Real Estate Industry in O.C. Still in Slowdown : Recession: Commercial and home construction have dropped and recovery is not expected for another year.


The sag in the once-robust real estate market has finally come to this. Not one office building was started in Orange County during the first four months of 1992, real estate analysts say. Six years ago, at the peak of the office construction boom, complexes worth a record $510 million were in the pipeline.

In basic economic terms, supply now far exceeds demand. From the gleaming curve of the new Cesar Pelli building near South Coast Plaza to lowliest cinder block mall in South County, a glut of office space sits on the market--an amount so huge it could take more than a decade to rent it all at the current pace of leasing.

Housing is better off, but it is in serious rather than critical condition. Modest home depreciation has set in, and new residential construction is a fourth of what it was in 1988.

Retail construction--the building of stores and shopping centers--has only been cut in half.

By all accounts, the Orange County real estate industry is still locked in a staggering downturn that has defied last year's assurances from economic prophets, the governor's office and President Bush that the recession would be over by now.

Not only is the recession moving into its 23rd month here, industry executives and consultants say that Orange County real estate will not begin to recover for at least another year. How much it will then improve, no one really knows.

"We are optimistic, but not necessarily optimistic about the timing," said Robert S. McFarland, senior vice president of Market Profiles, a veteran real estate consulting firm in Costa Mesa. "It will be a gradual recovery. It will probably take until mid-decade to really get back on our feet."

To an industry that once subdivided Orange County with unbridled optimism, starting homes at a rate of more than 100 a day, the recession has become an unrelenting funk, haunted by reckless business decisions of the past, and aggravated by an acute shortage of both capital and consumer confidence.

Just as significant, changing demographics and business conditions might hamper the demand for real estate in the future. Already, business leaders contend that local firms are beginning to move out. On the horizon, too, are potential changes in property taxes that could depress housing values, and proposed cuts in defense spending that could put another 20,000 people out of work in Orange County in the next few years.

"A blizzard is in full force with precious few berries to sustain us," said Gary Hunt, executive vice president of the Irvine Co., which reigns over a vast portfolio of industrial, commercial and residential development across the county. "We don't anticipate much sunshine until the spring of 1993."

Since the recession began in July, 1990, the toll has been significant for an industry that once affected an estimated $18 billion a year in the county's gross output, about a quarter of everything produced by the local economy.

Real estate foreclosures have doubled from about 20 a month to 40 a month in the last two years. Property sales remain uninspiring, and the number of permits to build new houses, while marking a recent upswing, has not increased much.

About 1,492 housing units received construction permits during the first quarter of 1992, a few hundred more than last year at this time, but half of what it was in the first quarter of 1990 before the recession began.

The value of industrial construction dropped from $196.8 million in 1986 to $39.3 million in 1991, according to the Construction Industry Research Board. Similar figures for office construction show a decline from $510 million to $124 million, before bottoming out to zero new office starts during the first four months of this year. Retail construction has been cut almost in half from $220.4 million to $119.1 million for the same period.

As a result, about 40% of the 178 construction companies active in the county in the late 1980s have gone out of business. The unemployment rate in Orange County may stand at 5.5%, but 16% to 20% of construction workers are unemployed, and that figure does not include thousands of others forced to work fewer days per week, or those who have left the county for greener pastures elsewhere.

Many of the surviving construction firms, including some of the area's most successful, have closed offices or cut their staffs anywhere from 10% to 50%. Among the pink-slip recipients are substantial numbers of professionals, including planners, architects, engineers, executives and real estate agents.

More layoffs in the industry were announced on Friday, when the Irvine Co. announced it would reorganize its upper management and reduce its staff of 326 by 30 to 40 people. It is the second time this year the huge developer has announced layoffs.

"Faced with a sluggish real estate economy, which is only slowly showing random signs of modest recovery, we must acknowledge that our world will be different," said Irvine Co. Chairman Donald L. Bren. "Economic growth in real estate will be slow and will not come without a significant effort on our part."

Best of the Worst

Nevertheless, there are some encouraging signs. In a sense, Orange County might be the best of the worst. With the exception of commercial property and raw land, real estate values have not plummeted here like in other areas of the country such as Houston, Denver, Phoenix or Detroit where some homeowners saw the value of their houses fall by as much as 30% to 40% in a single year.

