Regional Spotlight: California

By Mike Sheridan

October 24, 2011

http://urbanland.uli.org/Articles/2011/September/SheridanCalifornia

Real estate entrepreneurs and development companies have had to adjust to

demographic changes and economic constraints in California. At the same time,

the state's real estate sector is adapting to new market realities. With an

economy that seems to be on the mend, read what factor is bringing good news

to the housing market and leading people to think about expanding their

businesses.

Real estate in California is a tale of two states, says Constance B. Moore, president and CEO of

BRE Properties Inc. of San Francisco, which develops, acquires, and manages multifamily

communities. "Northern California is very strong, particularly the Bay areas and Silicon Valley,

where tech is on fire.

We're seeing significant job and wage growth for the knowledge worker," she says. "However,

in southern California, Los Angeles is our weakest market. There is limited job growth in the

L.A. area, so when we try to increase multifamily rents, we get pushback. San Diego is coming

along: it's a market that didn't go down as much as some others, so there isn't as much to come

up. Orange County is starting to see strength in office and that is enabling us to push rents on

the apartment side."

High tech is going to be on the leading edge in the Golden State, Moore adds, "but we've got a

ways to go for homebuilding. Construction of single-family homes is a laggard. What is helping

the market is that all real estate in California has been repriced. Housing has never been more

affordable, so that is good news, too. It means that people are starting to think about growing

their business in California rather than moving away, and that will be good for the economy."

After a rough couple of years, real estate in California-particularly in the northern part of the

state-is recovering. Spurred by a strengthening economy, a vibrant high-tech sector, and

renewed confidence in the Golden State by businesses inside and out, California is rising from

the doldrums. Although the nation's largest state is not out of the woods yet, things are looking

up and there is a more positive feeling in the state.

Though there are still bumps in the road, there are numerous reasons for optimism for the San

Francisco Bay area and southern California, says Alan -Chamorro, senior vice president of the

San Francisco office of Grosvenor Americas, an international property development and

investment group.

"Despite California's budgetary problems, the economy appears to be re-bounding and the Bay

Area is rumbling back," he says. "On the jobs front, Silicon Valley and San Francisco are

percolating nicely, and with some additional momentum, we hope that this economy will

continue to expand over the year. The Bay Area is the innovation capital of the world, and we

do not see that changing anytime soon. Technology, and all of its permutations-biotech, social

media, green tech, cloud computing, etc.-is the bright spot, and with it will come significant job

creation. Companies in Silicon Valley, San Francisco, and the East Bay have steadily continued

to create jobs, and we expect this trend will continue to gain momentum in the coastal

communities of the Bay Area, and southern California."

Grosvenor Americas is working on entitlements for several projects in the Bay Area, Chamorro

adds. "We are about to break ground on a boutique luxury residential condominium project in

San Francisco's Pacific Heights neighborhood," he says. "In Los Gatos, we are working with the

town of Los Gatos to create the specific plan for a nearly 40-acre [16.2-ha] mixed-use

development site which we believe is one of the best development locations in the Bay Area.

We see the opportunity to create a vibrant, mixed-use, sustainable neighborhood that serves

the local community and also a wider regional area."

Northern California will continue to benefit from the strong presence and profits in Silicon Valley,

as well as San Francisco's focus on the biotech industries, says John Ashworth, principal at Bull

Stockwell Allen, a San Francisco architecture and planning firm. "This means the Bay Area's

office market, including interior renovation and modest new builds, will reinforce a stabilizing

challenge both north and south, a strong rental market should lead to renewed interest in rental based multifamily residential development. California's leadership in the high-tech and

information exchange industry is an economic engine, primarily in the northern California Bay

Area. Apple, Google, Twitter, and Facebook are synonymous with Bay Area innovation. They

are collectively fueling high profits and reinforcing the area's better-than-average economy."

California is also experiencing an increase in public/private partnerships, points out Mike

Pattinson, principal at Bull Stockwell Allen. "With continuing restrained capital markets, state

and local governments have joined with the private industry on an increasing basis to assist

with infrastructure and regeneration projects that revitalize the economy and help local and

state job growth," he says. "Public/private partnerships appear to be playing a real role in

stimulating business while at the same time helping jurisdictions finance public projects that

would otherwise be on hold."

While ground-up development is still sluggish, says D. Jamie Rusin, principal at Berkeley's ELS

Architecture and Urban Design, his firm is involved in several projects that reposition and

refresh existing retail properties. "This work includes solving problems, such as vacant

department stores, and improving properties with capital investment that was deferred during

the downturn," Rusin says. "This trend will escalate as property owners become more able to

invest, tenants gain momentum to expand, and as well-capitalized new owners buy bankrupt

properties. ELS is also involved in early master plan and entitlement efforts with clients who are

looking forward to project openings in 2014, 2015, and beyond."

