Orange County’s real estate market in 2019 surprised many in the industry. The year began with sluggish performance in the housing market and the fear that the region had over-built office space. By Q4, however, it became clear that neither was true. The housing market broke price records while sales climbed year-over-year. And the office market absorbed added space with a much more diverse group of commercial tenants than Orange County was known for two decades ago.
The Housing Market in 2020
The California Association of Realtors predicts an uptick in single-family home sales and prices in 2020, but only a slight one, citing “economic uncertainty and affordability issues.” Single-family home prices in California are about twice the national average. Although interest rates remain historically low, more people are now moving out of California than are moving in.
For Californians committed to staying in the state, it should be possible in 2020 to cash out the equity in your home and buy another. Those leaving the state will find vastly increased purchasing power in many other U.S. markets.
Even with rents at historic highs of their own, single-family investors may struggle to find deals on properties that grow their portfolios.
The Commercial Real Estate Market
Multifamily properties are facing some headwinds of their own. California now has a rent control law, limiting rent growth to 5% per year in all properties that are more than 15 years old. In the short term, this policy change may only have a minor impact on landlords’ profits — but when it’s time to sell the property, rent control will affect cap rate calculations and investment evaluations significantly.
California’s commercial real estate market received an “optimistic” review from the Spring/Summer 2019 Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey in mid-2019. The study predicted a slowdown in construction through the end of 2020, but suggested that “developers are already gearing up for the next CRE expansionary cycle.”
Specifically, researchers believe the U.S. will face a downturn in 2020, but that it won’t last long. After that, they believe, office rents and occupancy rates will increase — except in Orange County, where they cite “an overhang of space and tepid job creation.” Other experts have disagreed with this forecast; however, suggesting that Orange County’s empty office space has largely been filled, though construction has remained paused.
The Anderson Forecast predicts a “lucrative” warehouse market in Orange County and Los Angeles in the coming years as products pass to and from both ports and population centers. Many of these new warehouses are high-tech buildings where employees’ work is enhanced by robotics.
There is still “pessimism” around retail, the Anderson Forecast says, a natural outgrowth of the broad national shift toward online shopping. Despite the pessimism, a panel of experts agree that retail is resilient.
Even for the shops that are predicted to be obsolete within the next 15 years, new businesses that cannot be replaced by online retail will take their place. And as multifamily construction continues in Orange County and neighborhoods densify, experts predict more opportunities for small, neighborhood-serving retail establishments. It’s all dependent on one thing: experience.
The Four Fs — fun, family, fitness, and fashion discounters — are the business models that will be effective innovators in their space and are likely to actively expand, according to Jason Ehrenpreis, Retail Specialist with Centers Business Management (CBM).
On top of that fact, Trump’s tax policies are a benefit to small businesses — if you’re looking to purchase a smaller retail space, the odds are in your favor. The only thing that could disrupt the market enough to change the healthy state of retail is a stock market crash, recession, or another unexpected event, panelists said.
IS NOW A GOOD TIME TO SELL PROPERTY?
Residential Real Estate
2020 could be the year that California housing values approach their peaks. Home prices have been climbing steadily since the American housing market bottomed out in 2011 and 2012, and in most parts of the state, prices eclipsed their pre-2008 peaks around 2015. Most people who bought at the top of the market could now sell their properties for profit.
But prices can’t climb forever. Housing affordability is now a crisis in California. According to the 2019 State of the Housing Market Study from the California Association of Realtors, 30 percent of sellers who plan on repurchasing homes say they’ll do so outside of California, including 37 percent of Baby Boomers and Silent Generation sellers and 30 percent of Millennial sellers.
At the beginning of 2019, price growth had dramatically slowed throughout the state, and experts predicted a downward trend. In the 2019 UCLA Anderson Forecast, director Jerry Nickelsburg said that home prices were actually falling in some markets, yet homebuying had not picked up. CNBC reported that home sales fell to an 11-year low in January 2019, having fallen year-over-year in Southern California for the six preceding months.
But by the end of the year, the market picked up, driven by low interest rates and low unemployment. The LA Times reported that although sales slowed in 2019 and bidding wars became less common, prices didn’t trend downward.
