Reprinted from University of California at Santa Barbara Economic Forecast 2006. Written by Greg Stafford and Steve McCarty of Stafford-McCarty Commercial Real Estate.
Issues of the Year:
- Commercial property valuations continue to escalate with capitalization rates in the range of 6.5 percent to 5.5 percent for investment properties.
- Two-tier rental rates: existing commercial rates have been holding steady versus escalating new construction retail rental rates for best locations. New, best-location, retail lease rates have attained approximately $3.00 per-square-foot per-month, triple-net.
- 2005 commercial loan rates have increased over 2004 rates by 25 to 50 basis points.
- The demand to purchase local commercial properties remains high from both local and out-of town buyers.
Overview
There continues to be extreme confidence in our local commercial markets evinced by new high water mark sale prices. The residential market also continues with double-digit price increases – 17 percent for 2005, (17 percent for 2004 and 20 percent for 2003). The high cost of housing has permeated all aspects of the community and points to a future of more of the same. The median price for a home in San Luis Obispo County has approached $600,000. New job creation needed to fill commercial vacancies has been thwarted by the high cost of homes, which is only part of a myriad of issues for California employers, i.e. double digit health insurance premiums, ever-growing energy costs, spiraling costs of materials, cost of employee housing, etc.
The problem of soaring building materials and labor costs has resulted in making newly constructed buildings affordable to only the financially healthiest of companies. For the owners of existing buildings, there has been significant equity gain. At the time of this writing, market rents have not kept pace with the costs of building.
As noted in our previous year’s report, home buyers getting priced out of the City of San Luis Obispo have purchased property in the outlying areas which translates to heavy commuter traffi c going south to Santa Maria and over the Cuesta grade to north county. As more homes are produced in the surrounding communities, traffic will only intensify without further transportation infrastructure. Central Coast communities are attempting to add more affordable housing in a variety of ways.
Mixed Use Projects Emerge
As noted last year, Mixed Use concepts, which may incorporate residential into new developments, have been approved and are starting the construction process. Most noted is WestPac’s proposed project bounded by Broad Street, Marsh Street, and Garden Street, including the city’s lot #2 in downtown San Luis Obispo. At this early stage, the city is contemplating whether to either sell the property or perhaps lease it to the developer. The project would include approximately 168 parking spaces, 70 hotel rooms, an equal number of residential units, and one or two floors of retail space.
Investment Real Estate-Strong Demand and Lower CapitalizationRates Continue
1031 Tax Deferred Exchange buyers continued to push the investment real estate market in 2005. Commercial brokers all heard the same refrain from exchange buyers -“I can’t find anything that makes sense and I have looked all over!” This also held true for 2003 and 2004. This market area is seeing unprecedented valuation increases in investment real estate. Demand for tax deferred exchanges as well as real estate investments as an alternative to the lackluster stock market have been driving capitalization rates down, translating into rising prices.
Ancillary issues and observations: the equity required for down payments has climbed in order to bridge the gap between lender debt coverage ratio requirements (DCR) and current market rental rates. Hence, commercial real estate is following patterns of residential real estate in that buyers must come into transactions with bigger down payments in order to have manageable monthly mortgage payments. Following are capitalization rate ranges evinced over the last four years:
2002……….. 9.0 to 9.5
2003……….. 7.0 to 8.0
2004……….. 6.5 to 7.5
2005……….. 5.5 to 6.5
To illustrate the capitalization influence on valuation, let us assume a commercial building produces a net income to the investor of $100,000 per year. The declining market cap rates would correlate to the approximate purchase prices according to the following years:
2002……….$1,100,000
2003……….$1,428,000
2004……….$1,538,000
2005……….$1,818,000
The following examples demonstrate a broad range of investment transactions – small to larger:
- The 3,173 square foot building at 89 Murray in San Luis Obispo sold for $1,325,000 at a projected cap of 5.1.