Troubling signs, however, are the very poor financial condition of state and city governments

and continued high unemployment. "The current improvement in business conditions may, to

some extent, reflect deferred improvements and available capital more than sustainable growth

in consumer demand," Rusin says.

California has a strong, educated, and skilled workforce, tremendous resources, and, most

important, a forward-thinking, progressive populace, notes Steve Pellegren, vice president,

preconstruction services, at Bernards. "California is still leading the world in technology and

leading the country in a dedication to protecting the environment, which will result in a lifestyle

that is clean, healthy, and productive," he says.

Pellegren does not foresee any industry in California that will be robust. "If anything, with the

current impetus to dramatically reduce government spending at the federal, state, and local

level, we would see a decline in activity," he says. "One of the problems with dramatically

reducing government spending is that any recovery will be slowed."

California continues to attract new industry. Utility-scale alternative energy projects-solar, wind,

and geothermal-will bring significant amounts of investment and jobs to California, predicts

David C. Michan, president of San Diego–based Strata Equity Group, a privately held and

managed real estate investment and development company. "They have the potential to attract

billions of dollars of investments into California and thousands of jobs," he says. "Alternative

energy technology will soon reach and surpass grid parity [on the cost to generate one watt of

energy] with coal and other nonrenewable resources. In the meantime, the sector is relying on

federal and state incentive programs in order to compete."

Accordingly, Strata is repositioning some of its landholdings for utility-scale renewable projects,

Michan says. "Strata is looking to become a major player in the industry by providing fully

packaged solar projects to solar developers either for purchase or for joint ventures," he says.

"This will include solar project applications with the state, an interconnection point, power

purchase agreements with a utility company, and entitlements."

Over the past 18 months, Strata has purchased a number of residential subdivisions with

standing inventory and finished lots while also focusing on rebuilding its income-producing portfolio,

and has purchased multifamily communities and a self-storage facility. "We are actively

pursuing additional income properties and also raw or semi-improved land projects," Michan

says. "Up to now, we felt that it was too early to venture to unimproved or unentitled projects

because of market conditions. We feel, with the lead time required to entitle projects, the time to

enter new raw land projects is nearing, especially for projects near core and secondary

markets."

Still, California cannot escape its past, says R. Zachary Wasserman, a partner at Wendel,

Rosen, Black & Dean, one of the oldest and largest law firms in the San Francisco East Bay. He

projects involving developments that are underwater-that is, that have more debt than the

assets are worth. "I do not think there will be a big rush of true foreclosures," he says. "But I do

think institutional lenders and trustees for securitized commercial mortgages are being realistic

and starting to respond-a few working deals with their borrowers and more selling the notes to

funds or the few well-capitalized commercial owners/developers."

Wendel, Rosen, Black & Dean is working on a number of developments, including a solar

project for the Peralta Community College District, which is partnering with Chevron, and an

energy-harvesting 35-story condominium project near Lake Merritt.

"The two major issues in California will be legal challenges to foreclosures or sales of notes and

the California Environmental Quality Act [CEQA]. With all the sales and foreclosures occurring, I

believe some owners will bring legal challenges to foreclosure," says Wasserman. "The CEQA

issue will be significant because new owners will want to start moving projects, and the terrible

length of time required for CEQA clearance will be seen as a major obstacle to both developing

projects as well as buying some projects. Governor Jerry Brown is sympathetic to this problem

and may well lead some legislative changes in this area."

California also needs more innovative design because the market has radically changed as a

result of demographic shifts and economic constraints, particularly in the residential sector, says

Barry Berkus of Santa Barbara–based B3 Architects and Berkus Design Studio. Berkus's firm is

busy because it is becoming more inventive, he says.

"As we move through this market, we're trying to reimagine things that have already been done

before, striving to make them better and also creating a product that doesn't now exist," says

Berkus. "For instance, we're looking at a multigenerational housing product where there is a

sharing of living space and costs, allowing people who can't afford to live alone the opportunity

to live comfortably with others. The household may be taking care of parents, grandparents, or

grandchildren requiring care, as well as 'bounce-back' children unable to afford housing and

coming back to live at home. There is a new family grouping, and we're looking at how to house

them all together with dignity so that they can each have their own individual enclaves while

living together."

At Playa Vista, a new housing project in Los Angeles, Berkus is designing three-story housing un

with bedrooms and bathrooms on every level in order to accommodate the diverse needs for toda

families. "People are sharing the house more: the kids are moving back home and sharing space

with parents and grandparents who can't afford $3,000 a month for a retirement home," he says.

"Designers have to adjust."

Adjust is what real estate entrepreneurs and development companies have had to do in California

for the past several years. At the same time, the real estate sector in the Golden State is adapting

new realities of the marketplace. With an economy that seems to be on the mend and with more

demand for real estate product now that the sector has been repriced, California may be

experiencing more good times in the years ahead.