Son of Boom

On the cusp of Southern Nevada’s economy returning to form – i.e. the Recovery Index is almost back to its 2005 level, it might be a good idea to examine the economy we’ve built over the past 10 years. The “Son of Vegas Boom” is a different cat than the “Vegas Boom”, and there are pros and cons to what we have become.

The recovery index above tells the tale. It shows numerous measures of the local economy, comparing their year-over-year performance. These indices compare current performance to an arbitrary date in the past, in this case January 2005. You can read the current level as a percent of the level in 2005.

On the positive side, we see Gaming Revenue, Employment, Taxable Sales and LA Port Traffic are all better than they were a decade ago (though not by much). Commercial Occupancy and Visitor Volume are nearly there. The takeaway – Southern Nevada’s gaming business is doing well. People are back to work and locals and visitors are spending money.

Two measures are well below where they were a decade ago – New Home Sales and, the driver of the home sales, In-Migration. In-Migration here is actually the out-of-state drivers licenses turned in at the local DMV. It suggests that Southern Nevada is no longer growing at the rate we used to. This population explosion was a key driver of the construction sector in Southern Nevada, one of the two pillars (with gaming) of the old economy.

Electric meter hook-ups tell a similar story of slower growth, and construction jobs, while they have in recent months shown improvement, remain well below boom levels.
This leads us to the two problems with the new economy. First and foremost, our eggs are truly all in one basket now – hospitality. We also can no longer rely on population growth to get us out of national (or global recessions). In the good old days, hundreds of new incomes coming to the valley every month created a buffer for Southern Nevada in times of recession – that buffer is effectively gone.

That means that when the next recession hits – likely within the next one to three years – Southern Nevada can expect to experience it in much the same way as the rest of the country (or planet). Keep this in mind as you advise clients in terms of expected return on investment properties, assuming they plan to hold them for fewer than four or five years, and on tenant renewals.

Stronger Headwinds in 2016

The general prognosis for the U.S. economy is for stronger headwinds to economic growth in 2016, but only a slight chance of recession, with the odds of a recession stronger in 2017. What this future recession might look like is anybody’s guess. Recessions like the one that hit in 2008 are relatively rare. Most recessions are a result of an economy overheating – producers produce too much for consumers to consume, everybody takes a little bath and then the economy gets back to growth one or two quarters later. The odds would suggest that a correction of this sort is all we’re in store for in the next few years, though global events and the lack of reform in Washington, D.C. keep the possibility of something more severe a possibility, albeit unlikely.

The two questions we should be asking are, first, what are these headwinds that might blow the economy off course, and second, how likely are they to impact Southern Nevada.

We’ll tackle the second question first. While Southern Nevada once had a reputation for being recession proof, the Great Recession put that myth to rest once and for all. In truth, Southern Nevada had never been recession proof, but tended to enter recessions late, and recover early. In the case of relatively minor recessions, the impact often went unnoticed. Southern Nevada had population growth to thank for this. Even when the locals were feeling the pinch of recession, more locals with additional incomes were moving into the Valley and offsetting the local weakness.

Southern Nevada can no longer depend on that kind of growth to keep recessions light. Population growth in Southern Nevada is lighter than a decade ago, though any growth in a region can help ameliorate a recession somewhat. Of course, each recession has its own particular character, and the character of a recession is a major factor in which regions and localities suffer the worst.

This brings us to the question of those headwinds. On a global scale, there is economic difficulty in Japan, China and Europe, and trouble in the natural resources sector has impact Canada, one of America’s most important trading partners. On the off chance that these troubles triggered a major global recession, Southern Nevada would of course feel the effects. More likely, these troubles will have a small impact on Southern Nevada’s tourist industry, and otherwise leave the Valley unscathed.

The more serious problem for Southern Nevada is the transportation sector. Globally, there is an over-abundance of transportation resources, and this is impacting transportation companies. In the BLS’s most recent numbers, there are two components of transportation employment that could impact Southern Nevada’s industrial real estate sector – truck transportation and warehousing and storage.

The warehousing and storage sector saw jobs decrease by 0.4 percent from December 2015 to January 2016, while truck transportation increased by 1.5 percent. A mixed bag, but on the whole probably positive for Southern Nevada and its warehouse/distribution sector, which have been surging over the past year. The most recent numbers we have for Southern Nevada show the growth in transportation and warehousing employment slowing slightly at the end of 2015 after strong growth through most of the year. The sector added 200 jobs month-over-month in December 2015, and 1,500 jobs on a year-over-year basis.