Still, the market has slowed enough that prices are unlikely to increase dramatically in 2020. Homeowners who choose to sell this year have a good chance of fetching their desired prices, since supply is still so constrained and interest rates are still so low. However, if you choose to sell your property and you need to buy another property right away — especially in California — you’ll be competing in a historically high-priced housing market too.
If you own single-family homes as investment properties, you know that rents are historically high as well. Further, California’s new rent control law does not apply to single-family homes (except for those owned by REITs or corporations) or duplexes where the owner lives in one unit, meaning investors can continue to benefit from an enormously competitive rental market.
Commercial Real Estate
High rents have been a boon to the multifamily sector in California during the last decade. There is so much competition in the rental market that rents are rising fast even in buildings where owners make no improvements. However, rent increases are now capped at 5% per year under California law in multifamily properties that are more than 15 years old.
Property owners and managers ought to be able to quickly calculate how rent control will affect their returns in the coming decade. Consult with a professional to compare those returns to how much you’d benefit from simply cashing out your equity now, compared to how much you’ll earn if you raise rents by 5% or less per year. If you’re considering selling your multifamily investment properties in 2020, consider that there may be less competition from interested investors — but note that interest in multifamily properties has been incredibly high in recent years, so “less competition” may still mean a lot of competition.
In the office sector, the buttoned-up financial services companies that dominated Orange County prior to the Great Recession have been supplanted by companies in the technology, healthcare, entertainment and many other sectors. The region’s skilled workforce is more diverse than ever — prompting a need for a variety of offices, both large and small, both traditional and startup-minded. This has forced office buildings to diversify their offerings for new tenants.
Tech companies and co-working space lead the office market in growth, industry professionals agreed at the 2019 Connect Orange County conference. While coworking may have reached its saturation point, many of the companies incubated in those environments have grown into their own spaces in the more traditional office market.
Coworking startup WeWork — whose plans for an initial public offering imploded in late 2019 before shares hit the market — operates 10 spaces in Orange County as of January 2020. If WeWork does not survive, the sudden loss of those 10 spaces could make for an unusual season in the office market as building owners scramble to fill Class A space.
Whatever happens to WeWork, its model of leasing traditional office space, updating it, and subleasing it to additional tenants is one that may be replicated in 2020 and beyond. The entry of such middlemen into the office leasing market could upend traditional leasing models. But it could also force office building owners to update their spaces themselves to attract those desired tenants.
In general, startup companies seek shorter office leases than well-established tenants do. Building owners with too many short-term leases could be in danger in the case of an economic slowdown. Additionally, office construction slowed in 2019 as vacancies have taken longer and longer to fill.
If your company is considering selling office space in 2020, consider broader economic indicators, like unemployment and business creation. Unemployment remains historically low and California’s startup sector shows no signs of slowing down — and indeed, startup founders are increasingly looking to the southern part of the state as they find themselves priced out of Silicon Valley. By those standards, 2020 ought to have a healthy office market.
However, the founders creating job growth might have different desires for their office space than their Baby Boomer and Gen X predecessors, however, which means owners of older buildings may need to make significant improvements to attract the tenants they want at the rental rates they want. Those improvements are more expensive than ever. If you own an older building and aren’t prepared to invest heavily in it, now may be a good time to sell it to an owner who is. Sale prices for office buildings remain strong.
In the industrial sector, the vast majority of Orange County’s buildings are built specifically for the tenants who will occupy them. Amazon and other e-commerce warehouses on the county’s eastern fringes have transformed the region’s freight traffic and its blue-collar economy. But investing in industrial property can be difficult since so much of the growth is in the build-to-suit warehouse sector.
IS NOW A GOOD TIME TO BUY PROPERTY?
Residential Real Estate
Orange County home prices are at historic highs. The market set a new record in November 2019, with the median sale at $735,500, according to the OC Register. Sales increased year-over-year as well. Even as experts predict some market softening in 2020 and beyond, suggesting that prices this high cannot last, 2020 is likely to remain a very expensive year for Orange County homebuyers.
If you plan to sell a home at the same time you purchase one, you can likely take advantage of the significant equity you’ve built up in your existing property, which will limit how much 2020’s high prices affect your family finances. Expanding a single-family rental portfolio in this environment may be difficult, however.
That said, when purchasing a new home is the right decision for you and your family, there is no bad time to buy. There is no substitute for having the space you need to raise your children or age safely and happily.
