San Diego investment activity slowed in the first half of 2017, dropping to the lowest total sales volume since mid-2013. Although the second half of the year roared back, the slow down in the first half of the had a lasting impact. Despite the overall slowdown in activity, however, deal volume in the market closed 2017 above the 15-year annual average $4.7 billion 15-year annual average, according to research from Cushman & Wakefield. To find out more about the impact of the slowdown at the start of the year and expectations for 2018, we sat down with Jolanta Campion, director of research at Cushman & Wakefield, and Rick Reeder, executive managing director at the firm.

GlobeSt.com: What drove the slowdown in San Diego capital markets activity in 2017?

Jolanta Campion and Rick Reeder: While San Diego's commercial real estate investment sales volume across office, industrial, multifamily and retail properties $10 million and greater did slip a bit to a revised $6.1 billion in 2017, recently re-stated in our Q417 report, compared to $6.7 billion and $6.5 billion in 2016 and 2015 respectively, total annual deal volume was still well above the region's 15-year annual average of $4.7 billion.
The reduction in sales volume across all product types in San Diego in 2017 can be attributed to the cautious approach taken by investors who were uncertain in the future, especially early on in the year, along with heightened investor selectivity met with a scarcity of market supply. At the start of last year, many sellers felt the markets were imbalanced subsequently restricting the amount of properties for sale. Today, however, we are already seeing more sales opportunities in the market to begin the year that should help generate comparatively stronger activity in 2018 as institutional investors come off the sidelines. The last several months have brought much more clarity, which has enabled sellers to feel more confident in bringing their product online at good pricing. Additionally, some sellers are also anticipating a limited window with the expectation interest rates will continue to climb.

GlobeSt.com: The San Diego market was slow at the start of the year, but picked up in 2H17. How did the second half of the year compare with the previous three years? Was the 1H17 alone the cause of the slow down?

Campion and Reeder: Total sales volume in the second half of 2017 at $3.8 billion not only outperformed the activity in the second half of the year for the last three years but was the highest sales volume in 10 years (or since the second half of 2007). During the second half of 2017, there were seven investment transactions topping the $100 million mark. The second half of the year also highlighted investor willingness to pay premium pricing for quality assets.
Sales volume in the first half of 2017 at $2.25 billion, however, was the lowest since the mid-2013. Again, this can mainly be attributed to the cautious approach taken by investors who expected we may see a recession, along with heightened investor selectivity met with limited sale supply. At the start of last year, many sellers felt the markets were imbalanced subsequently restricting the amount of properties for sale. Once there was more clarity, sellers began to feel more confident in bringing their product online at good pricing, which loosened the amount of product for sale. Consequently, the total sales volume in San Diego for properties $10 million and greater was lifted by a much more active second half.

GlobeSt.com: What is your outlook for investment activity this year?

Campion and Reeder: We highly anticipate an increase in trading volume given the current pace of deals in the market and BOV activity for office in 2018. It is tough to peg an exact growth percentage but a 10% lift overall above 2017 is certainly not out of the question.
In 2018, “economic activity is forecasted to expand at a moderate pace and labor market conditions are forecasted to remain strong. Inflation on a 12-month basis is expected to move up in coming months and to stabilize around the 2% objective over the medium term. Near-term risks to the economic outlook appear roughly balanced,” according to March 21, 2018 FOMC statement. The federal funds rate was increased for the sixth time since 2015 to 1.75% and three additional hikes are expected in 2018. Under these conditions, cap rates will slowly adjust to higher interest rates and investors will focus on income instead of appreciation.

GlobeSt.com: How do you expect this to play out in each of the asset classes?

Campion and Reeder: Commercial real estate will remain an attractive investment as investors are looking to deploy the capital and hedge against the anticipated inflation. The industrial market remains on a solid footing and is expected to continue to perform well. Office will perform the best in submarkets preferred by today's workforce near preferred housing, public transit and walkability and amenities. Retail will continue to be under pressure from on-line retailers putting pressure on landlords to attract shoppers to brick-and-mortar stores. Centers offering entertainment along with shopping will continue to perform the best. Multi-family will remain in short supply and among favorite asset classes supported by consistent year-over-year rent growth and the fact that less than one third of San Diegans can afford to buy a house with the affordability index at 26.