The prognosis for Southern Nevada remains positive in 2016. There could be a small disruption in the warehouse/distribution sector if transportation suffers nationally, and developers who do not have pre-leasing in place in planned projects may want to be cautious about beginning construction on those projects. Tourism saw weak gaming revenue numbers in the latter half of 2015, which could point to overall spending by tourists softening, but this softening is probably not strong enough to throw the industry off the tracks in 2016. Retail employment on a year-over-year basis has been weak in Southern Nevada (losing 4,900 jobs between December 2014 and 2015), but that weakness has not been evident in taxable sales numbers (which, admittedly, lag a couple months behind). Again, this might point to caution rather than worry. The construction sector, which languished during the recession and most of the recovery, is now showing strong growth, suggesting that the local economy is expanding, rather than just recovering. Cautious optimism is probably the phrase that pays for Southern Nevada’s real estate market in 2016.

One last graph before I go. This tracks year-over-year job growth in three sectors, Alpha Employment, Beta Employment and Gamma Employment.

Alpha employment are jobs that drive an economy and bring money into the economy. For Southern Nevada, it includes natural resources, construction, leisure and hospitality and a portion of food and drinking places jobs. In the graph, you can see that alpha employment growth has been on the slide for the past few months.

Beta employment supports alpha employment. Theoretically, it consists of jobs that were created as a result of alpha jobs. It has also been sliding.

Gamma employment is government jobs, which are not designed to make money, and to some extent draws money out of the private sector. Gamma growth has jumped around a bit, but has been positive for the past four months.

This is a scheme I've only just started to explore, so no big revelations yet, but I think an interesting thing to watch.

Escorting the Gorilla from the Room

If you have paid attention to the Las Vegas economy for any period of time, you have heard of the city’s economic Holy Grail … Diversification! We rely too much on the hospitality industry, and must diversify if we are to survive. Never mind the fact that we’ve gone from a population of about 5,000 people to around 2 million people in the last 100 years fueled by hospitality (they called it gambling back in the day), the future holds nothing but heartbreak if we do not diversify.

Of course, there is some truth to this. A more diverse economy would certainly boost Southern Nevada’s fortunes in the face of another economic downturn or a terrorist attack that struck the tourist industry. Diversification, though, is not necessarily easy. Industries operate in places not only because those places want them, but because those places offer a competitive advantage for them. The steel industry didn’t spring up in what we now call the “Rust Belt” because the local city fathers or chambers of commerce invited it. It arose where there was a ready supply of iron and coal and an efficient way to transport those raw materials to the foundries and the finished steel to its customers. A competitive advantage can be created by governments. Gaming predominates in Southern Nevada because Nevada made gaming legal. Southern Nevada also has lots of sunny days and nice weather – another boost to tourism. Government can also create a competitive advantage by offering financial incentives, but that is a very expensive way to attract new businesses to a region.

The other day, I decided to conduct a little experiment. I wanted to discover just how “un-diverse” the local economy was compared to other large cities. To do this, I decided to compare Las Vegas to another economy that is dominated by a large industry, in this case Houston, Texas.

The experiment was simple. Using the official employment numbers for the Las Vegas MSA and the Houston MSA, I backed out each community’s 600-pound gorilla – hospitality for Las Vegas, “mining & logging” for Houston (which includes the oil industry), and then looked at the percentage of jobs in the other employment categories. Here are the results:

The main differences between the economies are more manufacturing in Houston than in Las Vegas (possibly stimulated by the petroleum industry and Houston being a port city), and more trade, transportation and utility employment in Las Vegas than in Houston (possibly stimulated by the hospitality industry). Had I done this comparison several years ago, Las Vegas would have also shown a predominance of construction jobs – not surprising in a city as young as Las Vegas and one growing at such a rapid rate.

The bottom line – Southern Nevada, like many cities, is dominated by an industry that has found it a particularly competitive place to be located. Outside of that industry, Southern Nevada is not terribly different from Houston in terms of how people there make a living. As Southern Nevada grows older, the economy will likely grow more diverse, or at least as diverse as it needs to be.

Not Obsolete - Demand Challenged

A few weeks ago, I began an investigation into obsolescence of buildings in the office market here in Southern Nevada. The question has been floating around for several years now: Is obsolete space artificially increasing Southern Nevada’s office vacancy. This is an interesting question, and not an easy question to answer.

The first challenge is in identifying what makes a property obsolete. The factors might be structural (i.e. how the property is designed) or geographic (i.e. where the property is located). The character of the ownership of a property might make it obsolete as well. All of these are important factors, but they not necessarily easy to quantify – at least not when you have a few hundred properties to work with.

The term obsolete is itself a problem, as needs change over time, a formerly “obsolete” property can become viable once again. Witness the brief moment before the Great Recession when vacant retail big boxes suddenly became attractive to call centers (before they moved to India and then moved back to the United States ...).

For my part, I decided to ditch the term obsolete, and use the term “less desirable”. To decide whether a property was less desirable, I first examined the lease comps we have collected over the past three years to determine the average time on market for each class of office.

On average, Class A availabilities remained on the market for 2.7 years before they were leased. Class B availabilities remained on the market for 2 years. Class C availabilities for 1.6 years. I then assumed that an availability that was on the market for twice as long as this average period of time was “less desirable” for one reason or another.

