The industry’s sentiment survey reveals continued strength of the industry, although cycle is nearing a turn

By Vladimir Bosanac

[dropcap]U[/dropcap]nderstanding the state of the market is in many ways like forecasting weather. The experts can really only tell you what will happen in the next day or two and beyond that there are just too many variables at play to make an accurate prediction. The invention of the radar helped, because it was able to look at long distances and see the weather patterns to the west and predict outcomes with some certainty hours or days later as the systems moved eastward. An industry sentiment study is similar to that. There are certain segments of the industry—architects, developers and surveyors—who are to the west of what is happening today; they see things months if not years ahead of time. There are also those who have their ear to the ground and can detect tremors beneath us. Then there are those who have seen it all, the gray-haired soothsayers, the sages of the industry, the generals with deep battle scars. Everyone’s viewpoint brings valuable insight, which is why an industry-wide sentiment survey is a valuable tool and a useful guide to the true state of the industry, even as short-sighted as it may be.

In our second edition of the commercial real estate industry survey conducted in partnership with Wendel, Rosen, Black & Dean LLP, we explored some of the same questions that we had about the state of the market in the Bay Area earlier in the year. And given how much has changed since the start of the year, it would be hard to imagine that the industry leaders’ sentiments have not changed with that, as well.

Office market probably not the first, but the most significant to enter the new cycle of flat growth

One of the first questions we asked was about the market peaking. 55.6 percent of the respondents said it is peaking, and another 28.3 percent said we are standing at the top with no room to go. The respondents also predict that in 12 months we will be well on our way in the next phase of the cycle, with 18.2 percent saying commercial real estate values in the Bay Area will be receding, a full 44.4 percent think by that time the market will have peaked, while close to a quarter say it will be peaking. When asked about the timing, 15.2 percent saw the cycle ending within the 6 to 12 month timeframe, nearly 65 percent saw it happening between 12 and 24 months, and about a fifth of the respondents saw it occurring in over two years.

Looking at the asset types across the region, retail is one property class that has more than half of the responders saying investors will be looking to dispose of these assets. There has been a lot written about the imminent demise of that sector, which could be reflected in these responses. “The survey results reflect the continued disappearance of brick and mortar, however, it does not reflect yet what significant opportunities are going to arise for new retail uses where people can continue to congregate, meeting one of our basic human needs,” said Zack Wasserman, land use and real estate attorney with Wendel Rosen.

This could be why roughly a quarter of the responders see retail as a hold. The well-maintained, healthy retail that provides the right kind of experience and setting beyond just shopping is valuable, according to many sources in the industry, even with a certain amount of transformation occurring. For some this could present an opportunity.

The office product was the most equally distributed between acquire, hold and dispose camps. Some investors have completed their business plans, leased up the asset, and they are looking to sell. Some are ready to enter the market, and for them there are opportunities, albeit at relatively high prices (remember, we are peaking), and some are happy with the yields and want to keep the properties. “The survey results really demonstrate the confusion and uncertainty of the office market, because of the shifts in demographics, cost issues and transportation. And this sector is probably the one that will not be the first, but probably the most significant to enter the new cycle of flat growth,” added Wasserman.

The office market in the Bay Area is a fairly diverse pool of assets owned by an equally diverse group of investors, both on the urban and suburban side, and the mixed feedback corresponds with sentiments reflected in the general market—some brokers see asking rates increasing, some see them stabilizing at today’s levels, others are somewhere in between. Overall, 32.3 percent of the responders see investment in the Bay Area market increasing, about 43.4 percent see the activity at pace where it is today, and just over one fifth see it decreasing.

The responders listed interest rates, political risk, cautious optimism, fears of a decline, price and demand peaking as negative factors impacting the market. But on the flip side capital chasing a lack of other opportunities, fear of missing this long cycle and low vacancy factors in commercial office and apartments as indicators of continued interest in the region. But one thing seems certain with this survey, cap rates are predicted to go up, according to almost everyone who responded to that question, along with 87 percent of responders seeing interest rates increasing, as well.

And what may be the industry’s highest concerns? The survey shows increased construction costs having the biggest impact. The second largest concern for the industry is national politics followed by state of national economy. Naturally, these two items are closely related, and the news from Washington seems to portray more uncertainty in the remainder of the year. The next issues that the responders worry about are interest rates and what that may do to the industry as well as the region’s aversion to development.

One important aspect that was not measured by this survey is the effect of transportation on the industry and the overall economy. Wasserman concluded, “Rapid changes in transportation, both in policy and habits, will have intermediate and long term effect on the local economy and the real estate industry as a whole, as well. We have not yet tested the impact these changes may cause, but it is very likely the way the real estate industry views location and values different properties.”