Don’t Cry for Southern California, East Coast Pundits
For years, Californians have been telling skeptical Easterners, “Yes, but . . . .”
For instance:
* Aren’t you worried that an earthquake will push you into the Pacific? Yes, but we’re not swimming yet.
* Is it true that gangs are killing hundreds of innocent people? Yes, but there are millions more of us enjoying peaceful days at the beach.
* Isn’t traffic a nightmare? Yes, but get yourself a car with a phone, a good stereo and an air conditioner and it’s not so bad.
These days, the tanless doubters are anxiety-ridden over the future of perhaps our most sacred cow: real estate. Home prices are “soft,” and developers--particularly in Southern California--are having big trouble filling up all the office buildings that sprouted faster than bamboo around here during the late 1980s.
So, aren’t you worried that what happened to Texas and Arizona, or New York and Massachusetts, will happen to you?
Yes, but . . . .
It’s clear that California is in for a rough ride, especially since so many projections made about the state economy in recent years were based on the theory that you can’t go wrong by investing in California real estate. Of course, most of us always knew that wasn’t quite true, even if we didn’t admit it.
Now, there is a growing concern among California developers and commercial real estate companies that a number of areas--particularly downtown Los Angeles and San Diego--are significantly overbuilt. (That means too many buildings were put up faster than demand for office space was growing.) There is also worry that California is in for a protracted period of stagnant home prices and mortgage defaults.
Both concerns are deep and widespread. But also deep and widespread is the belief out here that the Easterners are too worried about us and that California’s economic troubles aren’t comparable to the “rolling recessions” that struck the Northeast and the Southwest.
What elevates all this above cocktail-party chitchat is that some of the gloomy predictions are emanating from influential financial analysts and economists in New York. Their opinions have serious consequences for investments and future economic growth.
Among the first to throw cold water on us was Salomon Bros., the giant investment firm that advises major pension funds and other big investors. After writing a bullish report on Southern California prospects in 1987, Salomon researchers David Shulman and Sandon J. Goldberg turned bearish in a report issued last March.
“(Los Angeles) will probably achieve its place in the sun,” they wrote, “but, like travel on many of its freeways, the trip may take longer and be more arduous than most market participants now expect.”
The underpinning of the Los Angeles economy is the single-family home and its pricing, Shulman and Goldberg concluded. Indeed, the huge run-up in house prices in the 1980s added $150 billion to the region’s wealth and had a lot to do with the boomtown mentality that has prevailed. But now that house prices have stalled and the commercial real estate market is headed south, that underpinning seems shaky.
Just last month, Moody’s Investors Service issued a generally bearish report on California commercial real estate saying that although things here may not be as bad as they are in New England, banks may experience some tough times as defaults occur on bad real estate loans. Defaults and high vacancy rates have a ripple effect; banks become much more cautious in their lending, developers stop developing and business conditions generally worsen.
Already, Moody’s has downgraded its opinion of Wells Fargo and Security Pacific securities for just such reasons.
When heavyweights such as Salomon and Moody’s start saying such things, the ripple effect through the financial community is enormous. Californians who deal with New York financial institutions have heard increasing anxiety. Moody’s talked about the situation in its report last month: “Considerable effort (in California) has been devoted,” it said, “to refuting out-of-state skepticism about the market’s prospects.”
So what is it the Californians are refuting? It’s the “spin” on the story.
“We’re softer, but I don’t think it’s considerably softer,” said Dennis Macheski, vice president of research services at Grubb & Ellis, a big California commercial real estate firm.
Adds Kathleen B. Cooper, chief economist at Security Pacific: “It’s not as scary as some very nervous stories tell you. Those of us who follow the economy closely knew it would slow down from the pace of the late ‘80s, which was unsustainable.”
Those two and others predict that vacancy rates in California office buildings, which haven’t changed much over the past several years, will rise significantly in the next few years, and that will cause defaults by owners of some of the lower-grade buildings. Home prices, which stalled last winter, will soften some more as the effect of aerospace layoffs becomes more apparent. The Californians stir all that together and get slow times ahead--not disaster.
They argue persuasively that what’s hurting the state’s commercial real estate market now are factors unrelated to general economic conditions, since new tenants are continuing to sign leases for space in new buildings at a fairly healthy clip, and most economists say that means the economy hasn’t deteriorated badly. Things aren’t booming, but they aren’t busting, either.
Those “other factors” are millions more square feet of new space coming to market next year--buildings that were designed and financed as long as four years ago.
Some of those buildings were rushed into construction to beat new regulations that are designed to slow down growth in California. Others were financed with foreign money that saw the California market, expensive as it is, as a bargain compared to their home markets. They were built, in other words, for reasons other than market demand. This “overhang” of new office space, coming to market as the economy is cooling, is what local observers believe is the most immediate cause of the current worries about us.
What the experts here quibble about with their counterparts back East is whether a rapid rise in the vacancy rate, which everyone agrees will happen, will turn a sputtering economy into a basket case.
