This time last year we were questioning whether we had truly come out of our economic slump and now we can answer with an affirmative—at least it certainly seems so here on the South Coast.
While world dynamics continue to impact our daily lives more and more, the economics of sleepy Santa Barbara are holding their own. In fact, 2014 is already shaping up to be The Year of The Big Deal.
The residential market, a critical component of our economy, has continued to improve, albeit at a slower pace than last year. Standing inventory for single family homes and condos is currently a three and a half month supply based on current sales activity. A six month supply is considered the norm, so this portends well for a continuing stable market. Furthermore, sales of downtown condominiums — which were jump started earlier this year by the Sevilla project on Lower Chapala Street and the Alma del Pueblo on Victoria Street—seem to be holding steady with strong activity. This has translated into rising median sales figures for condos as a result of these new, higher-end offerings.
The real question now is whether we are back to the peaks of real estate sales and values we experienced in the heydays of 2002–2007. By most accounts, it seems so.
Well located real estate, be it commercial or residential, has returned to 2007 prices and in some instances has surpassed those levels.
For example, if you own property on State Street downtown or Coast Village Road or the Funk Zone (that area between the freeway and the beach, for those of you who have been out of town for the last 5 years) or around Cottage Hospital, your values are back and then some. This momentum invariably influences the values of commercial development in the surrounding areas, but the pace is a little slower.
Notable sales since our last forecast will be covered in the Commercial Sales section but, suffice it to say, we are on track for a banner year in number of sales, dollar volume and average deal size.
What is particularly noteworthy is that we have seen more deals over $10 Million than any time during the past 12 years since we started tracking this data. Why? Well, as noted last year, there is always cash looking for well located properties, financing is still well below historic averages and there’s a combination of new blood coming to Santa Barbara and the beginning of a changing of the guard. More recently, however, many of these larger sales are a result of formerly reluctant sellers taking advantage of an improving market and cashing in some of their chips or trading up, and it’s evident from our data that we’re definitely seeing an increase in 1031 exchanges fueling the number and size of our deals.
Some of these big deals include three office properties and one industrial property in Goleta, a three story office building on upper State Street, a retail center on Coast Village Road and a five story R&D building in the Funk Zone. While all were fully leased at the time of sale, two of the Goleta properties were ultimately purchased by owner-users. One note, however, is that the owner-user trend has not been as prevalent this year primarily due to the competition from investors for well located, economically viable properties.
In spite of this activity, cap rates for stable, leased investments have compressed only marginally to the 5–5.25% range with some sub-5% exceptions for those properties that have upside in rents, are ripe for re-positioning or are just trophy properties.
In Santa Barbara sale prices per square foot are ranging from $350–$525/SF for office, from $450–$1,000/SF for retail (the upper end of the range is prime State Street and Coast Village Road) and from $200–$290/SF for industrial. These numbers all represent increases of roughly 5%–10% over last year’s averages.
While sales appear limited only by anemic inventory, office leasing activity is still not robust. There is still an abundance of office inventory and the demand has not recovered to pre-2007 years. The bright side, however, is that lease rates are firming up for quality properties, primarily in Santa Barbara, due to a slowly shrinking supply.
Additionally, we are seeing some influx of new businesses relocating to town, as well as the maturation of some local operations that have incubated here and are now starting to impact our market. The City of Santa Barbara is still their prime target location for office and retail because of the vitality and services within easy access. Goleta is starting to get a little more traction, but Carpinteria is still waiting for some love.
Alternatively, industrial and retail vacancies continue to be at all time lows with demand outpacing supply in most cases for Santa Barbara, Goleta and Carpinteria.
As reported last year, hospitality occupancies and bed tax revenues continue to improve. According to recent figures released by the City of Santa Barbara, bed tax revenues are up 14.7% over this time last year. Even more impressive, they are up over 31% from 2011. This has attracted the attention of some of the major players in the industry, notably Kimpton Hotels (Canary and former Goleta Holiday Inn), Orient Express (El Encanto), Summit Hotel Properties (Hampton Inn), Makar Properties (Holiday Inn), Texas investment firm Pacific Hospitality Group (Bacara), and Woodridge Capital Partners who intend to break ground this fall on the the 123 room former Entrada project.
Overall, we are certainly back in full swing in commercial real estate sales and apartment sales are off the chart with sub-4% cap rates for some South Coast units. The primary looming question for real estate investors is whether the market will adjust when interest rates are allowed to increase. According to investment and development experts at the October 2014 ICSC Convention in San Diego, current cap rates should not increase much even if interest rates increase 1–1.5%. While this doesn’t seem intuitive, the feeling is that historical spreads between cap rates and lending rates are at an all time high and the banks can absorb the adjustment.
Furthermore, the current imbalance between supply and demand and the returns on alternative investments will keep pressure on any appreciable increase in cap rates. Only time—and the feds—will tell if this is true.
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