Marcus and Millichap in their 3rd quarter 2015 Los Angeles apartment market report forecast 8,600 unit completions this year. Of those completions, M & M forecasts 4,400 unit completions in the Downtown area. That means over half of all new apartment units will be built in Downtown Los Angeles. Downtown is now the fastest growing residential market in LA and this trend is going to continue. Why is this happening? Billions of dollars have been invested in Downtown infrastructure and amenities including museums, parks, transits, and entertainment venues. A higher income residential cluster has formed to transform Downtown. Also, downtown is one of the easiest and most zoning friendly areas in the City to build. Developers can build density without lawsuits and homeowner fights.  At some point, maybe these new residents will push back.

In the short run, at some point, this expansion may lead to overbuilding. M & M forcasts an increase in vacancy over the next few years. But in 2015, M & M is only forecasting a 10 basis point increase in vacancy to 3.7%. In the long run, this expansion will continue to transform Downtown into a popular and upscale neighborhood. This trend will also help transform many adjacent Northeast neighborhoods.

New problems are arising with our mutli-level creative office warehouse conversions in San Francisco. Originally, these buildings were built for 3 or 4 people per 1000 square feet.  But, venture backed tech companies have pushed the current density to 9 and 10 people per 1000 square feet.  Luckily, because of great transit, San Francisco is not suffering from parking problems created by such density in Los Angeles.

However, some of the problems we face due to the new “collaborative densities” include the following:

1.  Wear and Tear: the common areas are getting trampled. Repair, replacement and refurbishment will now be more frequent.
2. Elevator: one elevator for 40,000 square feet and four or five floors–you can imagine the demand and wait times with ten people per 1000 square feet.  The elevator systems will need to be upgraded for better control and response times.
3. Bathrooms: first, you need more toilet paper and paper towels. Forget the paper, you need more toilets and sinks. Maybe a bathroom reservation app is next.
4. Stairwells: the stairwells are becoming more important. In San Francisco, people will use the stairs. Your stairwells become an important common area feature and method of access. The stairwells need to look good and be well lit. If you have a tenant on two floors without an internal stairwell, you need to deal with security from the stairwell and fire issues.
5. Security:  With smaller creative buildings, you do not have a security guard.  Electronic security is very important.  You need sophisticated control access at as many points as possible: lobby doors, elevator access, and suite access. Fobs are popular. Crime is on the rise, especially grab and runs. Tenants are more sensitive and aware of burglary risk–especially after an incident.

Squirl Restaurant Virgil Village

The Sqirl Restaurant at 720 Virgil provides a hip coffee shop restaurant experience appealing to the new millennials residents who occupy many of the newly renovated housing units in this East Hollywood neighborhood near the Sunset Junction. Previously, this area was devoid of such eateries.   New hip restaurants and retail continue to fill the commercial streets adjacent the gentrifying neighborhoods in Echo Park, Silver Lake, Highland Park, and East Hollywood.  Retail brokers are promoting York Avenue and Figueroa Boulevards in Highland Park as the next Abbot Kinney to drive up retail prices.

Inside the Sqirl

This cafe replaced the La Raza Market and Restaurant.  Although some in the older population resent the changes occurring to the retail in their neighborhood , the Sqirl is still one of the few such establishments on Virgil Boulevard between Melrose Avenue and Santa Monica Boulevard.  Gentrification takes decades and  occurs in fits and starts.   Currently, many homes have been renovated to appeal to younger home buyers and now many apartments are also being renovated.

Formerly La Raza Market and Restaurant

Cain Hoy Enterprises, a Greenwich, Connecticut private investment firm, shelled out $130 million for the 118,400 square-foot Class A office building at 100 N. Crescent Drive.  This price equals a whopping $1,101 per square foot.  The seller, New York’s Clarion Partners, purchased the building in 2012 from another private equity firm, Clarity Partners for $80 million, a 63 percent return in three years.

In April of 2000, Clarity Partners purchased the building from JP Morgan for  a measly $37 million or $313 per square foot.  Most forget that real estate values flat lined during the dot com boom.  Everyone wanted to buy internet stocks, not real estate.

