High costs stiflilng region's potential

San Diego continues to be a mixed bag of blessings and curses, triumphs and challenges. Anti-business policies, the high cost of living, the need for a new airport - and a new attitude in Sacramento - are among the challenges, according to those in the know. But the forecast for 2006 has some bright

San Diego has topped two market watch lists issued by the Urban Land Institute and PricewaterhouseCoopers.

Edging out the perennial star, Washington, D.C., San Diego for the first time took first place as a hot prospect for commercial/multifamily investment and development, and also in for-sale homebuilding. This, according to the 2006 Emerging Trends in Real Estate report, issued to a gathering of movers and shakers at the fifth annual Commercial Real Estate Trends Conference at the University of San Diego on Nov. 21.

The report bills San Diego as the "great lifestyle town," where "everyone wants to live but can't afford it. " The consensus of the real estate and financial experts at the event: San Diego still has some hurdles to jump.

"San Diego will be relegated to a thirdtier city if the airport issue is not resolved," predicted Doug Manchester, the event's keynote speaker, chairman of the Manchester Financial Group, and one of San Diego's biggest private developers, with properties in 11 states valued at more than $2 billion.

Having led the unsuccessful effort to relocate the airport to Miramar Marine Corps Air Station in 1994, Manchester continues to insist that a new airport "can and must happen."

"The problem with transportation - both air and ground - will be a risk factor in the future to get business here," he told the crowd.

The trends report agreed, noting, "The ,miniature' airport restricts the city's ability to compete as a major commercial gateway."

Manchester also wants to see a streamlining of government controls, including the permitting process, so that deals can go through.

In agreement is Randall J. Smith, executive vice president of business development for Westfield Corp., the U.S. unit of the Westfield Group, which has interests in several San Diego-area malls, including Westfield's Horton Plaza and University Towne Centre.

"San Diego has some great opportunities, but it's difficult to get things done," said Smith, citing the limited land and traffic problems that plague much of the area.

Retail Trends

Despite the hassles, Smith still considers San Diego "one of the most exciting markets in the United States."

"San Diego is an important market for Westfield," he said, adding that Westfield has plans to rejuvenate some of its San Diego properties to keep up with the times.

"Horton Plaza needs to be reoriented toward the Gaslamp, he said.

Are regional malls dead? That's the big question that Smith said he keeps hearing.

"It's a life cycle," said Smith. "When they mature, they must be recycled. I believe in regional malls. A lot of regional malls were developed by department stores, and they created these fantastic locations."

The trend toward consolidation of stores can be healthy too, said Smith.

"It's a great opportunity to recycle the product," he said. "You create a critical mass. To survive today, you have to be consumer-centric. Look at the early malls. Most of them had horrible restrooms, and they looked like bunkers, with no curb appeal. You will see a lot more public plazas and a sense of place."

But the trend toward mixed-use projects, combining retail with residential, while desirable in some cases, also can be a hindrance to growth, said Smith.

"Our first preference is retail, and its potential for expansion," he said. "Once you have mixed-use, you can't come back with more retail."

Robert "Bert" E. Dezzutti, senior vice president for Equity Office Properties, responsible for property management, leasing, and overall financial performance for the Los Angeles region's portfolio, agreed that suburban markets have their advantages. "The right opportunity hasn't been presented in Downtown San Diego," he said. "But we do have a lot of property in UTC. Downtown hasn't proved that it can sustain that kind of growth. There is comfort in suburban markets, where there is land."

Housing Crunch

Eric Hazard, senior vice president for Corporate Real Estate and Facilities at Science Applications International Corp., considers the housing issue a major obstacle to bringing in business to California.

"It's hard to bring people into the state unless they're coming from other high-cost arras," he said. "We don't bring people very often from the East Coast. It's too expensive."

Meanwhile, the question persists: Is Downtown San Diego overstocked with condos? While luxury condos might be doing well, sellers should be careful about pushing the envelope on more affordable housing, resulting in "zero sales."