For the most part, statistics show no appreciation or slight declines in residential property values in the last two years. The average price for all homes sold in Orange County was $252,500 for the first quarter of this year, down from the peak of $257,269 in 1990, less than 2%.

Hardest hit have been people forced to sell homes in the current market, which they bought in 1989 when appreciation hit a peak. Real estate agents say that without appreciation to cover sales commissions and closing costs, some sellers have lost their down payments and equity, if not more.

But California real estate values have gone down before, specifically in 1969-70, 1974-75 and 1982-83. Each time there was great concern, and each time residential property strongly rebounded.

In the short run, real estate experts see some potential at the bottom end of the housing market, though 1992 sales figures for new homes priced under $200,000 do not reflect it yet.

Sales of new homes in Orange County dropped 22% from 7,181 in 1990 to 5,578 in 1991, according to the Real Estate Research Council of Southern California at Cal Poly Pomona. Sales of existing homes rose by 10% from 37,914 to 41,636 over the same period. Overall, the sale of new and existing houses increased by 5%.

Out of six Southern California counties, Orange County had the only increase in overall housing sales, according to council statistics. Only Ventura did better with a 10% increase in total sales. The highest declines were posted in Riverside County, where the sale of all homes was off 22% from 1990 to 1991. New homes sales in that county were off 46% from 1990 to 1991.

At current sales rates in Orange County, inventories of new homes have been slowly reduced to a three-month supply, according to Market Profiles, which gathers statistics for the housing industry.

Analysts say that as the supply continues to be reduced, a shortage could occur and appreciation might resume. Hence, investment in real estate would become less risky, prompting financial institutions to resume lending for new subdivisions.

Over the long run, the construction industry in Southern California might be priming itself for another round of growth to begin in the mid- to late 1990s. The cautious predict a modest recovery, while the more upbeat believe it could equal the boom of the 1980s.

"The county faces a potentially high growth decade in the late 1990s," said Jeffrey S. Meyers, president of the Meyers Group, a real estate consulting firm based in Newport Beach. "As we find new sources of capital, solve our financial difficulties and move forward, it could explode again. The West Coast is still very attractive to investors."

Yet, it might never be quite like it was. At its peak in 1988-89, the Orange County real estate market was one of the strongest in the nation. More than 23,000 home-building permits were issued in 1988 alone. Roughly 74,400 construction workers were on the job then, compared to 54,800 today, earning annual wages of $25,000 to $40,000.

Confident in the market and spurred by federal deregulation of the thrift industry, financial institutions relaxed their underwriting requirements and made $4.7 billion in construction loans in 1988, more than three times what they loaned last year.

Demand was so brisk for homes, the average supply of new housing plunged to only 353 units in 1988. Potential buyers camped outside new tracts before sales offices officially opened, and decisions to buy had to be made almost immediately or the property was sold to someone else.

In the superheated market, appreciation of property reached about 25% a year, driving the average home price in the county to more than $257,000 in 1990. Profits were extraordinary for longtime owners who saw the price of their property more than double in 10 years.

One of the greatest periods of growth in county history finally came to a halt in July, 1990, under a mountain of consumer debt, a glut of office buildings, cuts in defense spending and some of the most prohibitive real estate prices in the country.

As the recession settled in, professionals and tradespeople were thrown out of work. Licensed contractors found themselves driving nails or laying concrete slab again. Eventually, they too joined the ranks of unemployed carpenters, heavy equipment operators, masons and electricians.

"I must get 10 calls a day from guys on the brink of losing their homes or having their cars repossessed," said Randy Thornhill, a business representative for Carpenters Local 2361 in Orange. "Their voices have the sound of desperation. This is one of the worst recessions I have seen."

Union officials say the bad times have fostered severe competition for work, downward pressure on wages, and the hiring of cheaper unskilled labor instead of better trained union members. There is a willingness to work for less than minimum wage and no benefits, Thornhill said.

If not for public works projects now underway across the county and a smattering of low- to moderately priced housing projects, unemployment in the construction industry would hit 50%, according to union estimates.

