Local Builders and Contractors, Though Still Busy, See a Slowdown Coming
With the economy in a down cycle nationally and an energy crisis crunching Southern California locally, most commercial developers believe the county’s days of “blue sky” expansion are over, at least for now.
Many outline a game plan something like this: seek product, proceed with caution and,remembering what happened in the early ’90s,do not overbuild.
“After the moon, you have to come down to reality,” said Kevin Newman, principal with Kaufman Meeks + Partners, an architectural firm specializing in planning urban infill, high-density, mixed-use projects. “We’re buried with work, but we’re still being prudent. This isn’t a knee-jerk reaction. We’re just being cautious.”
But it’s not necessarily self-discipline that has builders treading carefully,financial institutions are very jittery about a looming recession and are reluctant to lend to any builder that doesn’t have a track record and a solid project.
Kelly Olson, a senior associate with Hellmuth, Obata + Kassabaum Inc. (HOK), has seen the market changes firsthand.
“Nortel, a client of HOK’s, has had three projects put on hold,” Olson said. Cisco, another HOK client has plans for three campuses internationally. In light of Cisco’s recent organizational announcements, HOK “is closely monitoring the projects.”
Olson considers the current market a tenuous one and said the company’s goal is to chase more public-sector dollars or projects that have strong infrastructure and airport availability.
One sector that is especially sensitive to economic conditions is high-rise development. Nexus Development and Koll Development Co. are under construction on Airport Area high-rises; Opus West Corp. last week announced an anchor tenant for its planned second Irvine Concourse tower and said construction will begin in May. But no other high-rise projects are visible in the county pipeline in the coming months.
The outcome of the presidential election placed things in doubt temporarily, according to Nader Shah, vice president, development for Koll Development Co., but he thinks the outlook now is good.
“With interest rates down, it bodes well for us,” Shah said.
Koll is developing its latest high-rise project on spec, but Shah doesn’t see a problem with that.
“We believe there are enough tenants out there who are looking for good, available space, especially in the Airport Area,” he said.
Shah expects the building to be 70% to 85% leased by its September completion.
For now, though, Shah has added that word “cautious” to his everyday vocabulary.
“Until mid-year, there’s not much product out there and not a lot of opportunity for tenant growth,” Shah said.
When thinking of Orange County’s real estate market of the past few years, a mountain-climbing metaphor comes to mind: once you’ve reached the summit, there’s only one place you can go.
Tim Joyce, a senior vice president with Colliers Seeley Inc., doesn’t see that as an altogether bad thing.
“Last year absorption rates were three times over ’99 and six times over ’98,” Joyce said, pointing to the county’s record-setting 2000 rate. “Net absorption is still very good, just not at a record level. So, no, it’s not like last year, but you just can’t maintain that type of high.”
Joyce doesn’t see the near future as a time of doom and gloom. In South County, building rates have still not come down,a clear sign that landlords are not nervous.
“Vacancy rates are down 10% from three years ago,” Joyce said. “We have a 13 million-square-foot base with only 1 million square feet in vacancies.”
“We’re looking at short-term stabilization,” Joyce said. “And tenants are the same way. They’re being cautious about what the labor force is doing.”
The net result is that some expansion projects are being re-evaluated. Joyce predicts about six months of caution, with a rally beginning in the third quarter if the economy doesn’t get worse.
Can people, then, be patient? Can they afford to sit on property and projects for six months? Will landlords hold their resolve and refuse to discount rates at a time of slowing and even negative absorption rates?
“The Irvine Company is the bellwether of this marketplace,” said one industry insider. “They have a larger influence on this marketplace than any landlord has anywhere. They are the dominant landlord. They act as a buffer and they can hold rates longer than a typical marketplace can do. The Irvine Company has no debt and, because of this, they can be as patient as Job.”
The new year sees the Irvine Co. approaching the market differently.
“We’re more sensitive because it’s ‘our’ capital,” said Bill Halford, president of the Irvine Co.’s office properties division. “We’re not building with other people’s money. Many developers do not have a vested interest in the projects. We’re more mindful of that than ever.”
“We’re particularly mindful of watching job growth,” Halford said. “Our business is a by-product of job growth. The last few years, we’ve had phenomenal job growth. In most people’s view, job growth is still good, but off from the record growth of the past few years.”
Halford said vacancies are still low by national standards, but issued a warning against overbuilding.
Last year, the county absorbed 4 million square feet of flex product, an indication that flex remains a strong presence in the market, he said. But he noted that high-rise development has not taken off in the same way: the magnitude of flex construction left little demand for new high rises.
“I believe we’ll see high-rises slow in the future,” Halford said. “But, in general, we’ll see a good year of job growth.”
“Flippers” or “merchant developers” are not building to own forever, according to Halford. Their success is predicated on their ability to resell a property, tenants intact. So, it’s imperative for them to locate tenants with solid credit histories. No one wants to take on a property that carries the weight of high-credit-risk tenants.
Though no one is predicting a free-fall in the commercial real estate market, caution remains the buzzword. But when does negative thinking become a self-fulfilling prophecy? At what point does a negatively thinking developer say, “OK, maybe I shouldn’t go through with that project”?
The market swoon has piqued the interest of Dr. Esmael Adibi, director of the Anderson Center for Economic Research at Chapman University in Orange.
“For the next six months, we’ll see a slight rise in vacancy rates and some softness in rent and prices,” said Adibi, “though the South County will continue to outpace the North, especially in the Airport Area.”
It is the continued growth of the south that reminds some developers of the overbuilding of the past.
“It’s not strictly business as usual,” said Paul Lenz, Western regional president of Transwestern Commercial Services.
According to a year-end report compiled by Delta Associates, only 7% to 8% of the absorption in 2000 occurred in the fourth quarter. That makes developers like Lenz nervous.
“There are a lot of new building projects being talked about,” Lenz said. “That gets scary.”
The slowdown has others weighing in as well.
“My sense is,obviously,the outlook is not nearly as bright as 12 or even six months ago,” said Michael J. Gritters, vice president of business development for McCarthy Building Cos. in the firm’s Newport Beach office. “But I don’t see a severe downturn. It’s a little too early to say we have actually seen the effects.”
On a positive note, Gritters and others have noticed a few hot niches in the market.
“There’s been strong demand for institutional services,” Gritters said. “There’s also a large demand for educational and healthcare projects.”
Craig Atkins of O’Donnell/Atkins Co. said he is seeing an increase in demand for land.
“Urban infill is still the strongest area for us, though it’s difficult to find land. The demand for the product is strong. The problem is a lack of supply.”
Jack Goddard, principal with Shea Properties, was also of the positive mindset.
“For the last 90 days, we’ve seen a softening,a wait-and-see approach,from tenants wanting to expand into the marketplace. Until then, though, we’ve experienced some pretty fabulous times,” said Goddard.
Most agreed that the county’s diverse economic holdings keep it from being hit too hard by an economic downturn. If the market does slow down, then who gets hurt? From most indications, it will be the smaller companies that cannot afford to maintain a holding pattern until the market rights itself.
“Everyone’s expecting a downturn; it’s the cyclical nature of the business,” said Gritters. “But what’s important is volume and duration.” n