Commercial Real Estate
In the multifamily space, California’s rent control law is likely to limit cap rate growth on properties in the coming years. In turn, this will likely reduce demand for property somewhat. That said, rents remain historically high, and investments in multifamily housing are still likely to generate significant returns.
If you’re a prospective multifamily buyer, it may be most prudent to wait and see how rent control affects real estate prices in the coming year. If prices fall, you may be able to get a better deal than you expected. If they stay steady but returns decrease, you can explore other investment opportunities.
The office market in Orange County remains very strong, with one notable exception: With WeWork on the rocks, some Class A buildings may be seeking to shore up their balance sheets by filling vacant space as soon as possible. Building owners who’ve leased a significant amount of space to WeWork may face challenges if the company quickly downsizes or defaults on its leases. On the other hand, however, the improvements done to WeWork spaces will likely make them attractive to other startup tenants.
For now, WeWork’s 10 Orange County locations remain operable, and it’s possible they will continue to do business for years to come. But we do not predict much WeWork expansion in 2020. Class A office building owners should seek other tenants.
With a strong economy, high incomes, and low unemployment in Orange County — and with commercial construction fairly slow — experts do not anticipate much slowing in office leases in 2020. The right properties could deliver strong returns in the coming year.
In specific neighborhoods, particularly those designated Opportunity Zones by the 2017 Tax Cuts and Jobs Act, investors are carefully watching. Some real estate professionals feared that the opportunity zone designation would lead to overbuilding in Anaheim, Buena Park and Santa Ana, as builders sought to take advantage of tax breaks without doing proper market research. So far, however, it seems that Orange County’s commercial market has been strong enough to absorb the additional space. As original owners seek to divest from these properties, real estate investors should watch for opportunity zone buildings with strong cap rates and evaluate them as potential investments.
CONSIDERATIONS FOR BUYING AND SELLING REAL ESTATE IN 2020
Residential Real Estate
If you are considering purchasing residential real estate in 2020, make sure you understand the context in which you’re doing so — a housing market dominated by historically high prices that, most experts agree, is beginning to soften. Real estate values may not continue to grow steadily indefinitely. As the winds of population growth or shrinkage, changing national and state policies, and an evolving regional economy buffet the housing market, it’s possible that single-family home prices are currently at high levels that will not be sustainable. And while rental rates for single-family homes are high, sale prices are so high that investors who buy additional properties in 2020 may not see an attractive monthly return on investment.
Those who are considering selling single-family homes in 2020, however, may find themselves well-positioned to do so. Data show that sales did not slow during late 2019 — in fact, they picked up nearly 7 percent year-over-year in November. Homebuyers apparently, remain eager, and prices are high — a seller’s market by definition.
Additionally, interest rates on mortgage loans remain historically low, encouraging homebuyers to take action now. The Federal Reserve declined further rate cuts in December 2019, predicting slower economic growth in 2020 compared to previous years but falling short of predicting a slowdown or recession.
Commercial Real Estate
Apartment construction remains expensive, driven up by land prices, local and state regulations, and a tight construction labor market — yet multifamily construction has proliferated during the last five years, especially near the top of the rental market. These new units have absorbed some of the market demand for apartments, at least partly abating rent growth in older buildings — the buildings where rent growth is now limited by California rent control.
Despite rent control reducing cap rates and slowing investment returns, multifamily vacancy rates remain extremely low. Many of these buildings still present good investment opportunities. Rent control will have some impact on sales this year as investor sentiment evolves, but it will take several years before we have data about the impact of rent control on the multifamily market.
Nationally, the multifamily market is booming. The Mortgage Bankers Association believes 2020 will be a record year for multifamily loan originations, predicting a 14 percent increase year-over-year.
"The low-interest rate environment, coupled with continuously strong demand for commercial and multifamily assets, has pushed property values higher and increased demand for mortgages," Jamie Woodwell, MBA's Vice President for Commercial Real Estate Research, said in a September 2019 statement.
There is not much room in the Orange County market for new office construction, but the market appears to have absorbed mid-2019’s vacant office space. With a strong economy and low unemployment, office buildings have proven themselves as safe investments in Orange County today.
However, as a national election and national political decisions — especially decisions about trade, immigration and healthcare policy — affect the conditions in which businesses operate, changes in the business climate are usually followed by changes in the office and industrial real estate sectors.