"There used to be a country club mentality to all this. You know, like complaining you can't afford to restring your tennis racket," said Mike Potts, executive director of the Building and Construction Trades Council of Orange County. "Now we're talking about people who are hungry, who can't afford to pay the rent. We have union members hitting the food banks and Goodwill Industries."

Yet, the wage and salary concessions, competition by contractors for a dwindling number of projects, and declining or stabilized property values have made it more affordable for consumers to remodel, buy a home, or invest in real estate.

"The competition is intense to say the least," said Tim Davey, owner of Davey Roofing Inc. in Irvine, which has laid off several hundred of its 550 employees during the recession. "The square-foot cost is down about 15%, and that is passed along to the home buyer. But prices are all over the map. People are doing things for cost. I would describe some of the pricing as having a desperate look to it."

Sellers of new homes have offered discounts of up to 25% and a host of enticements to buyers--from free drapes and carpeting to paid vacations and luxury automobiles.

"There has been a softening of prices countywide and some big discounts," said Brenda Silvey, president of Residential Trends, a real estate consulting firm in Costa Mesa. "Home buyers still expect concessions and to haggle over price."

Plummeting Values

Real estate experts say the value of undeveloped land has plunged about 25% to 40%, depending on the property. The value of commercial real estate, where more than 21% of the office space is vacant countywide, has been almost cut in half in the worst cases.

Perhaps more troubling for owners of commercial property is the rate at which the vacant space is being rented. According to current figures from the Grubb & Ellis Orange County Research Services Group, it could take more than a decade to fill about 12 million square feet of vacant office space.

"You can step into a better building and a nicer office at the same rent you paid for your old one," said James E. Collins, chairman of Fuller Corp., a commercial and industrial brokerage. "All the office owners are having problems. It's good for the tenant, but it's the worst business climate I have seen in 45 years."

Thomas A. Filmore, research director for Grubb & Ellis in Newport Beach, one of the largest commercial brokerages in the area, predicts there will be some improvement during the next few months.

"The next six to eight months will be difficult and then it will get better. But the real estate market and the economy does not seem to reflect that right now," said Trent Anderson, vice president and director of marketing for Koll Construction in Newport Beach, which switched from commercial construction to institutional projects, such as hospitals and government buildings, as the recession hit.

Working against the recovery is an enduring legacy of the savings and loan debacle and declining property values. It has produced a crackdown by federal regulators and an unwillingness by financial institutions to lend money for real estate projects. In Orange County, construction loans have fallen 70% since 1988.

To qualify for a construction loan today, developers must be financially sound and put up substantial amounts of their own money as equity, as much as 30% in some cases. Better market analysis also is required and projects must present better potential for loan repayment than past projects.

"There is no question that as a consequence of national problems in real estate, press reports and the reality in various parts of the country, including California, that both the banking and thrift industry have raised their underwriting standards," said Jonathan L. Fiechter, deputy director of the federal Office of Thrift Supervision in Washington. "The standards clearly were too low a couple of years ago."

While commercial ventures may be certain losers, developers say, some housing developments are workable and should be financed. Particularly attractive in Orange County, they say, are low- to moderately priced homes for the first-time home buyer, and projects in older cities, where there has not been new development for years.

Fiechter, who is chairman of a joint agency task force looking into the so-called credit crunch, said there is some validity to the builders' concerns, but regulators are now trying to differentiate between residential and commercial real estate loans.

The situation has prompted developers to look to other sources for financing, such as pension funds, investment banks, partnerships of individuals, and foreign investors, particularly from Singapore, Hong Kong and Taiwan.

"There is plenty of money out there, the problem is getting it to the builder," Meyers said. "The newcomers have to be educated. But their money probably won't get here until 1993."

But future demand for real estate remains uncertain. Looming on the horizon are proposed cuts of as much as 25% of the military budget that could put about 20,000 people out of work in Orange County in the years ahead. A substantial number of layoffs could force more homes onto the market.

Similarly, the future of Proposition 13 is now before the U.S. Supreme Court. If the measure is thrown out, a substantial amount of property might be thrown on the market by those who cannot afford the potential increase in their tax bills.

