By Gary H. London

The U.S. business cycle is now approximately in the middle of a growth phase. Most of the metrics are quite strong, and expected to get stronger. I think the overarching concern is that the global economy is weakening, particularly in China, Europe and South America. The drop in oil prices, potential for deflation, new fiscal austerity, as well as political and social destabilization are all exacerbating the situation.

Right now the U.S. is benefitting, mainly because we are receiving global “safe harbor” investments. In the long run the remainder of the globe has to recover or that will not bode well for our economy.

Our nation is also in the midst of a “reindustrialization” period where new basic manufacturing jobs are being reintroduced, after a long period of decline and export to other countries. The benefits of this should play out in the coming years.

As to the immediate year, the main concern remains construction jobs, which are still lagging, especially relative to same stage recovery in previous cycles. Put simply, in most metropolitan areas we still are not building structures at a sufficiently robust pace to engage this important economic multiplier to further fuel jobs and wage growth.

In San Diego, for instance, the year to year increase in construction jobs was about 3,300. That’s a positive, especially compared to previous years, but modest in comparison to most other job categories.

There is a reason for this: in the commercial sectors, in particular, the demand for new construction has waned. There remains major compression in demand, the effect of which is to tamp down new construction. While we have been active on assignments on new projects, generally they are both smaller in scale than in years past, and they are mostly “infilling” niche demand versus filling large new demand voids in the market.

With that as a backdrop, let me go through the real estate markets, sector by sector.

Multifamily Residential

The apartment market has continued to experience strong growth, particularly in occupancy and lease rates. However, we are now seeing slippage in the delivery of new units.

I think that we are at a transitional point in housing demand. New condominium construction will start to dominate the new supply statistics in the multifamily residential category. This is inevitable, as interest rates have remained low. The only missing ingredient is slackening underwriting criteria—banks are still causing elevated qualifying standards as if we were still in recession. Rental lease rates are now about at a level in most metropolitan areas where these same renters/consumers could transition to a mortgage.

The question is, will they? Popular media and many urbanists have long suggested that with the dominance of the Millennials (aged now 18-34) and their propensity for renting vs. ownership, that somehow that was going to be permanent.

I believe that this is flat out wrong. I fully expect that Millennials will purchase housing — much like their parents did. It’s just taking them a lot longer to get started.

The residential consumer market is complex. Multiple market segments — Millennials, Gen X and Baby Boomers — are going to need more than apartments in the coming years.

Single Family Residential

While the economy and pricing have now recovered sufficiently to levels that normally would support new construction, we simply aren’t seeing much of it. There is insufficient vacant land remaining, and regulatory constraints and “Nimbi’s” play a significant role in tamping down supply.

I am reminded of the old adage, ascribed to Will Rogers, whose investment advice was “Buy land. They ain’t making any more of the stuff”. The business of building Single family homes has been rapidly declining in the development sector, whose players mostly now deliver small subdivisions and custom homes on ever diminishing land supply.

Price levels are mostly not yet back up to their 2006 peak, but they are now within 20%, sufficient to support new construction. With diminished supply and already higher prices, many households simply cannot afford the price. So, the markets are far less dynamic than in previous cycles, with both fewer listings, yet insufficient supply.

We are now in a period of perpetual housing shortage relative to demand. The result will be a constant bid up in prices, albeit at varying rates. During the last year the coastal markets generally saw pricing increases of about five percent, year over year. This year looks about the same.

The single family housing market will continue to increase in pricing, but not evenly. There will be flatness and then explosions. The effects will also be different throughout San Diego (e.g. on the coast vs. inland). A lot depends on economic and employment growth. Certainly we will see ongoing household formation fueling demand for all housing types. At best, the delivery system will be much more diverse going forward.


While presently quite healthy, I am waiting for the other shoe to drop in this sector. A flood of foreign investment dollars have targeted this sector such that prices are historically high, on a per room basis. This trend is not sustainable. At some point rising occupancies will stall, prices per room will drop, and there will be a crisis.

Of course, the same can be said of every sector. Movement of this sort is inherent in business cycles. But I think that these valuation trends are going to impact the hotel sector first, although there is no imminent crisis.