Warehousing has been a boon to the industrial sector in recent decades, especially as e-commerce increases traffic through the Ports of Los Angeles and Long Beach and those goods must be shipped across the country. Demand for warehouses will likely continue to grow as long as e-commerce continues to grow — and neither show any signs of slowing down.
UNIQUE MARKET CONDITIONS IN 2020
In 2020, many of the trends that threatened to slow California’s real estate market in 2019 — including the state’s strong economy but slowing job growth, declining housing affordability, and slow construction — are expected to continue.
Changes in state legislation, including laws that have already been enacted and potential changes that the Legislature is currently considering, could cause major changes in the multifamily rental market.
Also, of course, 2020 is a presidential election year in the U.S. Trump Administration action on trade or immigration could have ripple effects throughout California and the country. And whoever is elected in November, some economic uncertainty is likely to follow, whether Americans are concerned about military action, sweeping changes to the healthcare system, or otherwise.
Housing construction has long lagged behind what experts say the market can handle. Part of the problem is that California has a significant shortage of construction labor. 78% of contractors surveyed in 2018 said they had trouble finding workers, especially in the skilled trades. But despite high wages for construction workers in California compared to other states, South Bay Construction says high housing and living costs are driving the state’s construction workers elsewhere.
Experts do not expect significant construction acceleration until the labor shortage is addressed, which means both residential and commercial construction is likely to be concentrated in the high-end sectors. Without an influx of new space, competition for existing space will remain tight unless a significant number of people leave the state — and more people are now leaving California than are moving in.
The office sector has posted several strong years in Orange County as the region attracts companies from Northern California, Los Angeles and San Diego. In the Spectrum area and near John Wayne Airport, demand for office space is particularly strong. Construction appears to have paused, however, as new products get leased more slowly than competitive landlords like. If demand is re-ignited before construction catches up, lease rates could see significant growth in 2020.
The growth of e-commerce shows no signs of slowing. Warehouses are popping up near freeway after freeway in Southern California, acting as way stations between the Ports of Los Angeles and Long Beach and customers inland as well as millions of customers in their own region. Amazon captured 49% of the e-commerce market in 2018 and likely captures more now.
That means, however, that half of the money spent online does not pass through Amazon — and the total amount Americans spend on online sales continues to grow. There is ample opportunity in the warehousing space for investors who understand the e-commerce market and are willing to evolve fast.
In the housing market, multifamily properties will have to adjust in 2020 to the state’s new rent control regulations. The new law, signed in October, limits rent growth to 5% per year in buildings that are at least 15 years old. It does not apply to duplexes in which the owner lives in one unit or to single-family homes.
Some industry professionals say that rent control could slow multifamily construction, though the law does not apply to newly built homes. And in California’s hottest rental markets, rent control is likely to reduce long-term returns on investment for investors. That could put downward pressure on multifamily sale prices — but when multifamily construction is still so constrained by the construction labor market and by local regulatory issues, demand for apartment housing is still likely to outpace supply.
In California’s legislature, zoning has been a topic of much discussion in recent years. A proposal to allow more multifamily housing near public transportation stops is now before state lawmakers. The California Association of Realtors has endorsed the bill, saying it would ease the state’s affordability crisis, while opponents argue it would ruin the character of single-family neighborhoods. If the bill, known as SB 50, is enacted, supporters hope (and opponents fear) that it could lead to a new boom in multifamily construction, encouraging migration to California and continued job growth. It could also create a new class of multifamily assets that investors can acquire down the road.
Immigration reform remains a hotly contested political topic nationally, but it has particular relevance to California. In 2017, the Public Policy Institute of California reported that 27 percent of Californians were foreign-born. The same study found that 48% of those who had arrived since 2010 (and 58% of those who had arrived from Asia) had at least a bachelor’s degree.
These highly educated immigrants may work in healthcare, technology, higher education, or other high-paying sectors, creating and filling jobs in these sectors and purchasing homes. Legislation that restricts the ability of these high-skilled workers could slow migration to California, which could, in turn, slow home sales and the growth of white-collar companies. Those developments, in turn, could slow the departure of older Californians from the state. Whether immigration reform takes place in 2020 is still an open question, however, particularly as Americans go to the polls in November.