Using this assumption, I got the following stats:

Class A: 25% of available space is less desirable
Class B: 25% of available space is less desirable
Class C: 34% of available space is less desirable

If you removed this less desirable space from the market (without removing the “less desirable” buildings this space is in from total inventory), you would bring office vacancy down to around 13 percent. This appears to make the case that the office market, though not as healthy as it was before either the Great Recession or the Boom, is not as unhealthy as it seems.

I wasn’t done, though. I decided next to look the situation on a building by building basis, using the office market as my test case. It is possible to have a less desirable available unit in an otherwise desirable property, so simply looking at less desirable availabilities can skew our results. I wanted to figure out which properties in Southern Nevada were generally less desirable.

To figure out which buildings would make the list, I tallied the “less desirable” space in each building. If that space represented 50% or more of that building’s total size, I deemed the building “less desirable”.

What did I learn from this experiment?

1. There is a great deal of old space available in the office market. Medical office space is worse off than professional office space, and office space is worse off than industrial and retail space.

2. Medical Class B and Industrial Flex space stay fresher longer; the average Class B Medical unit was on the market for 1030 days before it leased, and for Flex 1380 days, indicating that tenants in these product types don’t care much if a space has been vacant for an extended period. Quickest turnover is in Incubator, Medical Class A and C and in Strip Centers.

3. Less desirable buildings are not the same thing as old buildings. The average age of less desirable buildings is 16 years, but the buildings themselves range in age from 5 to 37 years old.

4. Old parts of town do not dominate in the less desirable category. Properties built in the waning days of the Boom have struggled to absorb space. If any submarkets dominate, it is the Southwest along the Beltway, the Airport submarket and West Central. East Las Vegas, Henderson, Northwest, Downtown and the small North Las Vegas submarkets actually come off pretty well.

5. The Beltway is not a bust, but it does not seem to automatically increase the desirability of office space. Many of Southern Nevada’s less desirable properties are located near the 215. As alluded to above, the old center of the Valley – what we would characterize as Downtown, East Las Vegas and West Central – have the fewest “less desirable” buildings.

Into the Weeds with Employment

For several centuries now (or maybe it just feels like centuries), I have tracked Southern Nevada employment and used it as an aid in determining future performance of the industrial, office and retail markets. The concept was simple. Tie the different sectors of employment to the product types, look at the employment trend, and extrapolate commercial real estate performance. More jobs usually means more occupied square feet.

This was fine as a thumbnail sketch, but there were weaknesses in this concept. The employment sectors used by the State of Nevada for a given business do not always relate to what that business is using its occupied space for. A manufacturing company, for example, might take industrial space in which to actually manufacture things, but it might also take office space for its executives and accountants and such. Whether the company is in industrial or office space, it is still a manufacturing company, and its employees might – might! – be included in the manufacturing category, whether they are in industrial or office space.

I decided a few months ago to try to figure out, as nearly as possible, what percentage of jobs in these different employment sectors were tied to the different types (and subtypes) of commercial real estate. To do this, I downloaded random groups of companies from Sales Genie. This data included the SIC code for the company in question, its address and the number of employees at that location. I then cross-referenced the addresses to the properties in our own database, and thus determined the product subtype occupied by each business. It was then easy to discover how many employees from each SIC code were stationed in each subtype (and class, in the case of office properties). Granted, time restraints forced me to rely on random samplings of businesses, but I plan to revisit this process each year to further refine my data.

For an example, let’s look at industrial space. In the past, “industrial employment” was a sum of the following employment sectors: Construction, Manufacturing, Transportation & Warehousing and Wholesale. Now, I know that industrial properties take in a share of virtually all sectors of employment. Because of this, I know that industrial employment is actually larger than previously thought, and the drop in employment between 2010 and 2011 less severe.

The above table shows the change in estimated industrial employment between the old method of calculation versus the new method of calculation.

As a result, I think I have a much better idea now of how changes of employment impact the different property types, and therefore have an improved aid in predicting future demand.

Retail and Culture

Once upon a time, it is said, the United States of America had a mono-culture. All Americans, they say, watched the same programs, listened to the same music, ate the same food and wore the same clothes. This is not quite right … but it’s almost right. There was a time when the mainstream of culture was pretty wide. To some degree, this had a lot to do with the means of communication. In the 1930’s, for example, major theatres were owned by the major film studios, and played the movies of those studios exclusively. When this was broken up, the studios had to work harder to get butts in seats – they could no longer funnel people in to see their big films. Likewise television. In the 1960’s you have three major networks and maybe one or two local channels showing re-runs. In the 2000’s, you still have the big three (well, four including FOX), but you have a couple hundred cable networks and, more importantly now, Netflix, Hulu, and YouTube. My daughter watches more YouTube and Netflix in a day than television by a wide margin.

As the choices available to consumers has multiplied, the so-called “mono-culture” has fractured. Various TV shows, magazines, movies, books and songs that are popular no longer penetrate the overall culture to the extent they once did. One can still point to the best-selling comic book of 2015, for example, but its sales numbers are so anemic they would have gotten it canceled after a single issue back in 1970. Take movies for instance.

