Presented by Beacon Economics
Welcome to The Regional Outlook, a forecast for five of the state’s largest metropolitan economies. Each quarter, find updated analysis that goes beyond the state and national level to present a snapshot of employment, home prices, consumer spending, personal income, and other leading economic indicators within key areas of the state. Visit your region of interest and subscribe for email delivery.
Los Angeles Warehouse/Distribution Space Surges While Office Space Flounders
The commercial real estate picture emerging in Los Angeles is indicative of a global employment trend away from traditional office commutes as the COVID-19 pandemic accelerated the shift to remote work. With many employers utilizing some form of remote and/or hybrid work schedule, Los Angeles County’s Office vacancy rate surged to 16.5% in the third quarter of 2022, up 2.3 percentage points since the first quarter of 2020. In fact, estimates from the U.S. Census Bureau’s most recent American Community Survey show nearly 21% of the County’s residents work from home, nearly four times the pre-pandemic average. As a result, net absorption in commercial Office space since the first quarter of 2020 totaled -1.8 million square feet. This is despite office-facing employment in the county increasing 1.8% since February 2020. In fact, employment in sectors utilizing Office space has outperformed the broader economy, which was still down -0.7% relative to the pre-pandemic peak. The divergence in absorption and employment suggests employers are downsizing their Office footprint and offering more flexible accommodations for hybrid schedules.
Warehouse/Distribution has surged due to the need to scale delivery and logistics operations during and after the pandemic as spending shifted online away from traditional brick and mortar operations. As of the third quarter of 2022, the Warehouse/Distribution vacancy rate was 0.9%, a -4.8 percentage point decrease from the first quarter of 2020. The sizable decline in the vacancy rate occurred despite 8.4 million square feet of new stock coming online.
Moving forward, this rapid growth in Warehouse/Distribution will begin to cool off and settle. However, the outlook for Office is mixed. While established and emerging technology hubs like West Los Angeles and Culver City are somewhat bouncing back, more traditional and dated business districts with high-rise cubicles are struggling. As returning employees work fewer days in the office and remote/hybrid work becomes increasingly utilized, the demand for floor space has declined across Los Angeles. This trend is expected to continue, and thus negative net absorption rates for Office may be expected in the near term.
When broken down by property class, there is a clear divergence in vacancy rates. Although vacancy rates are rising for all classes of Office real estate, the level is much lower for Class A buildings, and the spread between A and BC properties has widened over the last decade. This reflects the disparity between more traditional and dated high-rise office cubicles versus modern low-rise buildings with natural light, high ceilings, gardens, gyms, and other amenities. In short, while the transition to remote and/or hybrid work diminished commercial Office space, it also intensified competition among many employers to create workspaces where employees want to come back.
Los Angeles Employment Outlook
After steadily rising from its trough during the COVID-19 pandemic, Beacon Economics expects total non-farm employment in Los Angeles to somewhat plateau during the next year. The unemployment rate is projected to drop to around 4.6% in the first quarter of 2023 before experiencing a slight uptick to just under 5% by the end of 2023 as Federal Reserve interest rate hikes cool down economic growth. Total non-farm employment will be limited by an increasingly short supply of labor, which has been driven partially by low unemployment and worker outmigration to areas with more housing supply. Although a recession is not currently expected, the economy is fragile, and additional negative shocks and excessive rate hikes could tip it into recession territory.
Los Angeles Housing Outlook
The housing market is showing signs of weakness, driven by a slowdown in sales activity, which in turn is being led by higher long-term mortgage rates and rapidly rising short-term interest rates as the Federal Reserve tries to cool inflation. Accordingly, Beacon Economics is forecasting a modest housing price correction in its forecast as higher interest rates cool housing purchases. Additionally, an already prohibitively high price level in Los Angeles is spurring many would-be buyers to more affordable markets in the inland parts of the state. Beacon Economics expects median year-over-year home price growth in Los Angeles County of 1.8% in the fourth quarter of 2022, but then declining through 2023.
Higher frequency data from Redfin also shows an emerging correction in the Los Angeles housing market. For example, year-over-year sales of single-family homes were down -40.5% in November, with median days on the market climbing to 48, which presents a gain of 11 days. Condo and townhouse sales displayed similar trends, declining -51.7% and -44.9%, respectively. Housing supply, or the number of months it would take for the current inventory of homes on the market to sell given the current sales pace, reached 3.5 months in November, which is the highest since May 2020. Inventories of homes on the market have increased relative to last year but remain low from a historic standpoint, which has kept housing prices afloat. Steep sales declines and elevated inventory carrying costs reflect higher interest rates cooling demand.
It is important to note that this is a housing market correction, not a bust. A market response to changes in interest rates is normal, especially given the pace at which interest rates have risen over the past year. Beacon Economics’ current forecast calls for the local median home price to scale back to about $840,000 by the end of 2023, which is around the same price level as the third quarter of 2021. Nonetheless, given the Los Angeles region’s limited housing supply and still-strong demand to live in the area, this correction represents a blip on the otherwise long-term upward trend in Los Angeles home prices.
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