Marterra Market Monitor - November 2023

YTD Activity

Home Sales Closed Units: 58

Home Sales Volume ($): $49,207,448

Residential Properties Leased: 109

Gross Collected Rent: $8,601,156.00

Listen up, everyone, we have some big news! We are in the process of formalizing a merger with our good friends at Skyline Commercial Real Estate. Skyline is a local boutique commercial real estate company specializing in Southern California, advising clients through 1031 exchanges and performing ongoing property/portfolio analyses. We expect to complete this merger by mid-December of this year. This partnership has been in the works since February of this year, and we hope that it will enable us to better serve our clients with multifamily and commercial real estate needs. Chris Pettit, the founder of Skyline, will be a guest contributor providing insights from the commercial real estate world.

Now, back to our regularly scheduled programming.

Single Family Transactional Market: The single-family home market in Orange County continues to show its resiliency in the face of almost 8% mortgages. Kate Markert on our team just sold 145 Morristown, a 2-bedroom townhome in Costa Mesa, for $968K - the previous highest comp in the neighborhood was $925K for a 4-bedroom.

While the absence of inventory is brutal for those whose industries are tied to transaction volume, the absence of supply seemingly offsets waning demand in the face of high prices and high-interest rates.

All of our agents have reported many buyers who have put off purchasing due to affordability concerns. I believe these buyers (unless something happens to their employment) who are currently priced out will help establish a pricing floor, as buyers will incrementally re-enter the housing market should prices or interest rates come down.

A growing number of people are vocalizing concerns about a repeat of the 2008-2009 housing market. I don't see it for coastal southern California, but I do have concerns for markets with the characteristics I described in last month's market monitor.

HOUSING DOOMSDAYERS: The number of homeowners hit with foreclosure notices in the third quarter of the year jumped 34%

REALITY:

Any time you see a trendline move in a negative direction, it is worth taking note. However, it is also very important to consider context. Foreclosure filings were at an all-time low. Percentage increases are larger when coming off nominally lower rates. Foreclosure filings are still at pre-pandemic levels.

Residential Leasing Market: Leasing activity remains strong, but we are seeing turnover at properties leased at "top of market rents" Those properties are releasing an approximately 10% discount to the YOY market rent. If this trend continues, it could marginally increase housing inventory as lower leasing rates could force marginal rental property owners to sell.

Mortgage Rates/Market: Starting November 18th, Fannie Mae will be making it easier for homeowners to purchase multi-family properties by reducing the minimum down payment to 5% for owner-occupied multi-family properties. Currently, the minimum down payment for duplexes is 15%, but this will be lowered to 5%. For those interested in purchasing 3-4 unit properties, the improvement is even more significant, with the required down payment dropping from 25% to 5%. In Orange County, where the high balance conforming loan limit is $2,095,200, this means that a 4-unit property can be purchased for up to $2,205,000 with as little as 5% down. In other financial news, the 10-year Treasury notes briefly reached 5% on Monday, October 24th, before quickly retreating to the 4.8 range.

Commercial Real Estate (CRE): Distressed commercial sales are finally coming to Orange County, with Greenlaw Partners leading the way. Greenlaw purchased a 315,000 sf office tower in Irvine for the second time for $57.5m (at 70% occupancy). In 2011, Greenlaw sold the building to AEW for $108.5M, after purchasing it for $56M (30% occupancy) in 2009 . Greenlaw has successfully had its cake, eaten its cake, sold the leftovers, and then took their cake back again.

Link to article

With $672 million of office real estate loans defaulting at their maturity last month, which is 9 out of 10 CMBS loans maturing, expect to see more of this ahead.

Project Updates: We have several ongoing projects; here is a quick update on one, also a quick summary of a deal we offered on and ultimately passed on.

Redlands, Costa Mesa: Since last June, we have been working diligently on the entitlements, architecture, and plans for a 2-unit subdivision in Eastside Heights. The plans allow for 2 new homes, 2,530 sf in the front and 2,571 sf in the back.

We are at the finish line, evaluating selling the project to a homebuilder or taking the project vertical ourselves. To properly evaluate our options, we have begun marketing the land with the plans to see what the market will bear today so we can compare that against what we think it will look like should we build the project ourselves.

As of writing this, we strongly lean towards a recapitalization (bringing in construction financing and additional equity) and building/selling the project ourselves.

If this is something you are interested in hearing more about - please reach out to me, and we can find a time to connect.

Undisclosed Address, Orange County: (the property is in escrow with another buyer): we had an off-market opportunity come through our office to acquire a small condo near a wildness preserve. The condo was an absolute wreck, with mold everywhere (see below). Our partners at All Dry of Orange County (link) got their arms around the mold and trash removal quickly, and it looked like the deal had pretty decent margins at the seller's expected price. In addition to the mold, we wanted to understand what our buyer's insurance expense would look like in today's environment. Given the property's proximity to the wildlife preserve it was likely going to be 2x average insurance rates; factoring in the additional monthly costs at a 7.75% interest rate, we adjusted our exit price accordingly. This adjusted exit price capped the amount we were willing to pay at the seller's expected price. Another buy offered to pay $16K more; sometimes the best deals you do are the ones you don't buy.