The graph above shows the number of tickets the top grossing movie of each year sold as a percentage of the U.S. population in that year. There were ups and downs, and some notable major successes: Gone with the Wind wins hands-down, but The Ten Commandments, The Sound of Music, Star Wars and ET: The Extra-Terrestrial are all pretty popular movies, being viewed, so-to-speak, by about the half the people in the country (well, probably not half, since plenty of people went twice or three times, but you get the idea). Titanic was maybe the last movie to get quite that much penetration into the culture. People made a big deal about Avatar, but in terms of cultural penetration, it didn’t do much better than some of the weaker films of the 1940’s. The trend line on the graph shows the overall rise of the movie in importance to popular culture, and the subsequent fracturing of that culture beginning in the 1970’s and continuing to this day.

So what’s the point?

I wonder if the continued fracturing of the culture also means a fracturing of people’s shopping habits. As sub-cultures on the fringe become larger in comparison to the shrinking “mainstream”, retailers will have to diversify their stock to serve them, which would suggest larger stores, or we will see the rise of specialty stores with higher price points (small sub-cultures cannot take advantage of economies of scale the way a monolithic culture can) and less real estate, i.e. smaller shops.

To date, the trend does seem to be “smaller is better” for anchors, though to be fair the trend was “larger is better” just a few years ago. Cultural fracking is probably not the source of these particular shifts. If the trend is for smaller locations, it might take many years to realize it in terms of statistics, since retailers are often forced to take space that is anywhere from 5 to 20 years old (or older). More likely, we would first see the trend in lower rental rates, as niche retailers are forced to take more space than they need, and seek to redress this by paying less for the space. Something to think about and look for in the coming years.

JMS

Almost There

When the Great Recession hit, back in ’08 (read that as “aught-eight” if you want to sound like an old pioneer), I decided to begin tracking the recovery that I assumed would eventually follow. I devised an index of economic measures that I thought had an impact on commercial real estate, and began tracking them. Month in, and month out, for eight years I’ve tracked these numbers, watching the index get worse, at first, and then begin to show some upward movement. Today, I am proud to announce that the index has almost returned to where it was in January 2005, midway into the boom.

Since historical context is valuable, the Recovery Index goes back to 1996. For that year, the index averages 68.5, which can be interpreted to mean that the local economic drivers of commercial real estate were about 69 percent as strong in 1996 as they would be in 2005. In 2006, the strongest overall year for the local economy, the index averaged 106.5. The highest index measure was in September 2006, when it hit 108.8. The worst year for the local economy was 2010, when the index averaged 84.7 – still well above 1996, but well below 2005. The lowest measures of the index came in April and May of 2010, at 83.3. Essentially, the Great Recession brought the local economy back to where it had been during the early 2000’s, erasing seven years of growth.
So far in 2015, the index has averaged 96.6, roughly equal to mid-2004. The highest recent measure was in September 2015, at 98.9. We’re at about 99 percent of where we were in 2005, a decade ago.

Of course, not all measures are increasing at the same rate. At this point, five of the eight measures are back over 100 – Gaming Revenue, Visitor Volume, Employment, Taxable Sales and LA Port Traffic. These measures range from 101.5 (visitor volume) to 120.9 (taxable sales), and suggest an improved commercial economy – people are buying more, making more and shipping more. Commercial occupancy is at 97.6 – nearly back to where it was in 2005.

The current weakness in the local economy comes from a lack of population growth. The Driver’s License Count is now at 73.9, indicating that migration into Southern Nevada is now at about 70 percent of where it was during the boom. The strongest migration into the area came during the winter of 2003 (and in fact, in-migration always seems to spike during the winter). More significantly, the Driver’s License Count averaged 89 during the mid-to-late 1990’s, so we’re now getting far fewer people moving into Southern Nevada. Migration was actually even stronger a few years ago, in 2012, than it is now.

When you consider the recovery we have seen in taxable sales without the influx of new people into the Valley, you realize how much the local economy actually has recovered, and how much stronger that recovery would be with continued strong immigration into Clark County. The real loser from this lack of population growth has been New Home Sales. That number now stands at just 22.8 – we’re selling approximately 23 percent as many new homes now as we were in 2005, and about a third as many as we were in the 1990’s.

The local economy has come a long way since the depths of the Great Recession, but new home sales and migration into Southern Nevada are still mired in the Great Recession. Perhaps this is the new normal. The key point is that despite population growth and the residential construction industry, two former pillars of the old normal, being so weak, Southern Nevada’s economy is close to reaching the strength it had before the Great Recession hit. This change to the “new normal” has been accompanied by changes in the demand landscape of the commercial real estate sector. For example, warehouse/distribution in particular and industrial in general is in high demand, while office and retail users are finding new ways to maximize their use of space (i.e., they’re doing more with less). Getting to know the “new normal” and what it means for your clients and their real estate needs is key to your success as a broker.

