Carl Muhlstein on Re-closure’s Impact on Commercial Real Estate

How are real estate markets responding to the extended impacts of coronavirus a day after Governor Newsom ordered the re-closure of businesses as COVID surges across the state—especially in metropolitan Los Angeles? What's the knee-jerk reaction of clients who reached out to you for assistance?

Carl Muhlstein: Every time we take a step forward, we get gut punched. All of the timelines have been extended. Everyone was prepared for three-months of rent forbearance, mortgage forbearance, and PPP funding before climbing back.  Seems like we fell off the cliff again especially for office re-openings manned by working parents with school-aged children indefinitely stuck at home.

The post-digital era is here. The Pandemic has accelerated digital transformation. Office tenants are having a hard time making a decision. If their lease isn't expiring, they don't want to deal with it. They are more concerned about how to support their staff working from home and put more resources to technology. Understanding their lease language, office layouts, flexible shifts, cleaning standards, social distancing within the suite and remodeling needs is all encompassing. Likewise, this pause leads to very few decisions on office sales. For example, not one office building traded in San Francisco during the second quarter.

Is your firm addressing these issues both nationally and globally to see where the alignment is between what you're experiencing in the LA market and what's happening globally?

Some of the brokerage firms see the cup as way over half full, but we have been very supportive working with clients to address the realities. There is no sugarcoating what we're all facing. The next normal or hybrid workplace is upon us.

I can't tell you how they're approaching New York and other parts of the country, but I am on a weekly call with my counterparts from Seattle to San Diego to review subleases, tenant movements, financing issues, sales, etc. and looking for context and trends. Like the Stock Market, tech and media are leading leasing activity in many markets. Reducing densification with offering Work From Home alternatives is balancing itself. 

The Financial Times reports today that US retail rebound falters as virus infections surge, noting that, "US retailers’ rebound from the coronavirus shutdown is starting to flatline as infection rates jump in swaths of the country." You're confirming that, but looking forward six months to a year, what does that mean for the market? 

I'm confirming that for regional malls and perhaps boutiques and high-street retail, but the world right now belongs to Walmart, Costco, Target, all the supermarket chains—who are reporting record sales—and Amazon's last mile e-commerce. Yes, department stores and specialty retailers are filing bankruptcy, but that hasn’t impacted suburban retail as greatly. Suburban home sales are selling at a torrid pace with 46% accepting an offer within two weeks. Buying a home in July was like buying toilet paper in April. Zillow says inventory is down 40% in major markets and prices are inching up. This is partly interest rate driven and nesting, for better WFH situations and play alternatives for kids.

What do you advocate that cities do to handle the land use challenges of retail in transition?

First and foremost, they need to realize that this is a trend that's not reversing. When we have meetings with municipalities, I send them a UBS report that indicates 100,000 retail stores will close by 2025 -only 12% of the retail, the study may need updating. They ask how to replace Sears, JCPenney, Barneys, Macys and the like. There are no replacements.

After we present dwindling sales tax revenue, we start dwelling on the land use issues. Unfortunately, that's become a real hot potato. Even though he vehemently opposes nine state bills that dilute local land use inaction, my hat's off to Paul Koretz for the timely conversion of Westside Pavilion to allow Google to lease and occupy 550,000 feet for what will be badly needed jobs in our City. With the amount of land use challenges, years can go by and makes these large blank canvases impossible to paint. Horton Plaza in San Diego is the next example to watch. More tests and dead malls will certainly follow.

What’s the solution from your experience?

Everyone has come to the table: the equity ownership, the lenders, and the tenants. Everyone at the table is motivated, but we're just not sure that City Hall is. Co-tenancy agreements, reciprocal parking agreements, changes in use, over-reaching mitigation fees, serial CEQA litigation, and NIMBY politicians won’t allow affordable housing, senior housing, PUDs to occupy miles of underserved parking lots and empty boxes. Expect YIMBY class action lawsuits similar to Plaintiff LA Alliance for Human Rights seeking court intervention in the face of growing housing and homeless crisis. They cite a lack of results from local government agencies to build affordable housing or place people into temporary shelter space, after wasting over a billion dollars of taxpayer funds and resources.

