The demographics forging California’s real estate market: a study of forthcoming trends and opportunities – Part II

This article series examines the effect California’s shifting age demographic has on future real estate trends, and provides insight as to how agents will benefit by anticipating the services needed to support the emerging real estate market patterns.

Part II of the series focuses on profitable ways to pair innovative start-ups founded by prime-age workers with owners of vacant nonresidential property, the effect of Boomers’ delayed retirement on real estate transactions, and prognosticates the Great Confluence of Generation Y and Boomers in California’s urban core.

For more information concerning the innate potential of Generation Y to single-handedly invigorate the real estate market this decade, see Part I.

Cascading social and economic adjustments of prime-age workers

Generation Y, though disproportionately susceptible to the current socio-economic adjustments, isn’t the only demographic to be financially and socially stunted by the Great Recession. The labor force participation (LFP) rate, the percentage of the population currently employed or actively seeking employment, of prime-age workers, those aged 25-54, is steadily declining. By the end of 2009, the LPF rate for prime-age workers was 88.9%, nine points below its peak in the mid-1950s.

Many prime-age workers are the victims of compounding social and economic hardship (the primary focus in the study of socio-economics). During the tumultuous frenzy of the Millennium Boom – 1996 through its peak in 2007 – when financial excess was the accepted norm and cash was far too easy to come by, a large percentage of prime-age workers were paid very well, substantially beyond their level of skill and training. During these years, workers in this age range became accustomed to excessive compensation (read: easy money for minimal work). In tandem with excess compensation, hubris was quick to grow. Self-indulgence in the form of luxury housing took a firm rooting, a manifestation of the ability of prime-age workers’ income to open all financial doors – including the ability to borrow heavily. [For additional commentary on opulent housing, see the November 2010 first tuesday article, Is housing a luxury or necessity?]

Unprecedented numbers of overpaid prime-age workers were discharged by private employers after 2007 as the Great Recession, then in the financial crisis stage, began wreaking havoc on the broader California economy. Many of these newly unemployed prime-age workers have been unable to find alternative employment – or have intentionally refrained from reentering the labor force at lower pay. This is especially true of dual income families, where the income of one employed spouse can sustain the couple, albeit at a more modest standard of living.

Thus, many prime-age workers who left the labor force during the Great Recession will either:

  • reenter the labor force at lower pay; or
  • never reenter it again, even after the economy recovers.
Those individuals who reenter the market at lower pay will likely have diminished home trade-up options.

Those individuals who reenter the market at lower pay will likely have diminished home trade-up options due to their reduction of income. Similarly, those individuals who never return to the labor force and accept the significant loss of income this decision entails will suffer even worse housing options. These prime-age workers who never return to the labor force will be forced to rent again or move into housing that is more modest than the property they currently occupy. These cash-starved individuals will also likely move to cheaper areas with low-tier rentals, either inexpensive bedroom communities in California (such as the Inland Valleys known as the Inland Empire and Inland Gateway), or out of California entirely.

However, some prime-age workers will likely return to the labor force through the “underground market.” These individuals will function in the grey economy, joining the ranks of a comparable but unlicensed workforce. Thus, these prime-age workers will have an income flow, but will not be reflected on anyone’s payroll. Depending on their professional success in the grey economy, they may never rise to the financial prosperity they once enjoyed, but they will definitely sustain themselves and be appreciated by those who hire them. The real estate brokerage industry will likely encounter these entrepreneurially inclined providers of services as they will be less expensive to employ for fixing up properties for sale or under management.

Thus, a large percentage of prime-age workers have forfeited their ability to be upwardly mobile in the immediate present – in the process, depriving agents of the fees they would have earned on property transactions that now will go unmade.

To compound the financial difficulties caused by unemployment, if the prime-age worker purchased a property using purchase-assist mortgage financing or refinanced after 2002, they are now likely saddled with a negative equity property that cannot be sold – an albatross built of lumber and stucco, cemented to the ground and immobile. This infertile economic condition creates inhospitable ground for buying and selling real estate, further inhibiting these prime-age workers’ ability to sell their current homes for a decade or so, an evolving condition of real estate rigor mortis for the immediate years ahead – probably through 2013. [For more information on the negative equity epidemic, see the March 2010 first tuesday article, The underwater homeowner, his future and his agent: a balance sheet reality check Part I and Part II.]

But, armed with these unpleasant truths, how are California agents to respond, and how can they use this knowledge to align themselves with upcoming real estate trends?

Incubator buildings – nothing to lose, future profits to gain

The army of unemployed (and underemployed) disillusioned prime-age workers has an intellect and energy waiting to be effectively marshaled to exploit their insight from prior employment and provide goods and services which would sell if made available. Many optimistic, motivated prime-age workers who are innovative will take the opportunity laid open by the Great Recession to create their own small businesses, called start-ups, and become self-employed – emancipated.