- The 3,870 square foot building at 84 Santa Rosa in San Luis Obispo sold for $1,400,000 at a projected cap of 5.5. This was based on $1.75 per-square-foot triple-net rental rates.
- The 25,500 square-foot Dallidet Building in San Luis Obispo sold for $6,550,000 at a projected cap of 6.5.
Rising interest rates are making real property investments less attractive. This being said, properties are still generating a great deal of interest and there is very limited opportunity to purchase investment property in this market.
Retail
In San Luis Obispo, Costco (140,000 square feet) has recently opened on Los Osos Valley Rd. In addition, there is another 140,000 square feet of ancillary building entitlements associated with the overall development.
The Copeland project of approximately 62,000 square feet in downtown SLO has opened and appears to have been well received. This is a retail/offi ce/restaurant complex bordered by Osos Street, Monterey, and Higuera. The primary tenants are Talbots, Abercrombie & Fitch, Banana Republic, Chico’s, Pottery Barn, and Giuseppe’s Italian Restaurant. The 243 space parking structure at the northeast corner of Morro and Palm along with an office building of 17,000 square feet is nearing completion. The balance of the Copeland’s downtown development (total of 200,000+/- square feet) is being deferred to the future.
Bill Bird’s controversial Marketplace retail/commercial development planned on the Dalidio Ranch on Madonna Rd. was thrown a curve when its approval was turned down by the voting citizens of San Luis Obispo. The developers are now processing the plan through the County.
Two large retail shopping centers sold at the end of 2005, Madonna Plaza Shopping Center and Marigold Shopping Center. (As of the date of this article, the sales have not recorded).
The rental range for new retail construction varies from $1.35 to $3.00 per-square-feet per-month triple-net.
Due to increasing construction costs, new buildings cost more to rent out than older “2nd generation” buildings. Therefore, we are seeing two-tiered rents emerging.
San Luis Obispo 2005 retail vacancy remains low at 1.7 percent, even lower than the already low 2.2 percent availability in 2004. These vacancy rates are calculated from an approximate retail inventory base of 3,593,694 square feet. Please see the table near this article for the vacancy time series data.
Industrial and Commercial
Commercial real estate investment values remain strong. The market has demonstrated slow but steady net absorption. The previously overbuilt C-S zoned office product now demonstrates an approximately 3.4 percent vacancy rate. However, this situation will soon be affected by three projects located in the Airport Area, which are under various stages of construction, i.e. Sycamore Court (24,000 square feet), Tank Farm & Broad office project (+/-77,000 square feet, and Aerovista Medical Campus (+/-70,000 square feet).
The low industrial space vacancy rate we have reported last year has disappeared. The supply of larger industrial spaces, e.g. 30,000+ square feet are virtually non-existent. The 113,000 square feet, Moore-Wallace Business Forms facility on Sacramento Dr., SLO, closed and was immediately
purchased and occupied by a local firm, ZooMed. Local unemployment continues to be in the low 3 percent range with no apparent new job creation on the horizon.
Commercial rental rates for new or newly new C-S office space are $1.25 to $1.35 per square- feet per-month triple-net, which is virtually unchanged from the preceding 2 to 3 years. These rates typically include a build-out allowance of $30 to $40 per square foot. Second and third generation space will rent in a range of $0.75 to $1.15 per square- feet per-month triple-net for C-S zoned office build-out and $0.55 to $0.80 per-square-feet per-month triple-net for industrial/ warehouse space.
A four-year snapshot of San Luis Obispo vacancy rates for Industrial/warehouse and Office space is shown in the table near this article. Vacancies are calculated from approximate inventory bases of 3,578,196 square feet for industrial and approximately 2,593,811 square feet for office.
Paso Robles Commercial
Paso Robles, which typically has had the only available variety of inventory for small to medium sized industrial/manufacturing users, also has very limited space offerings. Manufacturing vacancies were close to 16 percent in the first part of 2004. To this date, a great deal of absorption has taken place in the industrial markets of Paso Robles resulting in a vacancy rate of approximately 3.5 percent. The Paso Robles industrial base is approximately 2,215,000 square feet. Please see the table near this article for a historical Paso Robles vacancy rate data.