The Impact of Cheaper Fuel

Will lower fuel prices cause a spike in visitation to Vegas this summer? More importantly, will lower fuel prices give a boost to commercial real estate?

Generally speaking, when prices fall, people buy more, and when they rise, they buy less. Nothing ground-breaking in that statement, and suggestive that lower fuel prices will mean more people driving and flying to Las Vegas in 2015. But let's take a closer look before we commence dancing in the streets.

According to AAA, Las Vegas’s average gas prices have fallen by from $3.44/gallon one year ago to $2.896/gallon today, a drop of $0.544. Los Angelino’s have seen a $0.52 drop in gas prices, year-over-year. Let's assume a $0.53/gallon drop in fuel prices. The trip from Los Angeles to Las Vegas is about 270 miles. The average car in the United States gets about 21 miles to the gallon, so with the current savings in gasoline prices, you can now make the round trip with a whopping savings of ... $14! I cannot imagine that many road trips to Vegas have been derailed for the lack of $14. Some have, I'm sure, but probably not many. I also wouldn't bet on airfares dropping too much either. Airlines do not seem too generally not inclined to pass savings on to their passengers these days unless they absolutely have to. I don't think lower gas prices will have a major impact on visitation to Southern Nevada.

The effect of lower fuel prices on local consumers is where the potential for a benefit lies. Less money spent on gasoline means more money available for other things, the likely beneficiary being non-gas station retail stores.

In 2014, gas stations took in an average of $23.8 million per month. In of 2013, gas stations took in an average of $23.6 million per month. So, Las Vegans spent an additional $0.2 million per month at gas stations, year-over-year, while fuel prices dropped an average of $0.11 per gallon. Not suggestive of money flowing away from the gas stations, and lower prices at the pump may stimulated non-fuel spending at the convenience stores connected to gas stations, keeping that money "in the family".

Other retail stores took in $1.436 billion per month in 2014, versus $1.348 billion per month in 2013. So, Las Vegans spent $88 million more per month in other retail stores in 2014 than 2013. Perhaps this represents more spending on retail because of lower fuel prices, but then perhaps not.

The big retail boost in Las Vegas was in nonstore retail (i.e. online and, presumably, mail order sales). Now, these numbers are for such businesses paying taxes in Las Vegas, so the money spent does not necessarily come from Las Vegans. Still, taxable sales in nonstore retail climbed from a monthly average of $30.7 million in 2013 to $48.3 million in 2014, an increase of $17.6 million per month.

Many interesting figures, but nothing solid to indicate the impact these lower fuel prices might have on non-fuel related businesses in Southern Nevada. Let's take a different tack. Imagine if the percent reduction in fuel prices from March 2014 to March 2015 (16.3 percent) translated in a 16 percent reduction in spending at gas stations. That would free up $45.7 million dollars, annually, to be spent in other sectors of the economy. That represents just one-tenth of one percent of the total taxable sales in Southern Nevada in 2014 ... and it's probably significantly more money that will actually move from gas stations to other retail.

My prognosis: Don't expect any major impact on commercial real estate from the lower fuel prices we are not experiencing. Fortunately, commercial real estate is in a recovery, and it now appears to be a solid, sustained recovery. A boost from lower fuel prices would be welcome, but at this point it is not necessary to keep commercial real estate growing.

JMS

Art and Science

They say that economics is an art as much as a science. This is actually a fancy excuse for why economists have to spend so much time finessing and guessing – the truth is, there’s more information out there than we know or can know, and so we have to collect what we can, when we can, connect the dots, and present the most complete picture possible of the current state of the economy, and where it might be headed.

For the past seven years (!) I’ve maintained an economic index called the Commercial Real Estate Recovery Index. I use it to predict near future demand for commercial real estate in Southern Nevada. To look at now, you might not guess that Southern Nevada is kicking ass at the moment, economically speaking.

Looking at the index, we find year-over-year growth in most of the data points that make up the index, especially port traffic in Los Angeles (not a key data point, I grant you, but it does show 11.2 percent growth year-over-year, and some of that cargo makes its way to and through Southern Nevada), taxable sales (6.8 percent growth y-o-y), and employment (3.2 percent growth y-o-y). Only one measure is tanking at the moment, and it is unfortunately an important one: New home sales are down 21.8 percent from one year ago. Since 2010, the index has grown by an average of 0.2 percent per month.

We have positive growth, but not wildly positive growth. So why am I saying that the economy is kicking ass? Because the numbers do not show everything. The jobs data collected by the state, for example, is “establishment based”. This means that the data gatherers poll a variety of existing businesses and ask them whether they’re hiring or firing. Based on their responses, the state decides how many jobs were likely created and/or destroyed, and comes up with a number. What this process does not capture, of course, is jobs created in newly created businesses.