These prime-age workers who decide to forge their own financial destiny are in an advantageous position: it is likely they know of ways to make money in their given field that their previous employer wasn’t aware of, did not appreciate, was too risk-averse to implement, or was not in a position to consider due to downsizing and the hunker down psychology flourishing during recessionary cycles.

And this is where California agents and brokers come into play…

Though these optimistic and innovative individuals have the talent to start a new business, many lack the financial reserves necessary to make a commitment to rent space in which to develop their product and operate their company. Pair this condition with another existing market reality: a glut of vacant office, retail and industrial property (the result of massive overbuilding which occurred during the Millennium Boom) that cannot be filled by conventional incentives. Simply, there are not enough users around to fill all the vacant property.

Vacancy rates have increased across the board in the three major Southern California nonresidential markets since the beginning of the Great Recession. As of August 2010, vacancy rates in:

  • downtown Los Angeles hovered around 17%;
  • Orange County was 22%; and
  • the Inland Empire was 25%. [For more information addressing nonresidential property vacancy rates, see the August 2010 first tuesday article, Office vacancies deliver rock-bottom lease rates.]

Until employment levels begin to rise in California at regular monthly job increases of 25,000 to 30,000 (an annual rate of 300,000+ jobs recovered), nonresidential property spaces and rents, like the residential housing market, will continue to stagnate and falter.

Editor’s note – California eventually needs 40,000 additional employees monthly for 30 months to recover the 1,500,000 jobs lost since 2007 by 2016.

These vacant properties with no willing renters or buyers have very little chance of being rented or sold through traditional means in the coming years. Thus, these properties generate no income for their owners and provide no return until tenants can be found – users are the name of the occupancy game in the post-Boom market.

How can the owners of these vacant properties and the agents contracted to represent them tap into their potential to generate income?

Innovative agents can pair prime-age optimists and nonresidential property owners together in a mutually beneficial union.

Those agents intelligent and innovative enough to see the beneficial end use of a listed property can pair these two parties – prime-age optimists (read: visionaries) forming a start-up and nonresidential property owners – together in a mutually beneficial union. Since the start-up will have only minimal finance resources when their venture first launches, in place of rent, agents can negotiate with the owners of these vacant units to provide space to innovative start-ups in exchange for rent in the form of stock, stock options, percentage lease arrangements or other profit-sharing plans.

The owner has nothing to lose but time (a vacancy, not money) and has a chance of sharing in the success of the start-up if it succeeds. In this way, he is directly cutting himself in for a piece of the recovery action. Thus, the owner will be able to attain 100% occupancy by filling his vacant spaces, called incubator properties, with industrious tenants. When the recovery takes hold, businesses will expand quickly, and the rents will start to flowing in – and the landlord who became a quasi-venture capitalist will cash in as well.

Members of Generation Y are likely too inexperienced to launch a successful start-up (with a few obvious exceptions in the tech industries). Thus, a majority of start-ups will be founded by the legion of California’s unemployed prime-age workers who will become self-employed. Some may even pair with more experienced members of the work force, such as pre-retirement Boomers, or enlist the advice of retirees, known affectionately as the Service Corp. of Retired Executives (SCORE).

For an example of small start-ups which later became highly successful, look no further than the Silicon Valley. With the nascent small-business “green” movement gaining momentum in California, a second start-up boom may well be on the horizon.

How to attract a start-up: go green

Leasing agents listing vacant nonresidential property in this temporarily frozen-in-time real estate market realize that, even after using the most persuasive tool at their disposal to locate users (offering extremely low rents), they still cannot find users willing to pull the trigger and occupy leased space – not even to upgrade their space for the inevitable upturn in the economy.

Thus, an owner of vacant nonresidential property is faced with two choices, either:

  • let his office, retail or industrial space lay idle – fallow – along with the multitude of other vacant buildings competing for users; or
  • use this opportunity to improve the property by installing forward-looking improvements that increase its value and decrease its ongoing operating costs (and in the process, preemptively avoid future obsolescence of the property).

Thoughtful agents will advise owners of vacant nonresidential property to renovate and improve their properties now to entice start-up businesses to occupy the space and to ensure the properties are modern and suitable for traditional users when the market rebounds in the future as the California economy picks up steam and holds its momentum.

Editor’s note – Recent Orange County employment levels indicate something of a recovery is already underway, thus the ripple effect may be resonating out to the rest of California relatively soon.

Most of these property improvements should relate to improving the efficiency of the property, making it “greener” and more sustainable. These improvements could include:

  • adding additional windows or skylights to dramatically increase the level of natural light available within a unit;
  • replacing old HVAC units with newer high-efficiency units;
  • installing solar panels;
  • installing low-flow toilets; and
  • landscaping the exterior of the property with plants native to the area, requiring only reasonable amounts of water and upkeep.

This green retrofitting can transform an outdated, inefficient building into one prepared for the future: a magnate drawing in similar innovative and progressive tenants and start-ups. Curb appeal is the operative phrase.

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