Future looks sunny for Los Angeles.

Each city goes through its real estate cycles and Los Angeles has been no different. Following the stagnation of the 1970s, the i 1980s brought excessive development and speculation, while the 1990s were a time for contraction and caution in the real estate industry. Today, as evidenced by current marketplace trends and demographic data, Los Angeles appears to be poised for another real estate boom. It may not happen today, but it is on the horizon. This boom will be characterized by the real estate sector reinventing itself through urban redevelopment opportunities. Today's challenge is not over-investment in new properties, but rather under-investment and underutilization of existing real estate.

What lenders have learned

In the late 1980s and early 1990s, Los Angeles experienced a tremendous expansion of its economic base and real estate infrastructure. Homebuilders built on spec., hoping buyers would come; and commercial developers created properties, hoping business would fill the space. As recessionary woes and the excesses of over-expansion mounted, housing prices plummeted, businesses downsized and restructured, and commercial space experienced high vacancy levels as markets settled to lower equilibrium points. But since the correction of the early 1990s, banks have developed more insight about the market, and developers and have demonstrated discipline with regard to managing risks. Today, the Los Angeles real estate markets are generally very healthy and in equilibrium with the economic base.

The current market reflects a stronger influence from the rating agencies and Wall Street on the real estate industry than we saw 10 years ago. The emergence of commercial mortgage-backed securities (CMBS), and the underwriting discipline required by the conduits and the securities rating agencies such as Dun & Bradstreet, have stabilized and self-regulated the real estate capital market. Additionally, construction lenders remain focused and disciplined through their loan workout experiences of the 1 990s and are more sensitive to real estate market and business cycles. Today, attention is focused on sound fundamentals: strength and reliability of asset cash flow, and asset quality.

The coming boom in multifamily demand

In recent years, Los Angeles has become a city with a more healthy and diversified economy than in the past. The aerospace industry, once a monolithic economic driver, has splintered into technology, dot-coin and consumer electronics sectors, which has fueled entrepreneurial energies and economic diversity in the area. In addition, the war on terrorism has triggered a military defense boom along the Los Angeles-San Diego corridor, with many high-paying and skilled jobs expected to be added the region's economic base in the near-term.

In hindsight, Los Angeles was not the most efficiently built city, as evidenced by sprawling developments and incongruous land uses in all directions. There has been a disconnect between what urban planners intended, population growth, and economic evolution. Our metropolis, as we know it today, is ill equipped to succeed in the 21st century. Recognizing this, property investors, developers and urban planners have started dialogue to align strategies and achieve mutually beneficial results.

All these factors come into play, given the region's position as the fifth-largest economy and prospects for continued population growth. This. anticipated population growth will have a direct impact on the multifamily market, as well as other property sectors.

In the past 20 years, a huge influx of Asian and Latino immigrants have come to Los Angeles seeking economic opportunity and a warm climate, and this trend is not expected to slow. The continued inflow of people will further stress the already tight housing supply in the next several years. Due to short housing supply and increasing rental rates, many Los Angelenos have resorted to doubling up in apartments.

The apartment housing situation, with aging and sub-standard housing stock the norm, is exacerbated by the lack of investment in new development. This under-investment reflects the originally-intended protection of public interests gone awry: rent control, residential downzoning, and a costly, lengthy, highly political project approval process. Many new apartment developments are only economically feasible through governmental subsidies, zoning variances that accommodate higher densities, or higher rents that are beyond the reach of many working Los Angelenos.

However, solving the chronic shortage of quality and affordable apartment housing will require urban planners and developers to balance regional housing needs against the realities of capitalist economics. It won't be easy, but therein lies a huge opportunity that would benefit all.

Impact on office and retail properties

Also affected by Los Angeles' population growth are commercial properties. The recent increase in office vacancies has exerted additional competitive pressure on Los Angeles-area landlords, and tenants continue to capitalize on the situation. While there are pockets of softness in the office sector, this property category has generally remained above water in the current economic downturn. Unlike the 1990s, the current softness reflects a contraction on the demand side only, rather than the i 990s double whammy of contracting demand and excessive supply. Given present low levels of speculative office projects, this property segment should demonstrate resilience as the economy improves and job formation picks up. New development opportunities will likely be constrained by land availability for redevelopment.

With regard to retail, redevelopment continues to benefit the long-term health of this property segment. Recycling existing building inventory is keeping the area's high-profile retail properties fresh and competitive. However, many "mom and pop" retail properties are functionally obsolete. And, they are not economically efficient given increased land values, new highest and best uses, and incompatible surrounding property uses. Economics seem to be in balance for this segment, thereby facilitating the redevelopment process. The primary risk is oversupply.

Our industrial segment remains robust, reflecting the region's role as a hotbed for entrepreneurial opportunities, a home to many mature businesses, a regional distribution hub for the western United States, and a gateway to the Pacific Rim. Redevelopment of in-fill properties will likely benefit small-to-medium size industrial users, and larger users will be driven inland, where vast swaths of available and more affordable land will support their needs.

The future of Los Angeles real estate looks positive, but its ability to reinvent itself will depend heavily on increased cooperation and creativity between the development and planning communities. Solid fundamentals are in place, the desire is strong, and momentum is here. Los Angeles is on the cusp of a new vitality.

Greg Rickard is district manager of Key Commercial Real Estate's Los Angeles office.