Using a new method of allotting jobs by industry into the different sectors of commercial real estate, we get the following job picture:

A few take-aways from this graph: 1) The recession hurt different sectors to different degrees, and those sectors responded to that pain in different degrees. The industrial sector took the biggest hit in terms of lost jobs, but the industrial real estate market is in much better shape than the office market, which already appears to have regained the jobs it lost during the recession. 2) Employment in the different sectors peaked at different times - industrial first, then professional office, and finally retail. Medical office employment flattened for a brief time during the recession, but didn't actually peak until 2013 - I can't imagine what might have caused that. 3) Industrial jobs - really construction jobs - have stubbornly stayed lost during the recovery, while professional office jobs seem to be back to their pre-recession level and retail jobs have surpassed their pre-recession level. Unfortunately, this job recovery has not been matched by an "occupied square footage" recovery - this suggests a transition in how space is being utilized. 

The problem with the paragraph above, though, is that it takes for granted that the employment picture it depicts is completely accurate. Alas, it is not.

What the graph above does not capture – the “known unknown” – is how many jobs are being created in newly created businesses. Here, I have to fill in the blanks with my own anecdotal knowledge of the amount of lease and sale activity I’m seeing while I update my database on a daily basis. I don’t have this information dropped into a spreadsheet and calculated and analyzed yet, so I cannot offer any concrete numbers, but my impression is that new business creation is high and it is this new business creation that is driving commercial real estate activity at the moment.

Thus, the numbers we have look pretty good, but I believe the numbers we don’t have look even better, and therefore, using a little finesse and guess, that Southern Nevada’s economy is in better shape than the current numbers suggest.

Of course, I sincerely hope now that I've said this that an “unknown unknown” doesn’t pop up and make me eat crow.

The Eyes of the Nation Are Upon Us

During the boom years, the mantra for many large, national corporations was “You have to be in Vegas” – especially if you were in the retail business. The Valley was growing at a remarkable pace, and all those new customers were irresistible to big business.

Then 2008 happened, and the passion really left the relationship.

During the Great Recession, Southern Nevada lost jobs, residents and, of course, dollars. As incomes dropped, in both size and number, Las Vegas lost its luster in the eyes of big business. This reversal of interest was inevitable, given the circumstances, but it didn’t happen overnight.

As far as two years into the Great Recession, national companies were still taking space in Southern Nevada – perhaps because their competitors were going out of business and leaving gaps to be filled, and because rents were dropping fast. In 2009, we recorded lease comps in Southern Nevada totaling 2.4 million square feet by companies with national or international reach. This fell slightly to 2.3 million square feet in 2010, and then dropped significantly in 2011 and 2012, averaging about 1.8 million square feet in each of those two years.

In 2013, the tide changed, and national companies took 2.1 million square feet of space in commercial projects (again, in comps we had access to, and in projects we track). Most of this space was in Warehouse/Distribution, which ranked #1 in demand in each of the past five years. This has more to do with the nature of Warehouse/Distribution space than anything else – not only are Warehouse/Distribution units larger than other commercial units, they also dominate in the logistics roll, a roll for which national companies have a demand in Southern Nevada.

Light Distribution projects ranked #2 in demand by national companies, with companies leasing 274,000 square feet in those properties. Retail, primarily Power Centers, came in at #3 with 253,000 square feet of leases, and Professional Office rounds out the top four, with 177,000 square feet.

Each of these product types has seen a different demand trend over the past five years. Warehouse/Distribution saw higher demand in 2009 and 2010 than in 2013, and much lower demand in 2011 and 2012 than in 2013. Demand for Light Distribution has been very stable. Retail demand has increased steadily from 2009 to 2013. Professional Office space has seen demand by national companies steadily decrease from 2009 to 2013, by 61.9 percent to be precise.

If this is the space that national companies want, is Southern Nevada going to be able to meet this demand over the next two years? In the case of Professional Office, with demand steadily decreasing and 11 years of supply on the market, there shouldn’t be a problem. Retail is also probably secure, with six years of supply on the market in the retail category, and much of this in the form of big boxes. Things get dicey, though, when we consider distribution space. There is about 7 months of Warehouse/Distribution supply, and 2.4 years of Light Distribution supply on the market. Meeting the demand of national, regional and local companies for distribution product will be difficult unless companies can afford the time required to build their own facilities, or speculative construction begins soon.

JMS

Bucking the Trend

A new year has dawned, following a year of uneven progress for the real estate market. The industrial market had its best year in five, retail kept its head above water and tallied up its third year of positive net absorption, and office managed a decent year all the while looking about as appealing as Mylie Cyrus with a foam finger.

The underlying economic fundamentals of 2013 were uneven as well, but positive overall. I’ve already written about the trend in Southern Nevada's Napoleonic economic cycle of attack in the summer and retreat in the winter (yes, I hate myself a little for that Napoleon bit, but my father paid for a history degree so I need to use it), so now we need to see if that trend is holding.

