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The Big Picture: Sunny With A Chance of Frenzy

By John Salustri | Los Angeles


LOS ANGELES-We wrap up our series on Los Angeles with a wide-ranging interview with Lewis G. Feldman, a partner in Goodwin Procter's Real Estate Capital Markets Group and chairman of the Ziman Center for Real Estate at UCLA. Feldman takes a look at some of the major influencers of commercial real estate life in the City of Angels and provides his unique take on each.



Feldman: "I'm extremely bullish on L.A., subject to the entire city breaking off into the ocean due to a tectonic event." What are the drivers of the LA. market from a macro sense, Lew?


Lewis G. Feldman: Thanks for the opportunity to comment. My first observation is to unearth the old adage: Real estate is really free in LA; you just pay for the weather and quality of life. Beyond corny sayings, to understand the Southern California real estate markets, and what drives real estate values in Los Angeles in particular, I suggest we first look to external themes at play both nationally and internationally, and observe the direction and destination of people and money.


Energy: Energy is no longer the employment driver it once was in Southern California, as the economy has diversified since the days when oil was a dominant industry. Chevron, for example, is still California's largest single employer with over 60,000 employees, but California has 13 million people employed in our economy. Our aerospace business is no longer one of the tectonic plates of employment, meaning that shifts in the number of workers to other states, while difficult, won't send the local economy into a nosedive like it did in the 1980s. Make no mistake, however, the price of energy matters greatly here. We remain the manufacturing capital of America. Our ports and intermodal facilities transport goods by ship, rail, truck and air carriers, all of which are large consumers of energy. Not surprisingly, we've also been the alternative energy capital of America as prices have escalated. With oil dropping below $50 a barrel in the past several months, the question remains what impact low prices will have on alternative energy development and manufacturing in the Southland.


Industrial and Logistics: At the same time, with the internet serving as the ordering platform for the consumer, we see industrial real estate on the upswing, as more industrial product like that of Rexford Properties serves as the backroom warehouse for the Holy Grail of the online vendor: same-day delivery. A rapidly emerging trend in industrial is also stemming from legalized and medical marijuana in places like Colorado and Oregon. Twenty-two states now have some form of legalized cannabis, and more states are in line to do so. Industrial demand is growing. No pun intended.


Medical: Another theme we see is the healthcare industry and the aging of the Baby Boomers. Obamacare affects how medical office buildings, hospitals and ambulatory care facilities are used and distributed. Demographics are driving demand for retirement and continuing-care communities. We are seeing campus medical office thrive, and infill locations close to hospitals are particularly attractive to institutions now.


Retail: Malls are transforming into experience-based showrooms, engaging the consumer, those seeking entertainment and those in search of community. Caruso, Macerich, Simon and Westfield, among others, have wildly successful centers with denser showrooms, luxury amenities and a tailored experience for the consumer defined by aesthetics, technological connectivity and social branding. Airports are the newest retail development sector. Cheaper air travel and a greater number of travelers creates real demand. Airports create the safest shopping experience in the world, because everyone is scanned before they enter the retail area. Safety matters. Just look at the first-class shops for those arriving in L.A. that Westfield created at the Tom Bradley International Terminal at LAX. Speaking of Westfield, their most recent project is in the San Fernando Valley, the $340-million Villages at Topanga, and it will serve as a first-class destination for Valley shoppers and a venue for community events and entertainment. At the same time, office and hotel developments are being announced in the adjacent area, evidencing the magnetic effect of great retail.


Media and Technology: Southern California has always been known for its media and entertainment sector, the glitz and glamor of Hollywood. In terms of studios, movie and television production, Hollywood is still fighting the good fight, but it's easy to have production leakage to other places with competing tax incentives, such as New York, Vancouver and Toronto. Today, in many respects, entertainment has really become part of the technology sector. We're seeing the ascension of a new creative community in Southern California, the techies. They are everywhere. (When I was a kid, you had a bar mitzvah or a confirmation to demonstrate your arrival into adulthood; today you don't become an adult until you've given your first TED talk.) Because the cost of doing business in San Francisco, San Jose, Palo Alto, Menlo Park, Redwood City and Mountain View is quite high today, and real estate prices are at peak levels, Southern California has become a true alternative for start-ups, especially in the financial technology space, communications and video game areas. Capital players are also here. From Silver Lake to Playa Vista, from Downtown L.A. to Santa Monica, from Venice to Irvine, we're seeing the Tech Coast bloom. Google, Yahoo, Electronic Arts, Broadcom are just a few of the household-name resident here. We're seeing a lot of foreign money coming into the market.


Feldman: The impact of the American culture and the political and economic climate in other countries is attracting a lot of money to Southern California from those seeking security. Asian money is coming to the US and going into real estate because it can't be taken away arbitrarily. What people forget is that the Chinese revolution basically removed families from their homes, separating them from their real estate. But I assure you the Chinese who lived through Mao's revolution don't ever forget that. Today, SoCal has a lot of inbound intellectual, social and physical capital arriving from all over the world. Today's immigrants are seeking the four treasures found in few places other than Southern California and in a few assets other than real estate. Southern California has an unrivaled creative culture, an unrivaled collection of world-class colleges and universities, one of only five Mediterranean climates globally, and--critical in today's times--the Rule of Law that protects property ownership. In Irvine, for example, Five Point Communities is developing the former EI Toro military base. Nearly 80% of the almost 1,000 homes sold since 2014 in the Great Park Neighborhoods went to buyers from countries in Greater Asia, such as China, India and South Korea. And more than half of the buyers are paying seven figures in cash for a home. Let's talk a bit about the changes taking place Downtown.


