Lee and Associates part 2: the state of California Commerial on the Norris Group Real Estate Radio

Bruce Norris is joined once again by Paul Earnhart (Founding Principle) and Erik Hernandez (Senior Vice President) of Lee and Associates in Ontario, CA.

Bruce asks Paul how this downturn compares to downturns he’s seen before. He says this one is broader compared to the 90s. In the 90s there was an oversupply of four years. Lenders ended up taking back large quantities of properties and the RTC got involved. Values fell rapidly because of quick liquidation. The Inland Empire survived because of the influx of companies from the LA area looking at their bottom-line and moving into cheaper areas. Capital, however, never dried up. Banks were still making loans. Capital now is much tighter. This time it’s systemic and more problematic.

Bruce asks about oversupply of inventory. Erik says certain categories are overbuilt and in certain areas there’s lots of standing inventory. Some inventory is too far along into building to stop. There’s more coming in the coming year. They started building when vacancy and absorption rates looked good and the world has changed.

Bruce thinks there is going to be a vacant building glut. He asks how vacant buildings are going to be appraised. Paul says appraisals will be looking at income values not at sale comps. If someone wants a loan on a vacant building the financing will be of the hard money variety or you’ll need to prove a tenant is coming in. Owner occupied is still good but the income will still be scrutinized.

Bruce talks about what happened in the past with the City of Perris. Bruce feels the next two years will be ugly but long-term migration outlooks look good. He asks Paul about unemployment and how that changes the commercial real estate industry.

Paul says it’s a two-edged sword. Warehouses are a very small piece of commercial and over 100 million square feet over the past five years. The assumption was that consumers would keep spending so it’s been really overbuilt. The question becomes now if there’s a structural vacancy. Some companies are already gone: Linen and Things, Bombay Company, Levitz, etc. If people aren’t working they aren’t spending. There’s less need for these kinds of spaces.

Bruce asks if the new tenant that takes over for some of these large spaces pay much less. Erik says landlords are very motivated and list lease rates and significant discounts.

Bruce talks about reading through loan docs for his line of credit and how he was surprised at the ways the lenders can get heir money back. He asks if commercial is the same. Paul says that lenders do have some say if things start going bad. If lenders see the balance sheet doesn’t look good then they can take action.

Bruce talks about some investors writing themselves a check into savings from their home equity line of credit and the bank then taking the money out of the account and then closing the line of credit altogether. All agree it seems far reaching but more and more, even the most credit worthy individuals are having credit disappear.

Bruce asks Erik if we’re gaining commercial tenants. Erik says people who don’t have to be here are gone. Paul says the taxes and bureaucratic nonsense of California is not very business friendly. Businesses are only here because they have to be due to logistics of distribution and manufacturing. Those that don’t have to be here go to states like Texas and Arizona who are more business friendly.

Bruce asks if businesses tend to lease or buy in this market. Landlords are being very aggressive so buying a building would need to pencil. Commercial leases vary by sizes. Fixturizing a commercial building can be expensive so companies who put in the infrastructure for larger buildings will stay in longer leases.

All three talk about the very short time frame that economists and experts give industry constituents as far as market outlook and much of it is wrong. For those in commercial, there’s a very long time line and the world can totally change. Those that came out early saying there was a real problem took lots of heat.

Finally, Bruce asks where Paul and Erik see opportunity in the commercial sector. Paul sees land opportunity coming first followed by small to mid-sized office product. Industrial on mid to large size won’t be good for 12 to 24 months. Liquidity is the real issue here. See www.lee-assoc.com .

The Norris Group
6391 Magnolia Avenue, Ste. C
Riverside, CA 92506
www.TheNorrisGroup.com