Economic data never arrives as quickly as we would like it (“we” being people who have to think and write about economics - I'm sure the compilers of economic data think it comes plenty fast enough), but the numbers for November 2013 are finally filing in to be counted and analyzed. If the trend we discussed last time holds, we should see the CRE Recovery Index leveling off or dropping off in November.

And now for the good news –

November’s index number was actually up! In November, the index reached 95. This is the highest number we’ve seen on the index since December 2008, and that was when the index was plunging (it would be 93 the next month, and 86 six months later). In general, 2013 saw the index take a small step back in February, level off for a few months, and then begin to grow in June, with that growth continuing through the summer, fall and winter. December numbers are not all in yet, but when we look at the numbers that are in, and if we assume those that aren’t in at least stay stable, the index number for December 2013 should remain at 95.

What does this mean? It means that 2013, at least the latter half of 2013, was a pretty solid year. It’s no surprise that it was a year that generated pretty strong performance in the real estate market. We might be seeing the winter lag coming in December and maybe January, but if the region is able to build in 2014 on its reasonably good performance in 2013, we should see continued recovery in the real estate market through 2014. Based on last year’s performance, the trajectory of the retail market is the one to watch. Retail went negative at the end of 2013 after three years of positive net absorption, and this negative turn is taking place just as speculative construction is returning to the retail market. Whether those new projects will stimulate or cannibalize the existing market will be very interesting!

Cycles

If we had been waiting for the “year of recovery”, the year local economy was finally going to turn around, 2013 is probably it (and I mean that the way it sounds – yeah, 2013 is probably about the best we can hope for). The year has been bery bery good to commercial real estate, and the wider economy has seen some improvement, though not nearly as much as we would like.

Looking at 2012, we saw a year with faster improvement in the first two-thirds of the year, and then a slow-down and fall that lasted into 2013, essentially erasing all of the year’s earlier gains. When things began turning around in 2013, the question was – will it last?

Now, economies work in cycles (and cycles within cycles, and cycles next two cycles that sometimes correspond, which in itself is another cycle), and cycles don’t necessarily work within the parameters of human defined time. After all, some day had be chosen as the first day of recorded time, and that choice was ultimately arbitrary. If you peruse the accompanying graph, you can see a pretty fair example of these cycles in the CRE Recovery Index (which I’ve now extended back to 1995). From 2002 to 2007, you can see the index peaking in October of each year, and then retreating from November to March or April, before rising yet again.

Even during the crash years from 2008 to 2010 you can see small peaks each October, though obviously during those years growth in the index never lasted for more than two or three months, followed by very sharp declines.

By 2010, the normal cycle had once again reasserted itself. Growth in the index was not as smooth and stable, but did generally follow the pattern outlined above, though with weaker growth and sharper declines than during those halcyon days of old.

What does this mean for 2014? Well, if the pattern holds, it is likely we will see the index begin to retreat in November or December. This retreat will last through the first quarter of 2014. In 2012, the measures that caused the index to tumble were Visitor Volume, New Residents and Los Angeles Port Traffic. In 2011, it was Visitor Volume and Los Angeles Port Traffic. In 2010, it was New Home Sales, Visitor Volume and Los Angeles Port Traffic. Do you see the pattern?

We can assume that Visitor Volume and LA Port Traffic are going to begin to fall in the very near future. At the moment, they remain strong. Their retreat is cyclical, and thus normal and nothing to fear. If they perform better than expected, then so much the better.

The questions we need to grapple with, then, are as follows: 1) Will there be other measures of the local economy that will suffer during the inter-year lag months? 2) Were the growth months in 2013 strong enough to keep us on a better footing after those months of retreat.

My guess is that we will not see any other measures of the economy enter into retreat along with Visitor Volume and Port Traffic, and thus when the Spring thaw reaches us in 2014, we will find ourselves in a stronger position than we had been in 2013, and well on our way towards what we might term a “complete recovery”. I think I see the light at the end of the tunnel.

What Exactly Do We Mean By Recovery?

Declaring that an economy has recovered, at least in the context of the latest recession (you might have read about it – it was in all the blogs), is a tricky undertaking. Are we counting “recovery” as a return to the economy at the peak of the bubble, at where it was before the bubble began, or at some guess at where it would have been without the bubble?

Aside from the timing, what are we waiting for to recover? If it was just a matter of visitor volume, Las Vegas finished its recovery last year. Since I'm a commercial real estate researcher working for a commercial real estate firm (Colliers International, to be precise), do I need commercial real estate to fully recover before I declare the local economy recovered?

For the purpose of this article, I offer two definitions of recovery. A recovery will:

• Bring the local economy back to a point before the beginning of the bubble (circa 2005)

• Use an index of the following measures of the local economy – New Home Sales, Commercial Occupancy, Gaming Revenue, Visitor Volume, New Residents, Employment, Taxable Sales, and Port Traffic in Los Angeles (this is the Recovery Index I have been using since 2009)

Using these definitions, Southern Nevada’s economy had an index value of 100 in January 2005. The index reached a peak of 109 in October 2006 and a trough of 83 in April 2010.

