is a repeal of the Costa-Hawkins rent control limitation law. Last Friday it died in the committee hearing, but “proponents vow to keep fighting – and if they get nowhere in the Capital, to take the issue straight to voters”. If repealed, every California City and county could adopt rent control measures without limitations, and this would for all intent and purpose shut down all new apartment construction in California.

To keep up with our housing demands, California needs to build 180,000 units a year, and we have only been building 80,000 a year, so we are hundreds and hundreds of thousands of housing units behind.

Remember, just in the Bay Area during the past five years, we added 550,000 new jobs.

The San Francisco office market continues to sizzle. In 2017 this market had its strongest year since the dot com day, and in 2017 there was 9.5 million square feet of gross office absorption. The biggest deal was Dropbox that signed a lease for 736,000 square feet, and there were 14 other deals over 100,000 square feet. The 2 million feet of new office projects scheduled for 4th quarter 2017 completion were pushed into 2018, but they are already 95% preleased. There is only one major block of space coming on the market this year – Park Tower, with 750,000 square feet of available office space. To put rents in context, you can find Class A full-service office rents in Concord for $30 to 35 a square foot, loaded with bells and whistles like free garage parking, free exercise and conference facilities. Same rate is for San Ramon and Pleasanton, Downtown Walnut Creek is higher, at $50 to 60 a square foot. Oakland is $60, but San Francisco rents are $75 to 95 a square foot with no parking. Prop M limits new office development in San Francisco and that market will be tight for the foreseeable future. Thank you, Erin Pronto of the Colliers San Francisco research department for helping me with this statistics.

What does this mean for us here in the more stable East Bay region? Other than Workday and a handful of other expanding tech companies, our East Bay is mostly consisted of corporate regional and local offices and lots of insurance agents, bankers, CPAs, financial planners, and law firms. No big dramatic growth in these financial services and we’ve seen downsizing in Chevron, SAP and others. Right now just on the I-680 Corridor and the Tri-Valley region as of today, we have over five million square feet of vacant office space. Lots of opportunity, should any of those folks paying two or three times the rent on the Peninsula or San Francisco want to come out to the friendly, less hectic East Bay?

… Times there was an announcement of a million square foot planned office development in downtown San Jose that could bring 5,000 jobs, near the Google Village in the works of 6 to 8 million square feet of office space, which, at 5 employees per thousand square foot leased, could represent an additional 30,000 to 40,000 jobs. Yes, thousands. Adobe just announced expanding its’ Downtown San Jose presence by an additional 3,000 jobs, so that totals around 50,000 more jobs coming to Downtown San Jose. I’m sure glad they didn’t pick Alamo!

Available industrial space in the East Bay region – in some of our sub-markets it is getting increasingly harder to find. The North Concord industrial market has a 2 percent vacancy factor. We do have new product coming on stream elsewhere, with a million and a half feet down in Fremont, 300,000 square feet in San Leandro, out in Tracy they can build 20 million feet of industrial and warehouse with 45 cent rents, as compared to the Port of Oakland, where the new product is around a dollar a square foot.

In the past, legalized marijuana has caused a spike in values and leasing of older industrial buildings in local green zones, where the storage and distribution is allowed. I heard that in the Oakland green zone prices may have doubled, but around the State there is still a lot of uncertainty, cities and counties have not gotten their act together. In Denver the marijuana industry had caused the cost of warehouse space to shoot up over 60 percent, so, California can expect the same, eventually.

“We’ve all heard rumors about Google’s office — scooters, legos, copious amounts of free food. Facebook embraces its startup culture with an internal bike shop. Twitter offers free laundry services. Thrillist offers paid time off on your birthday every year. An evolving workforce has set off a wave of new office habits, needs, and wants.”

By 2020 Millennials will make up 40 to 50% of the working population, and they, as well as Generation Z, have never known life without the Internet. “Millennials want a cool, different environment-type of space and culture. They’re overstimulated 24/7, the phone is 24/7,” according to Jason Lewis, President of EcoSpace in Denver.

Internal physical flexibility and collaboration are critical today. Employees are collaborating and sharing knowledge from brainstorming to execution.

“Offices becoming more like home. Millennials never quit. The 9-5 became the 8-6 became the 24/7 as the work day adapted to globalization and technology. Early birds are in from 7am-6pm, night owls are in from 11am-10pm, we don’t bat an eye at 3am emails. Your cell phone is an extension of your arm and now talks to your car, syncs with your computer, and facilitates your dating life. Work-life balance is no longer about keeping it even, but ensuring a seamless integration between the two. In response to this 24/7 life, workspaces are beginning to look like living environments with gyms, game rooms, cabinets full of cereal and a beer fridge. Outside the office, there’s a demand for urban, mixed-use environments that offer ease of socializing, dining, living and working.”

