Developer sentiment for office product is weakening throughout California. According to the latest Commercial Markets California sentiment survey from Allen Matkins and UCLA Anderson Forecast, which GlobeSt.com have received exclusively, office sentiment is both down compared to six months ago and negative, meaning that less than half of respondents have a positive three-year outlook of the market, in six California markets reviewed. Los Angeles and San Francisco faired best, with 49.79% and 48.89% of respondents holding a positive three-year outlook for office development.
“We have had an incredible run in office, but the sentiment has come down. When you look at the sentiment of our panelists, they think that vacancy is going to be higher in three years from now, and we have an uptick in inflation,” John M. Tipton, the operating partner at Allen Matkins, tells GlobeSt.com. “Cap rates have also compressed about as far as they are going to compress. When you look three years down the road, the market may be a bit weaker than it is currently.”
While the sentiment report was negative across markets, the panelists in the video above sound more hopeful, showing there is a gap between the current fundamentals and a more psychological sense of the years ahead. “People can’t help but look at their past experience and project what they feel like might happen in the future,” says Tipton. “We have been approaching economic expansion now for 9 years. You have major tax cuts in 2017 that has trickled through the economy, and so there are some people saying that the cycle has to end; they don’t go on forever.”
Despite the changing sentiment—which focuses on developers that would be delivering properties in three years—the current market is still strong. “If you look at the data, the economy is still growing and we continue to have increased employment, and real estate looks like a good bet,” says Tipton. “Things are certainly not frothy and there won’t be incredible advances in rental rates, and when you look at the alternative investments, it still looks like a good asset class.”
However, more and more people are feeling like the end of the cycle is coming. Tipton says that developers will be the first segment of the market to feel the impacts of the transitioning market. “New construction is going to feel the pinch first, as you reach closer to equilibrium,” he says. “Beyond that, when you look at the more general market conditions, I think there will be a pull-back in construction. There has been a fair amount of building, but not overbuilding, like we saw in the late 1980s. That led to a long hangover, but we haven’t seen that this cycle.”
Co-working operators will also serve to put pressure on the market, especially during a down cycle when some companies might look for ways to cut back without impacting productivity. New co-working deals are already in the works today. “That is a very dynamic part of the market right now,” says Tipton. “This is definitely a real dynamic that is expanding rapidly. As far as the impact on office space, generally, it leads to a more efficient market, and it gives people flexibility. Over time, the real estate industry has modernized, and I think this is a manifestation of that ongoing evolution. I don’t think that it is making an impact on development, or making go/no-go decisions.”