Uneven Landscape

After three punishing years and a near grinding halt to private projects, the southern California real estate and development scene may be showing signs of life, longtime experts say. A few bright spots, such as a renewed focus on infrastructure and the underlying attractiveness of the area to new residents—as well as the nation’s busiest port and the continued strength of the entertainment industry—portend perhaps an even brighter future.

Meanwhile, several real estate sectors are already ripe for development. For one, the appetite for multifamily housing is very strong, says Mario Camara, a partner at Cox Castle & Nicholson in Los Angeles and a veteran attorney representing real estate developers, investors, and lenders. That is because Californians—like Americans in most regions—are finding single-family homes and condominiums less attractive to buy and are opting instead for rentals and other shared or leased units.

Likewise, regional and local governments have recognized that seniors’ and assisted-living housing is desperately needed as southern Californians age. As a result, governments have softened land use requirements for those developments and created density bonuses, Camara says. “We are bound to see more of that.”

As a result of Senate Bill X1-2, signed into law by Governor Jerry Brown this April, at least 33 percent of the electricity produced by California utilities must come from renewable resources. This means the state remains a hot spot for new solar, wind, and biomass projects, both in urban and rural areas. The same is true for water projects as cities scramble to find new and affordable water sources in the arid Southwest. One recent example is a new desalination plant in Carlsbad in northern San Diego County, construction of which began in 2009.

In the commercial, retail, and residential housing sectors, activity is slow if not nonexistent, but the thirst for medical offices and health care facilities is driving new work.

Above all, industry leaders point to Measure R as the future driver of growth. The Los Angeles County measure, which passed with a super majority of the voters in 2008, is expected to provide $40 billion in new sales tax revenues for transportation in the next 30 years. Already, regional transportation authorities are coordinating with municipalities to create residential, commercial, and retail communities tied to transit hubs.

One Westwood, Los Angeles, California

Among a flurry of activity, pending projects include extension of the Gold Line railway from Pasadena to Azusa, extension of the Metro Purple Line subway from Wilshire Boulevard and Western Avenue to Westwood (and possibly to Santa Monica), the Expo light-rail project connecting the University of Southern California (USC) neighborhood to Culver City, the extension of the Crenshaw Corridor light-rail through south Los Angeles, and extension of the Green Line railway to Los Angeles International Airport. California’s high-speed rail initiative is also looming—it currently is undergoing environmental review for two sections in the Central Valley—and should spur similar transit-oriented developments at its rail stations.

One dark cloud has been efforts by the state to take control of redevelopment agency funding from individual cities (see feature box, above). For many years, redevelopment agencies large and small have driven revitalization. Places like Long Beach, Pasadena, downtown Los Angeles, Glendale, and Santa Monica have been among the most successful at redevelopment through use of funds and tools like eminent domain to eliminate blight.

“Redevelopment agencies have been significant catalysts in areas such as Hollywood and downtown,” says Allan Abshez, a shareholder at Greenberg Traurig in Santa Monica who focuses on land use and related litigation. “They have also been a significant source of funding for affordable housing.”

If they are, in fact, eliminated, Camara asks, “Where do we get the revenue to replace the government’s portion of those deals?”

Redevelopment agencies may also be forced to liquidate their assets and unload their properties at relatively low prices, adding to the glut of cheap land on the market. As a counterbalance, other efforts to sell public property—such as the Orange County Fairgrounds, which were to be sold for $100 million during Governor Arnold Schwarzenegger’s tenure—have been pulled from the market by state officials after Governor Jerry Brown took office this year.

As is the case during any major downturn, lawyers have been spending much of their time resolving disputes among investors, developers, landlords, and tenants. A tremendous amount of turnover has taken place in the purchase and sale of major buildings in downtown Los Angeles, says Michael Matkins, founding partner of Allen Matkins Leck Gamble Mallory & Natsis in Los Angeles, who has spent more than 40 years representing clients in the real estate industry.

“Handling those transactions requires a detailed analysis beforehand to make sure that those buildings are indeed entitled to do what the new buyers want to do with them,” he says. “Then, following these transactions, attorneys are again called in to reentitle buildings for new uses.”

For instance, many southern California condominium projects are being repurposed as rental properties, while land originally zoned for industrial use and then rezoned for residential use during the housing boom, is now reverting to industrial purposes. Many property owners have also been seeking new financing to take advantage of low interest rates.

Another trend has seen southern California planning agencies expressing interest in developments that reduce automobile trips and provide affordable housing, says Abshez. Those developments incorporate the live/work/play concept, offering housing, retail, commercial, and entertainment options within one walkable development.

In addition, traditional shopping centers with big-box retailers as anchor tenants are being transformed into lifestyle centers, replete with a broader mix of tenants that includes entertainment, offices, and restaurants, as well as public space, Abshez observes. One example is the 70-acre (28-ha) Howard Hughes Center near Los Angeles International Airport. Developer Equity Office Properties is now seeking amendments to the campus land use plan to expand the array of uses on portions not yet built.