“People want to collaborate but they still need the ability to get away”, said Lewis. Phone booths, huddle rooms, war rooms, team rooms, nap rooms, soundproof and Internet – connected and away from high-traffic areas.

Co-working is here to stay and will continue its rapid expansion, but it still only represents a few percentage points of office space usage.

According to the U.S. Green Building Council, there are 54,000 LEED certified buildings. The latest trend is WELL Building Standard that focuses not just on the “built” indoor environment, but the health and wellness of everyone in the building. The categories of focus include air, water, light, nourishment, fitness, comfort and mind.

“In recent years, office design has taken another approach. Space compression has been accepted as the most prominent trend, modulated by the provision of “creative commons” areas where office workers can move away from their solitary tasks for more interaction with coworkers. The idea seems to be “planned serendipity,” which is, of course, an oxymoron. The real test is whether or not more work gets done, and the aggregate figures on productivity make that a very real question.

One veteran executive puts it this way: “The work space is rich in sensors, beacons, communication devices linked by the ‘internet of things’ to enhance space utilization—not in increased density, necessarily, but in greater productivity per square foot of space—extending time efficiency, improving workflow, capturing a workforce constantly on the move.”

A corporate real estate veteran remarks, “The biggest trend is toward flexibility, agility, quality. Real estate facilities are not just ‘overhead,’ but a way to improve not just employee happiness and engagement, but also productivity.”

I am going to spend a few moments reviewing the current apartment, condo, and hotel developments underway in Walnut Creek and I have the link to a most excellent City of Walnut Creek website link with renderings, plans and all kinds of details on each project.

Hilton Garden Inn 470 N Lawrence Way

127 Rooms

Walnut Creek Bart Transit Village

596 units 21,950 sf commercial Phase 1 2019

Vaya at Walnut Creek

178 apartments 185 parking stalls Spring 2018

Lyric at 1500 North California

140 apartments 18,270 sf retail 210 Parking

Trinity Condominium

12 units 28 Parking stalls

2211 N. Main Residence

52 apartments 75 parking stalls

Marriott Residence Inn 2050 N. Cal 160 rooms

1380 N Cal 112 condo N/A

Riviera Condos 48 condo

Riviera Apartments

56 units

1716 Lofts 1716 N. Main

42 units 100 parking stalls

Let’s step back for a moment and look at the big, long-term picture of the job and housing market for the Greater Bay Area. Last week in the January 11th edition of the East Bay Times, on the first page they had a headline reading “Housing Market To Get Even Hotter”, and the article listed a number of median house values for various cities. Dallas, Texas was at $218,000, Charlotte, North Carolina at $181,000, Nashville, Tennessee at $228,000, and then for San Francisco it was $893,000 and for San Jose is was $1,128,000. What a huge differential! If companies want to save serious money, don’t locate here in the Bay Area. No way! And yet, there have been very few companies relocating out of the Bay Area to go to less expensive regions. Sure, Bank of America, Wells Fargo and AT&T, among others, have shifted thousands of jobs to other states and to other countries, but this pales in comparison to the long-range massive corporate job commitments major tech companies have made and continue to make to our San Francisco Greater Bay Area.

We in the East Bay are blessed. Sure, commuting can be the pits – I heard on a radio show last week that several of our Bay Area bridges have reported a 19 percent increase in commute traffic at 4 a.m. and even at 3 a.m.! By 5 a.m. we are at rush hour. But we, here in Walnut Creek or Concord or Oakland, can commute to jobs in San Jose, the Peninsula and San Francisco and most of us will agree that Apple, Facebook, and Google are here to stay. They aren’t going anywhere – and so we have a humongous measure of long-term job security, especially with the hundreds of thousands of new high-paying jobs already planned for our region.

This segues into the next topic of discussion, the advent of driverless vehicles – Autonomous Vehicles officially and on my handout there is a link to an excellent article named “The New Industry Driver”. By 2030, according to one study, private car ownership will drop by 80%, ride sharing will be 4 to 10 times cheaper, and there will be a $1 trillion dollar boost in annual disposable income for U.S. households. In cities 30% of streets might be freed up for other uses, parking spaces across the U.S. might decrease by 70 to 80%, and there will be redevelopment of thousands of parking garages and surface lots.