JP Morgan, in turn, purchased the property in October 1995 from the original developer: Tracinda Corporation. Now deceased billionaire Kirk Kerkorian owned Tracinda  Corp and built the building in 1990 for his corporate headquarters at a cost of around $400 per square foot.  The selling price in 1995 was $21.6 Million or $183 per square foot Unfortunately, office prices plummeted during the early 1990 recession.

Prime Beverly Hills properties continue to appreciate, just not always in a straight line.

Source: Beverly Hills Office Trades at Premium Price | Los Angeles Business Journal

Eventually imbalances and overvaluations give rise to corrections we call recessions. Last weeks, the overvaluations and imbalances in the Chinese stock market and economy started to correct and gave rise to over a 10% decline in the SP 500.  Such declines do not always give rise to recessions and do not foreshadow future economic peril.  For example, in the third quarter of 2011, although  the S&P 500 declined over 12%, the economic recovery continued to proceed for four additional years.  Many large stock market declines over multiple   quarters occur  just before or during the early stages of the recession.  These losses are large and reflect the current deteriorating state of affairs.

Smaller stock market hiccups have presaged  recessions by one to two years and reflect cracks and strains in the economy. Such hiccups have occurred in 1978 (Oil Shock), Oct 1987, 1998 (Russian Financial Crisis).  The cracks and strains in major economic pillars  presage economic troubles, not the stock market declines.  Indeed, there was no stock market hiccup that proceeded by one or two years the 2008 recession.  By the time the stock market dived,  the recession soon followed. However, the housing market had already started to crack in some parts of the country as early as 2006 and the subprime market soon followed.

Last week’s events showed strains in the Chinese economy and its impact on domestic prosperity.  Despite these strains, the economy can keep chugging up, but other strains and imbalances will continue to grow. No other domestic indicators show any problems, and short term interest rates are still zero. The yield curve is still very positive.  Perhaps, these recent strains signal that we are in a latter  but not final inning of this cycle.

Gentrifying neighborhoods are seeing the influx of new companies and residents as developers create new offices and  apartments in the Art District in Downtown Los Angeles, Hollywood, Mid Market San Francisco, and the Mission District in San Francisco.  Rents are rising rapidly in those neighborhoods.  Many of the existing residents in these areas are protected by rent control.  On the contrary, those that are not protected are seeing their rents spike.

At the same time, these gentrifying areas are also seeing an increase in the homeless population.  This is a result of a combination of  early release from prisons, rising rents, stagnant wages, warm weather, and  new construction disrupting former homeless hangouts.  Locals and activists are calling for more aid, rent control, and less enforcement of homeless encampment laws.  Both activists and the real estate community agree that part of the solution is developing more affordable housing.

New residents and workers are encountering more homeless encampments.  The solution remains elusive.  Even in Venice, a mature neighborhood way down the gentrification road– where homes sell for over $1,000 per square foot– struggles for answers to this social issue.

The article below discusses the clash of new technology companies with lower income and homeless residents in the mid market neighborhood of San Francisco.

Blending Tech Workers and Locals in San Francisco’s Troubled Mid-Market – The New York Times.

Los Angeles is ranked #3 as the leading City for startups.   Compass and Techcrunch ranking gauges the world’s leading startup ecosystems—the broad infrastructure of talent, knowledge, entrepreneurs, venture capital, and companies that make up a startup community. The report measures these ecosystems based on their quality of talent, pool of venture capital resources, experience and mentorship provided by startup founders, market reach of their companies, and the ultimate performance and exit value of their companies. Increasingly, the global economy will be defined by the startups and entrepreneurs that are making tomorrow’s technologies a reality, according to Bjoern Lasse Herrmann, the chief executive at Compass. Herrmann believes a nation’s strength will continue to rest on the shoulders of hundreds of innovative small businesses. Herrmann says: “As the Industrial Economy falls away with increasing speed and half the world’s current jobs will be replaced by software, it becomes critical  to build thoughtful programs to nurture the entrepreneurial renaissance that will take its place.”

Los Angeles will gain economic traction as it continues to produce new business.