USC spurred a flurry of construction of student housing near its campus and is developing a medical park as well. Other southern California schools—including the California Institute of Technology in Pasadena and the Claremont colleges in the San Gabriel Valley—have been mostly unaffected by the vagaries of the economy and have expansion plans of their own.

Despite the lingering gloom, redevelopment of the Wilshire Grand hotel in downtown Los Angeles by property owner Korean Air has cleared the entitlement process and could soon constitute a new milestone: the first Class A office project to open downtown in the past 20 years. The billion-dollar development, which covers an entire city block, will include a mix of retail, office, and hotel components.

Nevertheless, while Los Angeles did experience a spike in housing activity downtown before the slump in 2008, few new condominium projects are expected anytime soon. “That stopped and hasn’t come back,” Matkins says.

Avenue of the Stars, Century City , California.

The last major downtown development was Anschutz Entertainment Group’s $2.5 billion L.A. Live complex, which added new entertainment, restaurant, and high-end hotel space to the blocks surrounding the Staples Center and the Los Angeles Convention Center. Further plans could include a new National Football League stadium—Farmers Field—at the site, but those plans are still in the very early stages and other southern California locations have been vying for stadiums as well.

Carl Rieger, Jr., a managing director for the national real estate investment banking company Eastdil Secured in Irvine, sees glimmers of optimism for the housing market in Orange County, which has remained fairly steady even through the recession. The Irvine Company and the Rancho Santa Margarita Landscape and Recreation Company, among others, are driving new housing. FivePoint Communities Inc. and Lennar are building 4,894 residential units, plus more than 1 million square feet (93,000 sq m) of commercial, office, school, research and development, and public facility space at the former El Toro Marine Corps Air Station in Irvine. Also, the New Home Company—composed of former top executives from John Laing Homes and the Irvine Company—has a new residential master plan for the 50-acre (20-ha) Lambert Ranch development in Irvine; sales of the 169 single-family luxury homes are to begin next year.

An increasingly popular development product has been high-end multifamily housing. “As people move toward rental products, we are seeing a number go more upscale,” Rieger says.

In other sectors, developers are reconfiguring busted retail projects in Orange County, and a handful of new, moderately priced hotels catering to local business centers have opened there as well. But overall, financing has been challenging for new retail projects that might take years to develop significant cash flows. “They don’t have a strong guarantee to repay those loans,” Rieger says. Besides, he says, “You can buy a lot of product today for less than what it costs to build something.”

The market for real estate transactions has been strong over the past 12 months, and pricing has exceeded most sellers’ expectations. Given that product supply for sale has significantly increased over the past few months, price increases witnessed over the previous 12 months are likely to moderate for many assets, with the exception of true core assets, says Mark Gibson, an executive managing director of the investment banking company HFF L.P. “We are back to a nearly normal market where supply of product and capital are reaching a more balanced state,” he says. “Development is slowly emerging in general and is most notable in the multifamily housing product class.”

Much as Silicon Valley in northern California has rebounded rapidly, the Los Angeles and Long Beach ports have driven new industrial growth in the Inland Empire, Gibson says.

Renata Simril, managing director of the Jones Lang LaSalle public institutions group in Los Angeles, agrees that an uptick in the volume of transactions has been seen in the region. “When you start to get lower cap rates, that will drive development,” she says.

A good deal of commercial real estate still needs to change hands, notes Michael J. Gillmore, partner and Pacific Southwest leader of real estate at Ernst & Young LLP. “We’re in the second inning of a nine-inning game,” he says. “The real estate world works best if there’s a lot of trading activity. That’s what sets prices. What that means is that there is a market again.”

The number of public/private partnerships has also increased as cash-strapped cities, counties, school districts, and agencies seek new uses for their vacant or underused property, Simril says. Rather then selling land outright, many public institutions are seeking developers to build projects that provide continuing revenue streams from ground leases and other sources. Universities, for example, are tapping developers to build structures meeting noncore needs, such as athletic facilities, book stores, and student housing.

“Now is the time to start having those conversations,” she says. “The next step is to engage the private sector and generate some revenue.”

Orange County, which Simril calls the hub of the action sports world, is also uniquely positioned for new development of recreation-oriented projects. Developers there are now creating master plans centered on water parks, skateboard parks, and other entertainment venues that add value to the projects, she says.

Perhaps the brightest sign for the real estate industry is that Los Angeles increasingly attracts foreign capital, Gillmore says. The most active investors recently have come from China and Singapore, and in the form of sovereign wealth funds emanating from the Middle East and Australia. Those investors are busy engaging in joint ventures, as well as private equity and opportunity funds, and often seek local partners to help them break into U.S. markets.

“This is a gateway city,” Gillmore says. “Foreign investors want to be here, in New York, Chicago, Dallas, and maybe Atlanta. They are seeing prices lower than they were five or seven years ago.”