“Imagine a new morning commute. Instead of entering your garage, you walk to the curb and jump into an AV. There’s no need to warm your car, check traffic, plug in directions or concentrate on the road. An AV does all of that for you, giving you the freedom to read a book, watch TV, sort through morning emails or take a nap. You arrive at your destination, climb out of the AV and enter your office building. The AV moves to the next destination, dropping off and picking up other riders, never needing to park, and only occasionally having to recharge or refuel during the day. Due to AV technology, commuting to and from work would arguably be safer as human drivers weaving in and out of traffic lanes would be a thing of the past.”

Amazon is not just dominating online retail sales, it is not just the largest user of warehouse space in the country, leasing tens of millions of square feet all over the United States, it is also changing the way states, counties and cities compete to get a new corporate headquarters to move to their area. Amazon reportedly has one of the top real estate negotiating teams, and last year announced it was seeking a new headquarters site for up to 50,000 employees. This set off a competitive incentive frenzy from one coast to the other, with as an example New Jersey offering an incentive package worth five billion dollars. Amazon wants land, site preparations, tax credits and exemptions, relocation grants, workforce grants, utility incentives, permitting and fee reductions, and if they can get it, changing the name of your city to “Amazon”. (Just joking!)

Our Concord Naval base is in the running, but don’t expect California to offer much in incentives, and just think of 50,000 more employees commuting to the Concord area.

If you look back on the past three major market crashes, back in the late 1980’s we had the collapse of the savings and loan industry. Most of you might not have been around back then, but up and down the I-680 Corridor one-third of all our office buildings were foreclosed on and I remember one downtown Walnut Creek Class A office building selling for $47 a square foot. It was horrific! Then in the early 1990’s we had the collapse of the dot com bubble when it didn’t matter what your cash flow was. What counted was market share, and when that bubble burst, we had tremendous office vacancies. Then in 2005 you could get a home loan by writing in whatever income figure you felt appropriate – imagine if college grades were like that, just write in what you thought you deserved. Well, that was the beginning of our Great Recession, and now we are still in one of the longest boom periods in history.

The PricewaterhouseCoopers / ULI 2018 report then asks the question, “What seems to be the difference now?” The answer is we have a very low unemployment rate, we’ve been getting more conservative and more defensive as the cycle has matured, therefore, for the most part has not been overbuilding in any of the market sectors, certainly not retail, not housing as we have severe shortages, not office and again, not industrial. Experts talk about a “soft landing”.

What could cause a hard versus soft landing? North Korea is producing an assembly-line of deliverable nuclear weapons, then one side or the other is actually pushing its respective button.

A major terrorist act like 9-11 is not out of the question. A dirty bomb in a densely populated city, chemicals introduced to our water supply, 50 stolen UPS trucks filled with explosives, simultaneously blowing up every major bridge or tunnel in America.

A worldwide viral epidemic that gets out of control and is not contained before millions or billions of casualties.

But none of that will happen!

In conclusion, and before we get into the Q&A, for a drawing for a great bottle of wine no sales person will call but I can show my boss. I was actually working this morning.

We covered a lot of ground, thanks for your patience – The Greater Bay Area, the various commercial real estate product types, the influence and impact of San Francisco and San Jose on us out here in CoCoCo land –That is Contra Costa County – My daughter misread this and thought I was saying Cuckoo land, but no, cococo.

Here is my prognosis – Barring any huge catastrophe like a major earthquake or one of the other scary events I mentioned … We are in absolutely great shape out here. We have tons of jobs. Yes, the commute for some is terrible if you don’t work closer to home, but there are tons of jobs. Office rents will continue to go up, no new supply in sight, and developers will keep building apartments … Yes, traffic will get worse, but long-term autonomous vehicles will solve this.

Remember back in 2009 when the Great Recession threw hundreds of thousands of us out of work, and caused massive foreclosures, but the commute was smooth and there was a lot of parking at office buildings – you can’t have it both ways.

We will selectively tear down obsolete buildings and build new mixed-use projects.

Even if the stock market goes down 3 or 4 thousand points, we, out here in the burbs, will have a soft landing. Our population is for the most part fairly well off and will continue to need the services of our local CPAs like RINA Accountancy, our local attorneys, financial planners, and insurance brokers. Landlords will raise rental rates, then give concessions or rent reductions if the space doesn’t move quickly enough, so it will be ebb and flow for years to come.

There will be two winners. First, on the back of one of the handouts is a small flower sticker, and we’ll draw a card for the second bottle of wine.

My father Arthur Weil has written 22 poetry books and for all those who would like one, free of course, please raise your hand.

Let’s open this up for questions and answers.

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Commercial Real Estate Forecast 2018

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