Putting dire prospects aside, with gas prices down and consumer confidence up, people are traveling. There are very strong sectors, particularly in key business and commerce centers such as New York, Chicago, and San Francisco. Tourist meccas, such as San Diego, are also strong.

But air prices have remained high. Also, the internet theoretically enables people to travel less. The point is that traveling is very elastic to economic cycles.  The sector is starting to feel expensive, if not overbuilt. Watch out.


There are now two kinds of industrial: “true” industrial as we see an incipient trend to “re-industrialize” America in such sectors as automobiles and their components, technology hardware (think smart phones, computers and robotics) and even fashion. That is strong in some regions, particularly the old rust belt, Dixie and non-coastal Sunbelt regions. But we are seeing a weak or nonexistent trend in land starved, expensive and more vertical (read “no tilt-ups”) coastal markets.

The other trend, which has played out as rather good for existing industrial inventory is the “repurposing” of industrial space to warehousing and e-commerce-driven logistics centers which services the retail sector. These large boxes are increasingly valued for their strategic locations and their very size.

As retail stores evolve smaller, and there is a lower desire to pay fashion center rental rates to store goods, the beneficiaries are industrial buildings reworked as warehouses. We also certainly see the construction of new, large warehouses all over America as a consequence of this same trend.

The result is valuation increases and high occupancies, fueled by both of these trends.


From the dawn of day, commercial office buildings have been classified by letters, with “A” the best, “B” still functional but long on tread, “C” barely functional, and, well you don’t want to reside in the rest. The actual classifications of what constitutes an A or B space varies from metro to metro, but the relative relationships remain clear across markets.

But there is a big difference today. The commercial office sector is rapidly transforming into a “mono market” where, if you are not an “A” or some version of “cool” space (think contemporized warehouse space) you are effectively disenfranchised from the market. This theme plays out in the statistics, where the vacancy rates are much higher outside of “A” than inside of it, and certainly can only be exasperated by new construction which, by definition, is “A” space at its birthing. There is also still a lot of cannibalizing in the office sector: newly constructed buildings on better located sites further eroding the occupancy of existing office buildings by attracting their tenants, but with no new “net” increase in office demand.

Couple this with declining overall demand for office space, not because job formations are down (they are way up, actually) but because we don’t demand as much space per worker, a derivative of our digital transformation from file cabinets to hard drives to virtual storage –you don’t need to rent that space- and certainly exacerbated by the hyper-mobility that now characterizes most professional and business services.

This is only going to become more pronounced, which undoubtedly will continue to place stress on the construction sector, and redefine the role of city centers and office nodes in our metropolitan areas.


Starting a few years ago, I often told audiences in my real estate “stump” speeches that retailing was undergoing perhaps the greatest transformation of any of the real estate sectors. Among the elements of that transformation included blending the virtual world with sticks and mortar retail centers, new lifestyle oriented centers, mixed use centers, and the overall downsizing of retail space.

My pipedream comment over this same period was that one day we will see boutique stores in shopping centers where the consumer would walk in, try on, measure up, and walk out with …nothing. Well, I was right. Bonobos Guideshop men’s store has now opened stores in several metropolitan markets where the shirt or pants a man buys is delivered to his house. He walks out with nothing.

I was alerted to this when the San Diego Fashion Mall, UTC, opened this store. The bottom line? This is just the beginning of this trend, and I have read about more retailers planning the same.

There remains a retail war, but the battles are now more blurry. Many traditional brick and mortar retailers have joined the other side and become more “virtual”, having compressed or closed locations.

Final Thoughts

In fact, this takes me to my last theme, which is the increasing push to mixed use projects: because many of these are taking place on old shopping centers or strip commercial sites. We are seeing many projects proposed as dominantly residential above and commercial below, or at least side-by-side residential and commercial elements, tied together with leisure and playing elements.

This is absolutely the future. Such projects are ultimately the solution to the changing patterns in current and expected demand for contemporary real estate development. In other words, the key to excellent new projects is to create multiple activities, lots of eating and recreational space, the expectation that people will be staring at their iPhones and tablets, all within integrated working, living and shopping environments. This picture represents almost all of what we are working on, and it’s a safe bet that that’s where the future will continue to take us.