San Luis Obispo County Economic Outlook 2004
Reprinted from University of California at Santa Barbara Economic Forecast 2004. Written by Greg Stafford and Steve McCarty of Stafford-McCarty Commercial Real Estate.

San Luis Obispo County Remains Resilient

Issues of the Year:

• Leased Commercial Properties continue to be high priced, i.e. low cap rates e.g. 7+/- cap rates for fully leased properties with quality tenants.
• Commercial lending rates continue to be at or near historic lows.
• Local unemployment continues to be low 3+/-% with no real apparent new job creation

Annual 20+/-% gains in home prices continue to grab the spotlight in the Central Coast overshadowing the relatively tame commercial real estate markets. The story for the commercial markets is one of relative stability with historically low interest rates as the underpinning for the Central Coast economy. There is extreme confidence in our local commercial markets evinced by the upward prices paid for the cost of ownership and lack of availability.

High replacement costs for new buildings are adding value to the current inventory. Owners of existing buildings are realizing significant equity from the increased costs of new construction-all ships rise with the tide, in a sense. Not surprisingly, this has been another active year for the commercial refinance market due to the historically low interest rates (lowest in last 45 years).

For the first time in recent history, there are unprecedented vacancies in apartments and homes within and around the City of San Luis Obispo primarily due to the addition of approximately 850 beds on the Cal Poly campus. Only time will tell if this development will lead to the softening of home prices within the area. The bleeding has stopped for manufacturing/commercial vacancies. 2002 saw the downsizing and closure of several prominent local companies. SLO County lost a great number of well paying jobs last year but, fortunately, that trend has subsided.

Employers are faced with the challenge of keeping and recruiting employees. A major hurdle related to new job creation is the high price of homes ($380,000, San Luis Obispo County median price). The high cost of housing is only a part of the larger problem with which companies must deal. Our region shares, as with the state, unpredictable energy costs, rapidly raising health insurance premiums, sky-rocketing worker's compensation costs, high tax rates, etc. all make it problematic for companies to remain in California and highly unlikely for companies to elect to re-locate to California. Therefore, the questions are, how, when and where can local service/manufacturing companies expand and fill our vacancies?

Affordable Housing – What is it? Where is it?
This year's dominant theme in local newspapers, radio talk shows and civic groups is "affordable housing". This endless discussion concerns what is affordable housing and how can it be provided through the traditional private development sector; moreover, where can it be provided. The major component of any new housing is the cost of land. Due to the high demand and low supply of housing in the central coast, land prices have escalated to such an extent that so-called affordable housing is a remote prospect without public subsidies.

Homebuyer disconnects (the inability of the local wage earner to purchase the local median home) have created the predicted larger numbers of commuters to the outlining areas. The previously overlooked housing market of San Miguel, at the northernmost part of the county, will experience many newcomers where the newest and most affordable products will be built.

Near term solutions are not clear. High new production costs will continue to set the market base data. The State of California record budget deficits have left little hope for municipalities to receive state assistance. Cities, counties and other entitling agencies are proposing titanic fee hikes-which further exacerbates the affordability dilemma.

As noted in the 2002 perspective, the Santa Maria area (approximately 110,000 population), at the southern end of the Central Coast, but in north Santa Barbara County, has major land annexations in process to accommodate population. In San Luis Obispo County, Paso Robles--the northern end of the Central Coast-- leads the way in the desire to grow by working toward a projected population of approximately 45,000 by 2025 (current population is approximately 26,000). As of last year, Paso Robles had over 1,500 residential units approved for construction with the bulk of land inventory for future build out in the County. And most recently, Atascadero is considering opening up larger areas for residential development with 800 residential units nearing approval.

Another question many are asking is, even if the cities agreed to build the additional state- mandated housing, will existing infrastructure be adequate to accommodate such growth, i.e. water, roads, sewer, electric?

Health Care
Health care delivery is still a major concern within SLO County. County General Hospital has closed and potential buyers for bankrupt French hospital are talking about shutting its doors leaving one hospital, from originally three, in the City of San Luis Obispo. However, there is a great deal of resistance by local citizens in allowing closure of French Hospital and have enlisted the help of the state's Attorney General. Templeton has seen an influx of physicians recently while San Luis Obispo has seen a diminution of practicing physicians. The primary reason for the loss of physicians in San Luis Obispo is simply there is virtually no available medical office space.

Pismo Beach and Arroyo Grande have responded to lack of inventory and have quickly oversupplied the market in the Five Cities area with the Pismo Medical Campus (58,000 sq. ft.) and the Pismo Beach Office Park project partly completed with 55,000 sq. ft. within the same community.

Investment Real Estate--Odd Bedfellows: Low Rents and Low Caps
Rental rates for newly constructed buildings in the CS zone in San Luis Obispo are dropping. Yet, valuations continue to set new high water marks. Buyers for income producing properties continue to pay higher prices. Commercial income product availability is virtually non-existent throughout the Central Coast.

As has been the case for the last two years, tax deferred exchanges continue to drive the market. In past years San Luis Obispo would command lower cap rates than the surrounding areas. Given the present climate, cap rates have evened out across the county. Last year commercial income properties sold at 8 to 8.5 cap valuations versus 9 to 9.5 cap rates two to three years ago. Today¹s market comparable sales are demonstrating 7 caps, about one point downward from 2002. The most noted example is 100 Cross Street purchased by the County of San Luis Obispo Pension Trust for $7,675,000, which represents a capitalization rate of 7.