The 1978 ballot initiative limited state property taxes to about 1% of the sale price. As a result, tremendous disparities in tax bills now exist between recent buyers and owners of property that has not been sold for years.

Orange County continues to grow due to natural births and immigration from foreign countries. However, figures from the state Department of Motor Vehicles indicate for the first time in years that slightly more licensed drivers--about 3,000--moved out of Orange County in the last two years than moved in from other parts of the United States.

Companies are beginning to leave as well, their flight driven by complicated government regulations, expensive land and the high cost of providing workers' compensation. Whether the trickle will develop into an exodus is hard to say because the number of departures are difficult to determine.

Nevertheless, real estate analysts remain bullish on Southern California.

Consultant Alfred J. Gobar, president of Alfred Gobar & Associates in Placentia, predicted that the overbuilt commercial and retail markets will not make a comeback for three to four years. Industrial properties should improve soon, he said, and the market will pick up this year for low- to moderately priced homes of about $200,000.

"We are watching the inventory of homes and very little new housing stock is coming on," said Robert F. Clark Sr., owner of McGarvey Clark realty in Fullerton. "If the existing inventory starts going way down and interest rates decline more, it could be a sellers' market again. There could be a hell of a demand for a very little pot. There is a big pent-up demand."

The Center for Economic Research at Chapman University, however, predicts that the recovery will "pale in comparison" to the recovery from the 1982 recession. Only $2 billion worth of new construction will take place in 1992, half of what it was in 1988, and the prices for resale homes will fall by 3%. Perhaps there will be some appreciation in property values by the end of the year, the center predicted. A recovery to the 1989 levels of construction activity is not expected until 1996 or later.

According to a study by the California Mortgage Bankers Assn., steady growth will occur through the 1990s. If trends continue, the state is expected to add up to 6 million residents by 2000 and 1.8 million to 2.5 million jobs. About 200 million square feet of new office space will be needed, as will 2 million to 3 million homes.

But the bankers' study concludes that property in coastal areas such as Orange County will be too expensive to attract a large portion of the newcomers. Tentative figures from county government indicate that Orange County will add about 800,000 people by 2020. Researchers said the inland real estate market, where everything is cheaper, will lead the way out of the current recession.

Gobar disputed predictions that growth will be concentrated in such places as Riverside and San Bernardino counties, which have often taken the overflow from Orange County during hot real estate markets.

"The bulk of jobs are in Los Angeles and Orange counties," he said. "People won't go inland. There is no incentive. The Inland Empire has the smallest concentration of manufacturing of any area in Southern California. . . . I am not as pessimistic as some."

The Bite on Construction

Dramatic declines in construction, particularly in housing and office buildings, have been reported as Orange County heads into its 23rd month of recession. Real estate analysts predict that it will be at least another year before the recovery begins.

Housing Permits Plunge

The number of building permits for new housing plunged 74% between 1986 and 1991. This year's annualized first-quarter figure of 1,492 would total 5,968--more than 500 below last year's.

1986: 24,913

1987: 24,698

1988: 23,455

1989: 16,637

1990: 11,979

1991: 6,530

Office Vacancy Soars

Vacant space in office buildings more than quadrupled between 1984 and 1990. At current absorption rates, it could take a decade for all the vacant space to be leased and occupied.

(In millions of square feet)

1984: 2.4

1985: 5.3

1986: 6.4

1987: 8.8

1988: 9.7

1989: 10.6

1990: 10.9

1991: 11.7

Office Construction Down

The total value of permits issued in this year's first quarter plummeted to $12.5 million--and that was for permits issued In January and February for the remodeling of existing offices.

(In millions of dollars)

1986: $510.3

1987: $388.8

1988: $436.7

1989: $392.8

1990: $235.8

1991: $124.4

Non-Residential Construction Also Down

The value of all building permits for non-residential construction totaled $136 million for the first quarter of 1992. Annualized, that would be only about half a billion dollars.

(In billions of dollars)

1986: $1.6

1987: $1.5

1988: $1.6

1989: $1.5

1990: $1.2

1991: $0.8

Sources: Construction Industry Research Board; Grubb & Ellis Commercial Real Estate Services

Researched by DAN WEIKEL / Los Angeles Times

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