A Little Caution Couldn’t Hurt

LOS ANGELES—As we continue our in-depth series focused on the local CRE market, one would expect to hear what we’ve heard before. The L.A. market is firing on all cylinders and there are no bumps in the road ahead.

But in an exclusive interview with Faris Lee president and CEO Rick Chichester, we find that while the first part might be true, for the second part, well, there’s always room for a bit of caution.

(This is part four in our Los Angeles Research series. To catch up on the series, click here for Industrialclick here for Multifamily and click here for Office.)

First the good news. In a generally up retail cycle, “The absolute strongest market is West Los Angeles,” says Chichester, “which has even surpassed its prerecession high. Then comes Silicon Beach and Santa Monica, as well as the core markets of Orange County and San Diego. Overall, there’s significant capital in the market for quality retail property investment opportunities.”

Not surprisingly, the Millennial push is driving a lot of retail’s shifting nature, and Chichester tracks a trend toward a “new age” of retail in the urban core, “responding to the live-work-play phenomenon.” Retailers with forward-thinking brand identities—those that, as part of their business model, keep pace with generational trends—are expanding in the core and urban markets, while more traditional retailers expand in the suburbs.

Chichester adds that some of the more traditional retailers are competing by “changing their business models to draw that Millennial consumer. They’re getting into organic options, aligning themselves with relevant celebrities or products, and repositioning or redesigning to create more experiential environments.”

But a market in the midst of dynamic changes doesn’t mean a perfect market, and there are pockets of concern for the Faris Lee leader. “Are secondary and tertiary markets relevant anymore?” he asks. “There are markets that are over-retailed, and there needs to be a lot of thought going into what the viable alternatives will be in those markets and specific centers. One of the most important things to understand about retail is not only current market demographics, but forward-looking demographics if the retail is to maintain its relevance.”

Another concern is not that there’s so much capital out there but that capital might be “outpacing the real estate fundamentals. A lot of activity I’m seeing is based on the abundance of lower-cost capital. As a result, some deals are getting done that lack disciplined underwriting at the real estate level.”

Market capital is here in large part because the stock market yields aren’t sufficient, says Chichester. The demand for real estate yields will apply continued pricing pressure and more cap-rate compression. “Figure the economic fundamentals by region and in the US and internationally and apply to that all of the outside factors–employment, under-employment, international volatility.

“Add to that student debt and global government debt,” he continues. “Now consider that we are supposedly six years into a recovery and that we have a recession every seven to 10 years.” Plus, he adds, the recovery has been bifurcated into the haves and have-nots, with the middle class largely being squeezed out.

What it boils down to, says Chichester, is that, “This cycle is not like anything we’ve dealt with before and if not managed with extreme skill, caution and discipline, the downside could be pretty significant.”

“Make no mistake,” he concludes, “as I indicated, it is a great time to be in the market. But we’re still providing a lot of caution to our clients, because of all of the factors I mentioned. It won’t take much to put us into tough economic times.”

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