Trends That Will Define Development in the ‘90s

While Southern California basks in a boom prosperity that has spurred commercial and industrial property development, a number of forces will define--and in some cases limit--economic prospects for the decade of the 1990s.

Shifting demographics, California’s affordable housing crisis, the slow-growth movement and the price of new infrastructure are among 10 trends that will define the marketplace for residential, commercial and industrial developers and owners.

Affordable housing. The number of households that can afford to buy a house in Southern California continues to plummet, with the average Los Angeles price reported by the Los Angeles Times at $227,000.

The economic consequences of spiraling home prices are considerable. Employers are being forced to pay premiums to attract workers--costs that force up prices and services. The diminishing supply of affordable housing will have a direct effect on the relative strengths of commercial and industrial markets throughout the region.

Business migration. The decade of the 1980s marked a period of corporate expansion, with companies primarily revenue-driven during a time when the baby boom generation was in its prime years of consumption. The 1990s will be typified by corporate moves to cut expenses and operate more efficiently--with relocation to areas that support a reduced cost of doing business.

Increasingly, we will see areas such as Riverside and the San Joaquin Valley cities such as Fresno become targets for corporate relocations. These areas can provide affordable housing to their employees, reduced traffic and higher quality of living.

David Shulman, research director for Salomon Brothers, has predicted the “end of location” as the real estate maxim measuring the worth of property. During the 1970s, development expanded from deteriorating downtown areas into the suburbs.

“Edge” cities such as Newport Beach sprang into being. In the 1980s; however, traffic congestion, declining air quality and other problems emerged under the assault of rapid growth.

The 1990s will see a further relocation of people and businesses away from these primary business centers to areas of lower housing costs and higher quality of living.

Infrastructure. It’s been estimated that the cost of maintaining and building new sewers, roads and other infrastructure will require $400 billion in Southern California during the next 20 years. Clearly, many communities have neither the infrastructure nor the financial resources to accommodate the explosive growth that some areas have experienced. Increasingly, their response is growth management.

Growing concerns about quality of life will add further complexity and delays to development of all types throughout the region during the next decade. The strain on infrastructure services will be another factor fueling business migration to outlying locations.

Proposition 13. The collapse of the Nimitz Freeway in Oakland during the recent San Francisco earthquake has thrown the spotlight on funding of road construction and the costs of seismic retrofitting. The revenue squeeze created by Proposition 13 has had direct impact on the state’s road systems.

State and local governments will need to re-examine revenue sources to pay for new infrastructure, particularly since many jurisdictions recognize that they have exhausted resources to raise funds through developer exactions and other user fees.

In addition, expect to see a new round of judicial challenges to Proposition 13 as well as more public debate about how to raise financing for highways and other public services.

Entity financing. Under the “bail-out” legislation approved earlier this fall, savings and loans will be forced to retreat from most thrift real estate financing, with the exception of home mortgages, under the new risk capital rules.

Commercial and residential developers will find that entity financing will be an efficient new method of tapping financing.

Analogous to corporate financing, entity financing frees developers from seeking funds solely on a project basis, which may not be economically feasible or practical.

Instead, developers establish permanent relationships with equity-capital providers--lenders and investors--who want to link up with development vehicles in attractive markets such as Southern California. These providers want conduits for investments that will yield significant long-term returns.

By providing financing on the basis of a portfolio of projects, they give developers a great deal more flexibility in planning, acquiring land and other properties.

Expect to see U.S. pension funds increase their real estate investment from a current 3% of funds to as much as 10%. The pension funds will be looking for sound real estate investments that meet their requirements in both residential and commercial development.

In addition, there will be more joint-venture development between foreign investors and U.S. developers. The acquisition of such symbolic assets as Rockefeller Center will be downplayed and partnerships used more frequently as a vehicle for investment.

Foreign investment. The Kenneth Leventhal Japanese Data Base in 1989 revealed another dramatic rise in U.S. real estate investment totaling an unprecedented $42 billion through 1988. We are witnessing a redistribution and reallocation of capital on a global basis.

Japanese investors, however, are sensitive to American public opinion and the high visibility and potential friction among government officials in Washington. Japanese investment in real estate is likely to level off.

The ease of totalitarian rule in Eastern Europe and elsewhere means the United States will lose some of its competitive edge as a target for foreign investment. Investment opportunities in Western Europe and the countries of the Eastern Bloc are likely to increase during the next decade.

This will stimulate Asian investment in Europe and other markets outside the United States. Investments will be measured on an economic basis and yields may be better in Europe than in this country.

Communism continues to be perceived as a major threat in Asia, however. As a result, Hong Kong, Taiwan and South Korea are likely to view the United States as a prime location for investment because of its political stability and free market. Investors from these areas may pick up the slack as Japanese investment in the U.S. property market levels off.

Corporate real estate assets. It’s estimated that real estate now accounts for 30% of total corporate assets--about $2 trillion. During the next few years, corporations will focus on finding new ways to manage these assets to increase core earnings and improve returns to shareholders.

How corporations manage their real estate also will be a prime factor in deterring hostile takeovers. With junk bonds diminishing in use to finance takeovers, arbitragers will be looking at ways to leverage a company’s real estate assets to finance an acquisition. Companies can prevent takeover bids through new structures to hold these assets.

The savings and loan bailout. With passage of the savings and loan bailout bill, the Resolution Trust Corporation became the largest holder of real estate assets worldwide. Assets are estimated to reach $300 billion in the next three years, with about $125 billion to be sold off and $175 billion requiring management through contractors to resolve problems. Forty percent of this portfolio is in land. The RTC officials have said it may take as much as three years to claim title for some of the properties it holds.

Clearly, the savings and loan bailout will provide an unprecedented opportunity for real estate developers to acquire assets or enter into joint ventures for development and management of the properties with government regulators.

The banks, for instance, will not be interested in dealing with the bad assets held by bankrupt thrifts. These institutions will need to align themselves with other developer groups to make purchases of thrifts or bulk assets work.

The RTC has confirmed plans to sell properties at fair market value, while distressed areas will be priced at 95%. As the process of receiving bids for assets gets under way in the new year, however, the RTC may find that many offers come in below fair market value and require financing. The RTC may be forced to take back “paper” in many cases.

Through December, the average recovery, according to the RTC, has been about 70% of loan value, but 95% of market value. The real issue for the RTC will be determining market value and finding ways to get it--with no clear-cut answers to these questions.

The graying of America. Shifting demographics as baby boomers mature will affect real estate markets throughout the country. U.S. Census Bureau figures reveal that between 1983 and 2010, individuals 45 years old and older will make up the fastest growing segment of the population, accounting for 92% of the nation’s population growth.

The baby boomers who were revolutionaries in the ‘60s, workaholics in the ‘70s and who became successful and affluent in the ‘80s will measure success in the next decade by how much free time they have.

More individuals will retire early but will work either part time or full time in second and third careers.

Successful future developments will give their highly mobile residents easy access to urban centers and airports. They will include business centers with fax machines, computerized data bases and communications capabilities offering global access to financial markets and other information.

Resort locations with quick access to major business centers will be favored as will second homes in smaller cities and outlying areas.

The real estate executive of the 1990s. Korn/Ferry International, the Los Angeles-based executive search firm, reports that executive hiring in the real estate industry was extremely strong during the 1980s.

The marketplace of the 1990s, however, will reflect the changes under way in property markets. As real estate markets become institutionalized, companies increasingly will be managed by more professionally trained executives--replacing the traditional entrepreneur.

These managers will need integrated skills in accounting, institutional finance and the capital markets, as well as construction-related expertise.