At this trough, Southern Nevada's economy reached an index value it hadn't seen since its last recession in 2001/2002 - essentially erasing 8 years of economic growth. It is entirely possible that the growth we might have seen during that period, had there been no economic surge, is gone forever. One could argue that, sans the surge, the economy would have an index value of 110 now, an index value we're about 5 years away from reaching at the current rate of growth, which isn't negligible.

If we look at index growth in 5 year periods, we see the following:

1996-2000 = 26.2% (5.2% average annual growth)
2001-2005 = 19.4% (3.9% average annual growth)
2006-2010 = -17.5% (-3.5% average annual growth)
2011-2013 = 9.4% (3.1% average annual growth)

Current index growth is about 80% of what it was in 2001-2005, and 60% of what it was in 1996-2000. Growth in the last three years is about at 90% of the negative growth experienced in the "plague years" of 2006-2010. If we wanted to erase the effects of the Great Recession, we would need to more than double current rates of growth, a situation unlikely without an explosion in construction activity in Southern Nevada.

Where is Southern Nevada today in terms of getting back to where it was in 2005, what one might call a "do-over recovery"?

In September 2013, Southern Nevada’s economy has an index value of 94, so not recovered yet, but not so far off. In 2012, the index value started at 89, increased to 93 by November 2012, and then it started to fall. From February 2013 to May 2013, the index value stuck at 91. Growth began in June and has continued since. If economic growth in the next few years matches the growth pattern of 2012/2013, Southern Nevada’ s economy should finish recovering by October of 2016!

Could the recovery move more quickly? Naturally. The economy was stronger in 2011 than it was in 2012 and has been in 2013, so it is certainly possible for the economy to recover at a faster pace. If we were to assume economic recovery on pace with 2011, Southern Nevada would have finished its recovery in July 2015 – better, but nothing to crow about.

Given the two possible rates of recovery described above, it seems reasonable to assume that Southern Nevada’s economy, and specifically its commercial real estate market, have at least two or three more years to go before they can be said to have recovered to a pre-recession level. Simply put, Southern Nevada is not currently making up the ground it lost during the Great Recession.

Happy Days Are Here Again ... I Hope

The human mind is a funny thing, not only because it apparently has the consistency of chilled pudding, but also because of the way it snaps between despair and ecstasy (though bear in mind that ecstasy is a strong term for what I’m about to discuss).

I was under the impression that net absorption was going to be lower in the third quarter than it turned out to be. It is good news that it wasn't, and though I’ve been a little leery about the industrial market due to weak job numbers and the large impact of build-to-suit projects on that net absorption, I’m almost ready to declare the industrial market completely healed, throw the confetti, toot the horn and start being an optimist.

When a person is expecting bad news, good news has a greater impact on their mood than it would have had had they been expecting good news. The reverse is true as well. It’s important for us to check our optimism and pessimism at the door when prognosticating, and instead look at the data and the trends it suggests, draw on our experience with past trends, and come to a reasonable conclusion.

A full year before the beginning of the Great Recession, I noticed that industrial vacancy rates were on the rise. Gross absorption was slipping a bit, but we were adding tons of new space that was not pre-leasing well. While the trends suggested to me that demand was flagging, the market had conditioned itself to expect strong demand, and proceeded on that assumption. Why let the facts get in the way of a good story, after all. That being said, I certainly did not expect demand to suddenly fall off a cliff at the end of 2007.

Now we’ve been engaged in the Great Recession for nearly six years. Gross absorption is healthy but not really on the increase, but net absorption is very strong, suggesting that existing tenants are no longer downsizing or closing their doors. The lack of new industrial jobs would tend to corroborate this impression on the market, as a lack of closures and downsizing does not necessarily translate into job growth. This is good news, and yet I’m having a hard time expecting it to continue.

So, what’s the story in Southern Nevada’s commercial real estate markets? As much as I fear admitting it, I think Southern Nevada has finally entered the recovery phase (I’m crossing my fingers right now hoping that the fourth quarter doesn’t make me look like an idiot). While job growth is not terribly strong (though this might have something to do with how the data is collected), most economic measures are leveling off or improving, and the real estate numbers have been pretty strong across the board.

The industrial market looks poised to absorb more space in 2013 than it absorbed through the entire Great Recession, and if net absorption remains somewhat constant, the industrial market will be ready for new speculative construction in about 12 months. Retail has been in positive net absorption territory for about two years, and though office is still seeing declining asking rents, its net absorption has been pretty strong for the past year-and-a-half. Office is not doing well in 2013, but that has something to do with continued weakness in the financial services sector (including real estate) and the health sector (health services companies tend to take space in professional office space more than medical office space these days, much to the regret of medical office landlords).

Office notwithstanding, the Great Recession appears to be over. Go ahead and throw some confetti - get it out of your system - and brace yourself for 2014.