"The challenge for Downtown is not to kill the goose that laid the golden egg," said Peter Houghton, vice president of Canyon-Johnson Realty Advisors LLC, a joint venture between Canyon Capital Realty Advisors and Johnson Development Corp., an enterprise of basketball star Ervin "Magic" Johnson.

The venture manages the Canyon-Johnson Urban Fund, whose local development partner is Lankford & Associates, currently building SmartCorner, a $120 million mixed-use project in Downtown San Diego.

Another challenge facing San Diego's housing market is the future of condo conversions, a once-hot commodity. San Diego City Attorney Michael Aguirre wants the city to perform environmental reviews of condo conversions, gauging their impact on what he sees as diminishing affordable rental housing.

Daniel J. Epstein, founder and chairman of ConAm Management Corp., which is based in San Diego, commented, "It could bring a halt to conversions if there is a strict interpretation."

The condo conversion market already is cooling down, he said.

"Those that bought a few years ago did well," said Epstein. "But, in the last 90 days, there have been a significant slowdown in condo conversions."

Epstein also predicts sluggish times ahead for apartment builders, despite the "insatiable demand."

With construction costs as high as they are these days, "You have to build for-sale housing, in high density," he noted.

Building new apartments in San Diego isn't cost effective these days, he said, adding, "I don't know when they're going to start building apartments in San Diego again. Mixed-use is where the opportunities are for the future, with infill."

Another sign of the times: Epstein said that he's been monitoring real estate ads, and has been struck by their tone.

"Pricing discounts, incentive packages, 100 percent financing available, holiday bonuses, and one - buy a condo, and get a new car," he mused. "We are seeing a change in the marketplace."

Innovative Markets

Tyler Orion, chief operating officer of Connect, which fosters emerging hightech businesses here, noted that San Diego is rich in scientists, innovation and "a collaborative community. It is an amazing R&D economy. But they can't stand alone."

There is a gap between what goes on in the lab and what eventually happens in the marketplace, she said.

"Keeping companies here and growing them to become big companies is not in our DNA," said Orion. "How you grow, and where you will go, there are more disincentives. It's a selfperpetuating problem here. We can't think that we will always have the great science stars here, and will always have innovation. We can't rely on our past successes, or take anything for granted."

Michael Severson, director and portfolio manager for the RREEF Funds in Irvine, said, "I am bullish on San Diego. The economy is so diverse with R&D, wireless and biotech. There is not a lot of competition for pure industry, because of the lack of land. Finding land to meet the demand will be a challenge."

And land costs will continue to be an issue, he said.

"They're not making any more land in San Diego," said Severson. "I don't see a whole lot of retreating in land prices."

Severson predicts that San Diego's market strength will be in research and development, attracting a white-color, welleducated work force.

"But I don't see a lot of large manufacturers moving to San Diego in the near future," said Severson, currently managing a 14-million-square-foot portfolio of industrial and R&D properties with a total value of $1.2 billion in San Diego. Los Angeles, Orange, and Riverside counties. "The bulk of demand for space will be R&D."

Pressuring Sacramento

James H. Renzas, president and chief executive officer of Location Management Services, a site selection and incentives negotiation consulting company, gives San Diego high marks for image.

"This is number one in the minds of CEOs of where they want to live," he observed. "The labor skills here are great, the climate is great. The bad news -- the number one problem is Sacramento. They only have about two people marketing the whole state of California. It's a complete shame."

While Renzas noted that while he "loves (Gov.) Arnold (Schwarzenegger), the state's attitude is, " 'Locals, you're on your own.' This is holding back the state of California. We need to put pressure on Sacramento."

But overall, with all its trend shifting, real estate in San Diego remains a good deal, according to Mark DePrima, managing director in the commercial mortgage investment team for TIAA-CREF, a financial services firm.

"Real estate gives the best return, and is why capital is flowing to real estate," he said. "Unless some alternative investment comes along that gives a better return, we will continue to see a lot of investment in real estate."