I have no answer for you except that the pressure on municipalities for sales tax, jobs, and quality of life will really putting the heat on. With remote work opportunities becoming mainstream, job seekers will have choices. UHaul’s #1 one-way-out market is California. Politicians don’t seem to care. They must do something, and the only way to do it is on the 20- to 30-acre parcels that can be redeveloped and that aren’t surrounded by single-family residences. Otherwise, we're frozen.

The cratering of finances and the economy from COVID reaches into every jurisdiction imaginable. What has the path been for cities that have joined others at the table constructively?

Without being specific as to city, there's been a growing acceptance of Amazon’s last-mile e-commerce logistics centers. I believe the municipality that has Wayfair's 2-million sq. ft. foot distribution center gets $5 million in tax credit revenue, dollar for dollar, into their fund. Municipalities are changing their tune about last-mile e-commerce distribution, but we await new CEQA guidelines that not only measure traffic in and out of the property (level of service) but also where the traffic originates (vehicle-miles traveled). Generally speaking, municipalities are slowly starting to warm up. But I don't think that Los Angeles is at that forefront.

We have to bring remote work into the discussion if we're going to talk urban versus suburban. Working from home was a stopgap that is now greatly accepted by a lot of people, so it's going to gain acceptance and utilization by companies. Reimagining the Next Normal delineates client facing activities, culture, behavior and productivity. This new ecosystem will impact coworking, office layouts, satellite locations, client offices, conference centers and virtual reality. I'm not suggesting it's the end of office space, but rather a new Enterprise Hybrid Workplace Ecosystem.  

Working from home is going to change our commuting pattern. For downtown, urban, rental residential, we had a record number of units built; there's probably 15,000 units being delivered between Downtown and Santa Monica along the Expo (E) Line. At the same time, I'm not sure people will pay the premium and renew their leases like they were expected to. Class A apartment rentals and leasing velocity are the most affected in the last four months.

Newton's first law of motion states that an object at rest stays at rest, and an object in motions stays in motion. In the context of housing advocates who've been pressing for greater density by way of urban infill projects, has that strategy run its course? Ought there be a mid-course correction, now, in terms of where housing supply is focused

We have an insatiable demand for housing, but I think it might have run its course. The city insisting on burying parking, type 1 construction, affordable components, project labor agreements, and the volatile financing market makes projects unviable. In the suburbs, you have the NIMBYs and the people who want to maintain the integrity and suburban nature of their neighborhoods, so they're not allowing new housing there either. Many entitled, ready to build sites will propel in value; newly constructed developments may sell for near replacement costs. Nearly free cost of debt, fear of split roll Prop 15, and rhetoric about higher tax rates, and phasing out 1031 exchanges is creating new momentum in the sales market with a strong Q4 expected.

When you say Newton's law, I think housing is going to dominate politics in the next 10 years in Greater Los Angeles and probably other places within the state. With homelessness and unemployment exploding and people deserving a better shot at a roof over their head, something's gotta give. I've taken the position that it’s not all on the developer's back, and a lot of it has to do with land use. Delays add 10 percent per annum to construction costs which are passed on to the consumer.

Housing isn't the focus of much of your real estate activity, but at a time when public revenues are cratering, joblessness is growing, and homelessness is spiking, what is the land use and financing model to build that?

The formula is frozen, and projects are now selling for near or below replacement cost—which leads to the conclusion—why build new? That applies to the first retail and office trades coming to market as well. We talk about the constraint of supply, but we no longer have to hang that hat on land use obstacles. Now, we can hang it on financial and feasibility reality.

