Meanwhile, retail fundamentals in the Inland Empire, which continue to deteriorate, have led to significant distress in Riverside and San Bernardino. More than a third of all distressed properties in the Inland Empire are retail as the strip and power centers built in the path of development in the two counties have been unable to maintain operations in the face of the flailing single-family housing market. Retail distress is so severe in the Inland Empire that the total dollar volume of distress exceeds the dollar volume of retail distress in Los Angeles and is the fourth largest in the country behind only Phoenix, Las Vegas and Chicago.

With improving fundamentals and limited new construction, the retail markets in Orange County and San Diego have seen relatively limited retail distress, although there are a few dozen properties in severe trouble (60 or more days) that may enter the market in the coming months. Many of these assets, however, are in the second or third ring of suburbia, and the halt in new housing construction limits their near-term fundamental improvement potential.

The retail sector, in general, has remained relatively healthy in Los Angeles but has not been immune from the general economic struggles and store closings, and more than 120 retail properties are currently in distress. For investors, Los Angeles provides the greatest source of distressed retail opportunity, although with recovery rates for lenders trending toward 80%, the pricing discount is not as strong as it was just six months ago.

The Southern California office market is the most distressed sector of the major property types with more than 260 assets representing some $5.7 billion labeled as distressed in the four metros in Southern California. Nearly half the assets and 60% of the distressed dollar volume is in Los Angeles, led by the MPG portfolio in Downtown, where a lack of leasing improvement and the inability of MPG to afford necessary tenant improvements has the buildings operating as zombie properties and heading the wrong way down the distressed pipeline.

MPG properties have also been a focal point of distressed opportunity in Orange County, where the extreme increase in vacancy in the marketplace after the housing bust led to numerous REO/foreclosures and a fertile environment for opportunistic investors. Pricing has become more competitive with the increased investor activity, but with vacancy projected to decrease 110 basis points by the end of the year and projected rent growth, buyers are still circling opportunities when they become available. While distressed opportunities are also plentiful in the Inland Empire, its tertiary office market status and its continuing rising vacancy rate is keeping investors away at this point.

San Diego's CBD has fared relatively better than most urban cores across the country, but there are several dozen distressed office properties in the suburbs, particularly in the northern submarkets. The lower price point on these assets, coupled with slightly better fundamentals in the north, will make it a very attractive market for private, opportunistic distressed buyers.

The Los Angeles industrial market remains one of the tightest and best performing markets in the country with a vacancy rate below 5% and the first signs of increasing rents during the first half of the year. But, in spite of solid fundamentals, overleveraging and functional obsolescence has led to the largest amount of distressed industrial assets in the country by property and by dollar volume. As a percentage of overall industrial space, the distressed portion remains extremely low, but there are opportunities for investors. While many of these obsolete properties will be converted to other uses or completely redeveloped, there are pure investment opportunities mixed in, but the competition is extremely stiff and pricing is not as advantageous as in other markets.

Distressed industrial opportunities in both San Diego and Orange counties are limited as both markets have maintained relatively healthy fundamentals. Any potential owner/user assets, however, are moving toward REO/foreclosure, and investors with tenants in hand may see attractive opportunities in these markets. The significant dislocation in the Inland Empire industrial market after the housing bust and recession has provided numerous distressed opportunities for investors. These range from newer, speculative developments to older but functional warehouse space. It is important to distinguish the stronger West Inland Empire market from the weaker East Inland Empire market. While vacancy in the Riverside-San Bernardino area remains above 10% for warehouse space, investors are still attracted to the area because of its proximity to Los Angeles and the significantly more attractive pricing and yields offered.

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