California was last to enter the nation's recession and it may be the last one out, according to predictions by economists and industry leaders. One major woe is a $38 billion budget deficit that will hurt local governments' ability to provide services. The deficit will also trickle down to businesses in the form of fee hikes and fewer government contracts, as the state looks for ways to cut spending and generate more revenue, suggests Jack Kyser, chief economist at the Los Angeles Economic Development Corp. (LAEDC).

The year's earlier predictions for job growth have been pared back due to the ever-increasing cost of doing business in California. Other negative business factors include the state's paid family leave mandate that becomes effective Jan. 1, 2004, and an increase in the employer contribution to the unemployment fund. The state's overall unemployment rate did decline slightly from 6.8 percent in June to 6.6 percent in July; it was 6.7 percent a year earlier. However, the report predicts that California's economic recovery will lag the nation's, which is expected to rebound during the second half of this year and into 2004.

Meanwhile, other concerns that run deep into the state's social fabric are the high cost of living and the lack of affordable housing. John McDermott, regional manager for Sperry Van Ness in Southern California, contends that the high cost of housing poses a major barrier to entry for businesses, because “Where are their employees going to live?” With rent averaging more than $1,200 and home prices averaging $350,000, he says, “Too much of what people earn is going into housing. They are leasing cars they can't afford to buy and living on credit.” Adds McDerfmott: “High consumer debt will result in more personal bankruptcy.”

On a brighter note, lower interest rates put additional cash in consumer pockets, sending total retail sales up 3.3 percent in 2002 over the previous year, according to the LAECD report, which predicts that sales will grow a moderate 2.3 percent this year. Value-minded shoppers gave big boxes and discount chains most of their business, while middle-market retailers toughed it out amid competition from newcomers like Kohl's, which entered California this year, as well as rising costs related to security/terrorism and supply disruptions from the SARs outbreak and labor disputes. A number of retailers expanded, causing retail vacancy to drop 10 basis points in Los Angeles County to 5.2 percent, down from 5.3 percent a year earlier, according to Marcus & Millichap. Rents increased 3.1 percent to an average of $22.32 per square foot and are expected to go up another 2.5 percent this year. Community and neighborhood retail centers anchored by a grocer were by far the most popular with investors, which is evidenced by an 11 percent rise in sale prices for this product type and record low cap rates of 7 percent to 8 percent.

But with the controversial recall election scheduled for Oct. 8, California's economic future remains uncertain, at best. The state's economy could be in the hands of an action hero, a skin mag publisher or even a porn star.

CALIFORNIA INTELLIGENCE

What retail real estate execs are talking about in the Golden State.

One real estate rep for a large ethnic grocer in Southern California decided not to hire a star broker at a major firm because of his big mouth. The broker was talking up his current deals so much the publicity-shy retailer decided to stick with a smaller firm for more confidentiality…CBL & Associates Properties is following its manifest destiny with plans to develop its first West Coast mall. The Chattanooga-based REIT is joint venturing with MGHerring Group to build a 768,000-square-foot regional mall in California's Imperial Valley region (right)…Forever 21 shored up its L.A. presence with the $3.5 million purchase of Reference, a 14-store specialty chain aimed at women aged 13 to 30. Forever 21 plans to overhaul signage and inventories to return the Reference chain to profitability…Trimark Communities is developing the first whole planned community to be founded in the U.S. since Walt Disney Co.'s Celebration, Fla., in 1996. Called Mountain House, the town is located east of San Francisco and will eventually be home to 44,000 residents. Plans include an “old-fashioned” downtown with retail space…The owners of one SoCal community center are paying more than $17 million to renovate the property, even though its previous owners had just renovated it. The reason for the rehaul? The new owner's wife wasn't a fan of its Moorish architecture…California shopping center owners are being sued by a litigious quadriplegic. Several companies against whom the individual has filed ADA compliance claims allege that the man has agents who scope out shopping centers for ADA violations before giving him the green light to visit the center and subsequently file a complaint…Mills Corp.'s acquisition of the Great Mall of the Bay Area in Silicon Valley presented the REIT with a Catch 22. The company had to score an attractive price on the deal. But because the mall is a value-oriented enclosed regional mall, much like Mills' standard property, it couldn't achieve a cap rate that was too high without making investor's question the cap rates they use to calculate Mills' NAV. Pundits say Mills didn't have a lot of competition in the bidding war for the property. The deal's cap rate is 8.6 percent…More changes are under way in San Francisco's Union Square. Neiman Marcus hired Atlanta-based Niles Bolton Associates to add a new sixth floor to its Geary Street store and create a pedestrian feel at street level'More changes are under way in San Francisco's Union Square. Lend Lease Real Estate Investments has commissioned broker Madison HGCD to find a tenant for its 40,000-square-foot former FAO Schwarz property down the street from Apple Computer's new flagship store and Neiman Marcus hired Atlanta-based Niles Bolton Associates to expand its five-level Union Square store by 60,000 square feet both horizontally and vertically.

California by the Numbers

JOB DROUGHT

San Diego employment growth took a nosedive in the first half of 2003 to -0.92 percent in June. By comparison, San Diego's total employment grew 2.1 percent in June 2001. And while San Francisco's job growth has remained more consistent, it's consistently bad, down more than two percent each month in the first half.

DELIVERIES DOWN A NOTCH

In major California markets, retail developers are still churning out new space, though not at 2002's volume. Los Angeles leads with 4.2 million square feet online, down from more than 5 million in 2002. Riverside/San Bernardino, located in the Inland Empire, maintains a steady pace with 1.85 million square feet this year.

WHO'S NEXT DOOR?

Safeway is vulnerable to Wal-Mart's expansion into California, according to Morgan Stanley research. More than 17 percent of Albertsons stores in California are facing off with a Wal-Mart within a 5-mile range.

NOT SO CHEAP

San Francisco is the most expensive market in California for grocery-anchored space.

Average Neighborhood Center Rents
Market Average Rent ($ per sq. ft.)
San Francsico 74.5
Santa Clara County 30
San Mateo County 27.5
San Diego 30
Ventura County 27
Source: NAI 2003 Real Estate Planning Guide