I'd say the hottest part of the market would probably be small unit subdivision, entry-level housing, urban infill or suburban. But again, that is the toughest component to get approved. Do we need more 20-story apartment buildings now? Of course we do, but AIDS Healthcare is suing every single project unabated because of a lack of political leadership. Do we need more housing near transit? Of course we do, but with the Crenshaw Homeowners challenging every buyer who tries to buy the Baldwin Hills Crenshaw Mall, we're not going to see that kind of relief. The risk and economics don't pencil right now, and you're going to see almost no construction.

Without giving you the ability to consult with your family and friends, imagine that someone asked you to run for mayor. What would your platform be in this arena? 

I would want the same Los Angeles that attracted my immigrant father after World War II and my mother after escaping Poland in 1939. I would want everyone to have a chance at jobs, housing and public education.

Housing is first and foremost. It doesn't take rocket science. If all of the sudden, we told every developer we’d guarantee building permitting in six months if the project had 20 percent affordable—six months for litigation, CEQA, challenge, end of story—that would reduce 20 to 30 percent of a project’s cost.

It would require politicians showing more backbone, leadership, and support for projects. I think back to Richard Riordan when, after the earthquake, we dealt with LAUSD to get kids into K-2 primary school centers in the neighborhoods where they live. That way parents could get involved with the schools as opposed to an hour bus ride each way. We worked around LAUSD’s contracting and procurement rules, and we made things happen quickly. There's just not that sense of urgency now to make things happen. Watching the FBI turn our Council, Planning and Building Departments inside out is not surprising. More people will be implicated as you can’t imagine how the abuse wasn’t witnessed by dozens of City employees during the process. What surprises me is how the City Attorney, City Councilmembers and AIDS Healthcare turn on the victims who followed instructions by people and departments in power. Housing, jobs and tax base shouldn’t be sacrificed for a corrupt process and civic malpractice.

Richard Riordan lived in a beautiful home in Brentwood. Is quality of life and the planning of neighborhood amenities that make where you live so rich something you don't want to override by building more housing?

I would love more small unit subdivisions in my neighborhood, because I would love to see young people moving in, strollers on my street, and kids in the park. I'd rather see that than wait for a federal judge to hold the City of LA in contempt, waste money and force them to get 8,000 people out of freeway underpasses and on-ramps. Ride down San Vicente by the VA—don't walk the sidewalk, you'll not make it through —and you'll see what I'm talking about, near Dick Riordan's home.

There are such easy solutions. Westwood Village, Ventura Boulevard, Park Mile and Third Street Promenade are so logical; it would take one hit of the gavel put apartments on top of retail, on bus lines, near transit, and near jobs that would help retail, jobs, and affordable housing ratios. It's not so complicated. The Cities take six years to do a specific plan, and then for a $10,000 legal retainer, they can block these projects for four to six years, while the City spends millions of dollars on man hours, public vignettes, meetings, and hearings; it's just broken and outdated on completion.

The LA County Economic Development Corporation (LAEDC) has just spent six months updating its strategic plan—which was impacted by the pandemic—and will be releasing that plan in a couple of weeks. What's the economic strategy that the region ought to advocate? 

There are a couple things that go through my mind in addition to land-use reform. City tax structure is a deterrent. How is it that a company can move a hundred feet from Toluca Lake to Burbank, save $250,000 in gross receipts tax, and get a class-1 police and fire department services? Our tax structure compared to El Segundo, Burbank, and many other municipalities is broken.

And now we have statewide rent control on the ballot, and the business communities in Texas, Arizona, and Nevada are cheering it on. Rather than focusing on the supply side, they focused on dampening ownership profitability, which doesn't lead to more supply. We also have the split roll tax coming up, which will just get mostly passed to tenants. They want to tax buildings that someone has pride of ownership for—that individual investors saved up every penny to buy thirty to fifty years ago for retirement. That's all going to be under fire and make us less economically viable.

Texas is very much a draw. In fact, Tesla—whose stock probably jumped 20 percent since they made the announcement—is kicking tires in Austin right now. It's the same kind of draw that made Apple not want to bring manufacturing to California. There's been over 3 million square feet lost by San Francisco and Los Angeles, including Toyota's US headquarters in Torrance.