Retail
In San Luis Obispo, Costco (140,000 sq. ft.) received approvals for a site adjacent to Home Depot which recently opened on Los Osos Valley Road. The opening is anticipated to be on or before third quarter of 2004. In addition, there is another 140,000 sq. ft. of ancillary building entitlements associated with the overall development.

Copelands is under construction of a retail/office/restaurant complex of approximately 52,000 sq. ft. in downtown SLO bordered by Osos Street, Monterey and Higuera. A parking structure for 243 spaces is planned at the northeast corner of Morro and Palm along with an office building of 16,000 sq. ft. The balance of the Copeland's downtown development (total of 200,000+/- sq. ft.) is being deferred to the future. Bill Bird's controversial Marketplace retail/commercial development planned on the Dalidio Ranch on Madonna Rd. is currently undergoing environmental review.

Generally speaking, rental rates for all types of product (industrial, retail, office) have remained relatively constant with little or no upward trends. The typical range for C-S zoned office space is $0.95 to $1.40/sq. ft./mo./NNN, $1.35 to $2.75/sq. ft./mo./NNN for retail and $0.65 to $0.80/sq. ft. for industrial space.

Retail vacancy remains low in San Luis Obispo (2.4% in 2003; 1.9% in 2002; 3.6 % in 2001) compared with other commercial market segments.

New retailers to San Luis Obispo now occupy recently renovated Madonna Plaza, with tenants such as Best Buy, Borders, Petco and Starbucks.

Industrial and Commercial
With all of the economic bad news it is remarkable that commercial real estate values remain strong with minimal vacancy, with exception of large C-S zoned office space in San Luis Obispo. There is virtually no large (10,000+ sq. ft.) commercial user demand for space, and minimum demand and minimum supply of retail and industrial/warehouse space. C-S product vacancy has stabilized, with a slight net absorption, at approximately 8.4%. (C-S vacancy rate for 2002 was approximately 9.7%.)

Product offerings have differentiated and larger spaces have been broken into smaller offerings, e.g., 10,000 sq. ft. units have partially leased and the units have demised into 5,000 sq. ft. offerings

Land Prices:
Industrial land prices continue to increase in San Luis upwards toward $12.00 per sq. ft. The availability of industrial land is virtually nil. This also applies to retail and office land availability.

An acre of industrial land in Paso Robles is approximately $4.00 to $6.00 per sq. ft. with on-site improvements. As there is limited supply in South County, in-fill parcels still range in the $5.00 to $8.00 per sq. ft. depending upon location and availability, if it can be found.

Lease Rates:
Industrial (C-S zoned) space rental rates can range from $0.80 to $1.40 per sq. ft. depending on tenant improvement allowances provided by the ownership. New construction drives the upper values.

New multi-tenant space with a modest build-out is approximately $0.55 per sq. ft. gross rent per month in Paso Robles.

Vacancy Rates
Little net inventory gains have been made from 2002 to 2003 in the San Luis Obispo area. Working from a combined building base of institutional, office, retail and manufacturing /warehouse of approximately 10,118,000 square feet, Stafford-McCarty calculates vacancy rates for the City of San Luis Obispo and adjacent County area inventory as follows:

2002

• 2.8% Industrial/warehouse
• 1.9% Retail functioning
• 9.9% Office functioning

2003

• 3.8% Industrial/warehouse
• 2.4% Retail functioning
• 8.4% Office functioning

Presently Paso Robles has the only available variety of inventory for small to medium sized industrial/manufacturing users. Available inventory in the Paso Robles market is scheduled to increase over the vacancy listed below as company cutbacks announced this year relinquish their leasehold interests first quarter 2004. Projected manufacturing vacancies will be 16% on a base inventory of approximately 2,100,000 square feet in the first part of next year. Retail and Office products have little vacancy.

• 9.4% Industrial/warehouse
• 1.9% Retail functioning
• 1.2% Office functioning

Agriculture
Paso Robles and Edna Valley regions continue to gain prestige and recognition-- with over 100 wineries in the County. Wine is the epitome of value added agriculture. The vineyard industry has been a key component of Paso Robles' appeal and downtown revitalization, which has served as an excellent example of Agri-tourism.

This year resembles last year in that quality product and premium grapes are finding buyers but many growers are still seeking to place product, as once again, vineyard production has exceeded demand. Vineyard production sales still surpass any singular vegetable crop even with the drop in sales from approximately $138 million per year in 2001 to $117 million per year in 2002.

Conclusions
Our demographics are slowly changing. Santa Barbara's community coined "newly wed or nearly dead" is becoming applicable to San Luis Obispo as well. The equity immigration-new residents bringing their money with them-is continuing. People are coming in but not with their businesses or worker base. Young families are electing to commute to the outlying communities where their housing dollar goes further. The region's unemployment rate is the one of the lowest in the state.

Construction related businesses and activities are an active part of the market segment. It is the opinion of the authors that interest rates remaining historically low and stable is the major factor keeping local commercial markets healthy.

Nonetheless, given the multitude of issues discussed in this article, there remains a high luster on the desirability to live in San Luis Obispo County.