Macro Observations: For my market view (which is that we will see a recession in the next 6-12 months - that will lead to meaningful lower interest rates), the economy will have to see either a) a significant decrease in consumer spending (which I have laid out the case for in previous posts - the main driver being increased interest rates slowing the volume of housing transactions and student loan repayments starting again) or b) significant weakness in employment, or some combination of the two.

Employment weakness has been more invasive to date. However, I think we are starting to see some indicators that employment might also be softening.

Exhibit A - Seasonal Hiring Imbalance on the low end of the wage spectrum

According to a study published by Indeed earlier this month, there was a 33% increase in searches for seasonal jobs this September compared to the previous year. However, employer demand for seasonal workers decreased by 8.2% during the same period, resulting in more workers potentially competing for fewer roles. Additionally, employers have scaled back on incentives such as signing bonuses, further compounding the challenges faced by job seekers.

Link to article

Exhibit B - Unprofitable Tech Companies on the high end of the wage spectrum

According to report recently published by Goldman Sachs, nearly half of all publicly traded firms are not profitable or worse

Some of these companies, such as Uber, have been intentionally losing money in an attempt to revolutionize an industry. Uber has lost a cumulative $32B over the last 14 years. During ZIRP (zero interest rate environment), these investments made sense. While I don't necessarily believe that Uber will go bust, there is a significant population of tech companies (with high payrolls) that will likely run out of money and need to declare bankruptcy or otherwise seek restructuring. Bankruptcy/restructuring is not great for employment. Meanwhile, bankruptcies are well above pre pandemic levels.

What's The Good Word: I want to make and document a prediction - the area surrounding the 2300 block of Harbor Blvd in Costa Mesa is primed for a renaissance.

For those of you not local to Costa Mesa/Orange County, the below still might be useful as it demonstrates the massive forces that have to be a play and the time and money in order to change the trajectory of an area. "Improving area" is frequently cited as a rationale for investments in areas that don't see much improvement during the investment period. Turning around an area is more challenging than flipping a "u" in a containership in the Suez Canal.

The recipe for meaningful change often includes:

1. Addition By Subtraction - the removal of blight or the source of blight - in our story, the Motor Inn

2. Massive Capital Infusion - generally in the form of jobs, new/better retail, and/or housing - CM Lux Apartments and Northgate Market.

3. Regulatory Change - a new law or incentive that encourages large-scale investment - the passage of Measure K

The revitalization of Harbor Blvd. started its long journey in 2014 when the Motor Inn (the poster child for problem motels and, at the time, the City's 2nd only to Segerstrom Mall source of police calls) was purchased. From there, a wild legal battle (see link below; its worth a read) took place to enable the property to be redeveloped into approximately 200 new apartment units. The property will begin leasing in Q1 of 2024, almost 10 years after being purchased.

Link to article

Meanwhile, in February 2020, a ~70K sf Albertsons closed down. A considerable vacancy like that hurts the property owners and harms nearby businesses as traffic falls, and this was no exception - several long-time tenants shuttered in the immediate center.

Luckily the property owner was able to attract another tenant, Northgate González Market - a popular Mexican grocery chain. In part due to COVID and in part due to changing plans and additional City requirements (needed for some of the changes), the market is set to open shortly after nearly 3 years and a reported $27M investment by the owner. Typically a grocery store won't move the local area. But a typical grocery store doesn't require $27M in improvements. A political consultant who worked on city approvals has described the market as a Mexican version of Eataly, with 20 food stalls, a communal kitchen for aspiring restauranteurs to learn/test concepts, and live music. This place has the potential to be a destination and the type of place that aspiring small businesses would want to be next to.

So far we have added population with the addition of the 200 units right across from the new Northgate Market - which is great and all, but what about the rest of Harbor?

Harbor Blvd has been sliding further and further into decay. To exacerbate its problems in 2016, the citizens of Costa Mesa passed measure Y, a law that required all developments of any real scale to go to a ballot. Spoiler alert: zero developments went to a vote because a) only NIMBYs show up in scale to vote and b) it costs between $500-$1M to get a project designed and on a ballot, so Costa Mesa became a no-go zone for developers.

Fortunately, a few brave council folks, including Andrea Marr, whom I am fortunate enough to call a friend, put forward Measure K in 2022, which made redevelopment on Harbor Blvd possible. Measure K ended up passing by 200-300 votes - a very good reminder of the importance of voting in local elections; thank you to those of you who voted in support!

Here is where it all comes together, at the shiny new intersection of Harbor and Wilson. Northgate will help attract new and exciting businesses to 2300 Harbor, and the new residents at the old Motor Inn site will help these businesses be successful. The improvement of the center, new residents, and the passage of measure K will encourage developers, investors, and small businesses to take a chance on vacant properties along the corridor.

*A caveat for my prediction - as much as it has taken us 10 years to get to where we are, it will take at least another ten years for us to see the final impacts of these changes.