The following are a few significant retail openings in Paso Robles: Petco, (+/-12,666 square feet), Starbucks along Theater Drive, as well as Kohl’s (96,075 square feet) near Wal-Mart on Niblick Rd.
New multi-tenant space with a modest build-out rents for approximately $0.55 per square feet gross rent per month in Paso Robles. Retail and office products have hardly any vacancy. Paso Robles has been adding and absorbing approximately 115,000 square feet of retail per year for the past 6 years.
Atascadero
Atascadero is making itself known by several major commercial projects. Traditionally, Atascadero has primarily been a market with a commercial services base functional to meet the needs of the local population.
The current talk-of-the-town is the highly anticipated Colony Square mixed-use project. The development will consist of an aggregate of approximately 200,000 square feet in seven buildings. There are 55 condominium residential units planned plus a 12- screen movie theatre. It’s hoped that this project will inject vitality into the heart of Atascadero. This development is in the early stages of appraisal/financing.
Moresco Plaza (approximately 30,000 square feet of a master plan of approximately 56,000 square feet of commercial) is under construction along Hwy 41. A portion of this project will be occupied by Midland Pacific Building Corporation, the owner/builder.
The three most significant residential developments approved for Atascadero are Dove Creek (279 mixed units) at El Camino Real & Santa Barbara St., 3F Meadows (111 mixed Units) on San Marcos Road, and the Woodridge Specific Plan (279 mixed Units) on Halcon Rd.
Land Prices
There have been huge increases in downtown land prices during 2005. Entitled land in downtown San Luis Obispo has reached $300 per square foot, up from $100 per square foot within the last year.
Industrial land prices also continue to increase in San Luis Obispo: $15 per square foot for C-S raw land up to $25 per square foot for improved parcels. Last year, the cost of industrial land was approximately $12 to $15 per square foot. The availability of industrial land listed for sale is virtually nonexistent. This also applies to retail and office land availability.
An acre of industrial land in Paso Robles is approximately $4.00 to $6.00 per square foot with on-site improvements. As there is limited supply in South County, in-fill parcels range from $6.00 to $10.00 per square foot depending upon location and availability, if it can be found. All land prices continue to escalate.
Polishing the Apples – Downtown Renovations
A great number of communities have embarked on facelift projects and Earthquake Retrofits. Avila Beach is continuing its total makeover following Unocal’s massive soil clean up. In addition to numerous hotel and condominium projects, there is 70,000 square feet of projected new retail space. Land prices have reached $100+ per square foot.
Arroyo Grande Village land values are +/- $80 per square foot. Grover Beach and Arroyo Grande have begun street improvements on Grand Avenue. There is money earmarked for storefront enhancement in Grover Beach and there is a traffic signal planned for 10th Street and Grand.
Cambria has the Main Street Improvement Project, which affects Main, Burton and Pine Knolls.
Pismo Beach is improving downtown streets, planting trees and generally beautifying the area. San Miguel and Templeton also have entered into the downtown beautification effort.
Street Talk: “The Bubble” vs. the “Soft Landing”
The still most common asked question is whether or not we are in a real estate “bubble” – meaning essentially, will the rapid price expansion collapse at some point or will we just see an overdue price adjustment? We are seeing longer selling times and downward price adjustments in the residential markets; however, key factors underpinning increased values of recent years remain in our market: a lack of untitled land on which to build, increased construction costs (linked to high energy costs for the production of concrete and steel), and the influx of a well-heeled retirement community. Ultimately, we are left with high costs, (creating new socio- economic barriers to entry), and new stakeholders attracted to the San Luis Obispo County’s lifestyle. Regardless how the tea leaves are read, we are casting our votes with our clients and investors – San Luis Obispo is a good place to be.