The World’s Leading Cities for Startups and Innovation – CityLab.

Moderators at every real estate conference ask their speakers to comment on what inning of the cycle they believe we are in. Howard Marks of Oaktree Capital says we cannot predict the timing of the cycle– we can only recognize where we are now. Unfortunately, we cannot predict the length of the latter stage. It is during this stage that excesses are produced and expanded upon. Up it goes until it blows.

Over the last 30 years, I’ve been able to identify certain events, signs and trends that have occurred at the latter stages of some cycles. Not every one of these indicators have appeared during all the maturing cycles.

1. Prices and rents soar substantially above their previous peak. The new records are discussed at parties, conference, and dinner conversations and described as “crazy.”

2. Property prices and construction costs are climbing but developers/investors count on rising rents or prices to make their projection. Worse yet, developers trend up their projected rents or prices.

3. A form of very high leverage debt enters the market shifting the risk from equity to credit and increasing equity yields. Worse yet, the debt is non-recourse.

4. There is noticeable jealousy between the guys doing deals or selling properties and making significant amounts of money. Some developers and investors are achieving spectacular results.

5. The Fed is raising interest rates.

6. New construction reaches very high historical levels in some real estate markets and/or real estate property types.

7.  Mortgages are easy to get, and there is a lot of competition among lenders.

8. Some lenders start to lend more on appraised value and are less restrained by cost on recently acquired deals or new construction.

9.  Politicians and activists become more focused on the problems of growth and inequality than on the creation of jobs.

10.  Architects are very busy, and it is hard to get things through the City.

11.  The high prices and high levels of new construction are justified by supply and demand projections and changes in society and demographics making this time different. Some justify the prices paid or low expected yields by reference to the long term.

12.  Few are predicting an imminent recession.

13.  Good acquisition people are in short supply and being paid increasing amounts of money.

There could still be remaining runway, even after these signs appear.  For example, the latter stages of the last housing boom in Los Angeles lasted from 2005 through mid 2008.   It is just a risk call. Indeed, the latter innings are usually the most glorious of all, and one can make a lot of money if they play it right– or crash.   For the risk averse, when the signs appear,  it may be time to leave the casino and enjoy the floor show.

2015 Annualized Permit Rate Highest Since 1988

Building permits issues in the City of Los Angeles soared in the first half of 2015. The City issued over 7,000 multifamily permits in the first half of 2015 versus 9,500 permits for the entire year in 2014.   At this rate, Los Angeles will issue 14,000  multifamily permits in 2015–which would be the highest level since 1988.

The Commerce Department says that metro LA saw permits issued for just under 20,000 residential units (total of all units in the metro area versus the City of Los Angeles) in the first six months of 2015, up 41.4 percent from the same time last year.

We addressed the implications of the building permit data in our blog of May 2015 below.

Are We Going to Have too Much Apartment Construction in Los Angeles? | PMI Properties.

We are pleased to announce that our tenant at 3525 Eastham in Culver City, mobile game developer SGN, just got a $130 million dollar investment for its Asia Expansion.  SGN  leased 17,000 square feet from us earlier this year.   Our brokers earlier brought us several startup companies and were disappointed and displeased when we passed on their credit.  Finally, we struck a deal with SGN after reviewing their prospects, profits, momentum, and interviewing others in their space.

As Landlords of creative office space in Los Angeles and San Francisco, we are forced to review the prospects, initial funding, and burn rates of startups and make credit decisions.  Unlike the Venture Capitalists who aim to make a killing from one of many small bets, Creative office landlords need to try to hit 100% that the startup tenant will last the term of the lease.  Unlike in the dot com boom, venture capitalists now are restraining their startups from posting more than two to twelve months of a security deposit.  At a LACRA event this week, Mark Laderman of Tishman Speyer said that Tishman tries to lease only to credit Tech companies. For creative office landlords leasing 7,000 to 20,000 square feet, it is easier said than done.

In any case, we struck it right with SGN.  You can read more below.  Now, will we get that call for a sublease so they can move to a larger space?

Mobile Game Developer SGN Gets $130 Million for Asia Expansion | Los Angeles Business Journal.