The Trump Administration’s trade war with China has had significant impacts on certain industries, including California farmers. If consumer goods become significantly more expensive, the country could see a slowing in e-commerce activity, which could be reflected in traffic at California’s ports and in its warehouses. The impact of tariffs that have been delayed remains to be seen.
Finally, presidential elections often come with some economic uncertainty, particularly when candidates represent the possibility of dramatic change. Nearly every Democratic candidate has backed significant changes to the healthcare system. Some have argued for significantly increased tax rates for corporations and wealthy individuals. As Election Day approaches, activity from companies that perceive threats to their business models and individual investors who sense threats to their assets may slow.
BUYING AND SELLING REAL ESTATE IN 2020
2020 is poised to be a year of change for California real estate investors, both in the housing market and the commercial real estate market. New regulations in California could upend the multifamily housing market, or they could have only a minor impact on market dynamics. The single-family home market could slow, as it did in the first few months of 2019, only to come roaring back in the fall. The office and industrial sector will be buffeted by the winds of national politics, whether we see shifts in trade policy, changes to immigration laws for white-collar workers, or continued low interest rates. And all capital markets will be subject to some uncertainty surrounding the 2020 presidential election, as they are every four years.
But, as seasoned investors know, every year is one of change. Every market has headwinds. And every company has different needs. Even in a tight housing market and a turgid office market, successful real estate investors are those who know how to tell which is which for their company — or, in the case of homebuying, their family.
The single-family housing market remains a seller’s market, and that is likely to continue until price increases slow dramatically or construction takes off. Price slowing is possible in California in 2020; but between a tight construction labor market and high land prices, a huge spike in construction is unlikely. At the same time, mortgage lenders remain so strict following the financial crisis that experts say a real estate bubble like that of the mid-2000s is unlikely. The buyers in this market are those who can genuinely afford to buy. In fact, those with inadequate financing are likely to get outbid.
Multifamily housing is probably causing investors more trepidation than any other sector of the real estate market due to California’s new rent control law. Although the new regulations only apply to buildings more than 15 years old, rent control will limit the lifetime value of all properties. That lifetime value may still be more than enough to convince investors, lenders, and builders that multifamily buildings are good investments — but it may also dissuade investors in search of the highest possible returns. Industry leaders will be watching this space closely to understand the impact of rent control over the coming years.
In the office sector, what looked like a stale market in early 2019 turned out to be a fairly brisk one. New spaces were leased up as the region’s unemployment rate dropped even further. Orange County now boasts a wide variety of tenants, diversifying beyond traditional white-collar offices to include tech and startup space and coworking space. After coworking startup WeWork canceled its IPO, however, experts have begun to wonder if coworking is a trend that will soon run its course, putting some Class A and Class B building owners on edge.
The industrial real estate market remains strong, with new warehouses cropping up along transportation corridors constantly in Orange County and the Inland Empire. In such a strong e-commerce environment — double-digit growth in each of the last 10 years — warehousing is likely to continue expanding. And the runway is long, as digital sales still only comprise about 10 percent of the retail market.
A wild card for warehousing, however, is how much land a new build-to-suit warehouse requires. Many cities in densely populated regions, like much of Orange County, could not make space for an Amazon-sized warehouse. So, for warehouse investments that will yield high returns, search for land parcels inland and near freeway corridors.
2019 was full of surprises for real estate investors. Experts predicted stagnating housing and office markets; neither prediction was ultimately borne out. Although current signs point to a sellers’ housing market, tepid multifamily market and booming industrial market, those predictions could be upended by changes to interest rates or major state or federal legislation.
To navigate such a fast-changing environment, real estate investors need steady, reliable partnership from industry experts. Working with a broker who knows your company’s needs and can deliver on them is essential to succeeding. Whether you need to liquidate an asset, fill vacant office space, or purchase property, real estate agents can find buyers, sellers or tenants and help walk you through each step of the deal.
WindWater’s team of real estate experts offer those brokerage services and more, including marketing and consulting services. If you’re already a landlord or if you own your own real estate brokerage, WindWater can manage the marketing of your properties while your team focuses on transactions. Our consultants can help you create market reports and do competitive analyses, which can help you price your portfolio and get the most out of your investments.
Whatever your goals are for real estate investing in 2020, WindWater can help you navigate the market’s ups and downs — whether you’ve predicted them or not.