Feldman: A number of new commercial buildings are rising above Downtown, but we're not quite sure who all the tenants will be. The largest building west of the Mississippi is under construction in Downtown LA, the Korean Airlines Building, at 85 stories in height. Downtown ordinances were actually altered for that project, because until recently L.A. prohibited anything but a flat roof for safety purposes. With technology and new designs, safety and architecture can experience harmonic convergence.


Downtown still doesn't have enough hotel rooms, which is ironic because lodging and leisure is very strong here. We need about 5,000 hotel rooms and we're short of that, with only 3,000 or so within a half-mile radius of the IM Pei-designed L.A. Convention Center. Despite the reputation the City of Angels has as a tourist destination, it's still hard to have major conventions here without more rooms. The City recently contracted with AEG Entertainment to program the convention center. It has a vibrant calendar of artists, conventions and events. More hotel rooms are on the way, with the City willing to subsidize developers seeking to build several hundred rooms at a time. A split of site specific tax revenues generated by the hotel development is available under the City's policies. That tool was deployed to finance LA Live's first two hotels, the JW Marriott and the Ritz Carlton. It has further been deployed on the Courtyard and Residence Inn product directly across the street, which was also paid for with EB-5 syndication proceeds. The Korean Airlines complex will include a hotel component financed with a modest net new revenue split, for example.


Residential construction is robust in Downtown. Apartments produced from adaptive reuse practices applied to historic structures, former factories and outdated commercial buildings are everywhere. Historic gathering places like Grand Central Market are being revitalized, offering residents in Downtown what Bon Appetite magazine recently named one of the top 10 restaurants in the United States, which is evidence of the power of cuisine authenticity and uniqueness because Grand Central Market is actually a collection of original counters and specialty shops with names like Egg Slut and Wexler's Meats. You won't find the franchises at this place. But the big labels have their place Downtown, too. Whole Foods has arrived, which tells you a lot about the purchasing power of nearby residents. Over 45,000 people live in the Downtown district now, with average household incomes in the mid-$90,000 range. Both of those figures will be probably be considered low when we look back even five years from now. We talked about foreign money. StateSide, who are the major buyers and sellers?


Feldman: It's really a diverse mix of market participants. Some are institutions backing sponsors. Some are foreign corporations like Korean Air. Chinese developers active Downtown include Greenland USA, which is building the Metropolis hotel, condominium and retail complex north of L.A. Live, and Oceanwide Real Estate Group, which is building the Fig Central condo, hotel and shopping complex across Figueroa Street from Staples Center. Brookfield added to its Downtown holdings with the purchase of the Maguire portfolio of office buildings last year. This September, the $140-million Broad Museum will become the biggest addition to the Los Angeles cultural scene since the debut of the Walt Disney Concert Hall in 2003. It also has the potential to be a game changer for Bunker Hill, as the museum, with its free admission policy and artworks chosen from a 2,000-piece collection, will draw visitors from around the world. That's bullish for all things Downtown. How is underwriting doing? We've heard different things from different people.


Feldman: Underwriting, while confined by regulation and the sting of the Great Recession, is adjusting to current economic trends. Continued capital flows into real estate as an asset class from people from all walks of life, not just banks and pension funds, is the order of the day. Capital is still abundant, with more money chasing fewer deals and lower capitalization rates. One question is whether the increasing value of the dollar will incentivize foreign investors to seek alternative investment locations. Right now, we aren't experiencing a huge drag on available capital. It's a far cry from 2008. Is that worrisome?


Feldman: There are interesting analytics at play. Banks are still very tight in their underwriting and they feel hamstrung by regulation. That's why some of the transactions will be lost to more aggressive players who can close faster with less regulatory burden. REITs are all the rage again as predicted several years ago, because they have a tax advantage over other capital aggregation models and they offer a liquid market for sellers and buyers. Capital players are now aware of the impact of initiatives like crowdfunding and disintermediation, which give the smaller investor a place at the table. This past week, Regulation A+, the next step in expanding the power of the crowd, was released by the SEC. It's 453 pages of pure reading pleasure. Crowdfunding for real estate in Southern California and throughout the globe is in the first inning. But it is game on, folks. Overall, what is your outlook for the health of the Los Angeles market and of course, by extension, the national CRE picture?


Feldman: I can comment on Los Angeles, because I still believe a local understanding of real estate is essential and I practice mostly in California rather than nationally. In the City of Angels, continuing prosperity seems the order of the day for the next year or so. Threats to continued confidence in Los Angeles real estate include high state and local tax rates and proposals to further tax business for transportation and seismic upgrades, slow government processes, security concerns, environmental regulation, Federal Reserve policy, state and federal political races, natural disasters and climate change. In short, I'm extremely bullish on L.A., subject to the entire City breaking off into the ocean due to a tectonic event, in which case things will probably work out anyway because LA will have more oceanfront property available for everyone to buy.

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