With the US economy challenged by the subprime mortgage crisis, real estate values are falling, especially for housing, and consumer confidence is at a five-year low.

At the annual Invest Ontario: State of the City conference in April, real estate professionals commented on how they assess the situation, particularly in their home base of Ontario, California, located within the Inland Empire region in southern California that encompasses Riverside and San Bernardino counties.

Raphael Bostic, interim associate director of the University of Southern California Lusk Centre for Real Estate, observes that market fundamentals have deteriorated.

He says: “We have job loss, tremendous inflation and losses of capital income. The question is – when do people start having confidence in assessing risk? When that happens, capital markets and real estate will come back. Until then, the markets will remain volatile.”

Although deteriorated property values may be beginning to present good deals, the perception of further deterioration remains, meaning that perceived risk outweighs opportunity. “Capital players are afraid to invest,” adds Mr Bostic.

According to Kevin Assef, a senior vice-president and managing director in the Ontario office of Marcus & Millichap Real Estate Investment Services, only 65% of consumers now have confidence in the economy, compared to 90% a few months ago. Consequently, there is no liquidity in capital markets. “There’s no capacity on the balance sheets for institutions to buy loans,” says Mr Assef.

It is stalling the real estate market, he contends, arguing that the problem is not associated with low interest rates. “Lowering interest rates is like prescribing antibiotics to someone with a viral infection. It is not going to do a thing,” he says.

Market cycle

Ashley Powell, managing director for development at RREEF, one of the country’s largest institutional real estate investors, refers to this cycle as “one heck of a party. And we are just having our hangover”.

His firm still sees trades going on: “Those trades have a vision to get through the short-term disruption,” he says. That is because there is a silver lining to every cloud. “There is plenty of money to be made in this economy,” he adds. “Regulators need to get out of the way. We need a correction.”

Dene Oliver, chief executive officer of Oliver McMillan, a private developer of unique, quality mixed-use retail, entertainment and residential projects, observes that this real estate downcycle differs from that of the early 1990s, when the financial institutions were collapsing major private equity players. “This time, that won’t happen. But there’s going to be some blood in the water. It won’t be seen until later this year,” he says.

He also predicts that there will be a major transfer of wealth. A lot of loans will come up for renewal in the next five years and people will have to write cheques to keep them. “The liquidity in market has evaporated,” he says. Consequently, he contends that housing developers and homeowners are going to take hits. “It is a fait accompli,” he adds. “And the government cannot bail everyone out.”

He contends that capital is abundant in the markets on the debt side. “It is the redistribution system that is broken,” he says. “There’s a high velocity of rental and an infinite supply of land out here and it was absorbed.”

So, he believes that the downturn will be more largely felt in certain geographic areas and by product type, unless a real estate product is distinctive and in a unique market.

Long-term outlook

“There is no question that the strength will be on both of the US coasts and will hurt more the more you go inland,” says Mr Oliver. In this market, he advises developers to build for the long term. That is what his firm is doing in developing the Historic Guasti District in Ontario. “We have a long-term outlook,” he says. “We have deep pockets behind the project, so we will succeed more so than other projects.”

Natalie Bazarevitsch, senior vice-president/ senior managing director for the Ontario office of CB Richard Ellis, a global leader in commercial real estate services, reveals that Ontario’s office market is still strong: “For example, RREEF and PGP partners just broke ground on 14,000 square metres at Ontario Airport Towers, one-third of which is potentially pre-leased.”

Overall, she sees the office market as wait-and-see due to a lack of trade volume. “On the industrial front, there is some fervour in tenant and user interest, so cap rates have been depressed,” she says. “The residual effect on the market is the strongest in the country. There may be some start and stop to development, but we need to focus on the second half of the year.”

Velocity drop

Pat Cavanagh, senior vice-president of ProLogis for the Pacific Region, reveals a drop in the velocity of deals and an increase in the length of time for warehousing transactions.

Unlike other real estate, seaports drive warehousing, as does trade with Asia. “Our market is not going to stop – even in a severe downturn,” he says. Still, the company is looking for opportunities elsewhere in global markets, such as Europe and Asia.

“We need to be focused on investing in healthy markets,” says Mr Cavanagh. He contends that Ontario has done things right: “It has taken advantage of its location, the airport, the freeways, the residential markets, etc.”

“It built an industrial hub when people didn’t think it could work and grew it to where it is today. That is quite an accomplishment. It goes to show you, don’t take your eye of the ball.” That is also good advice for investors in the current climate.

IN FOCUS

ONTARIO, CALIFORNIA

In the face of a difficult national real estate market, Ontario, California, “has positioned itself as a critical hub”, says Raphael Bostic of the University of Southern California Lusk Centre for Real Estate.

The city, located just 56 kilometres east of Los Angeles, is considered the inland region’s population and job growth centre. It is anchored by its international airport, three major freeway arteries and two major railways. Ontario also provides strategic access to the ports of Los Angeles and Long Beach.

“Helping markets such as Ontario is a current flight to quality by institutional investors,” says Kevin Assef of Marcus & Millichap Real Estate Investment Services.

He adds: “Institutional investors are looking for quality products. But institutional investors are only active in 15% of the market; 85% are private investors who have a different outlook of how they get in and out of an investment.”