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.

Recovery and Transition

The economy is not only going through (or suffering through? – it seems like it sometimes) a recovery after a rather rough recession/depression/panic, it is also going through a transition that started with the invention of the World Wide Web, or really, with the invention of the computer itself. In truth, economies are almost always going through some sort of transition – innovations do not stop or start, but always seem to be trickling in. Computers and the internet, though, just like steam before them, are putting the global economy through a much larger transition than we might be used to. The effects are happening slowly; it takes time to find the next market efficiency, and most new market efficiencies are resisted by the existing major players and the congressmen they employ. But happening they are, and happen they will and your best bet is to get on board sooner rather than later.

Efficiency really is the name of the game. It is the reason capitalism, with its focus on competition, beats mercantilism (i.e. crony capitalism) and socialism. Efficiency in this regard means cutting costs – getting the most for the least – and commercial real estate is a great place to make those cuts. For one thing, values were forced to reset after the Great Recession. But more importantly, computers and the internet continue to change the way people work. Office tenants have been trending towards less office space per worker. Computers are only getting smaller, and smart phones and broadband allow more workers to be productive away from the office. So even when office firms are hiring and signing leases, it’s likely that they’ll be taking smaller spaces, relatively, than they did in the past, and this extends the time it will take for the office market to fully recover.

Medical office has been going through a similar transition. The day of the artisan doctor – one man in one office with his own receptionist and assistants – is over, and the new era of medical groups has arrived. Doctors become salaried employees who are not on call 24 hours a day, 7 days a week, several doctors share a receptionist and office staff, and ultimately take less medical office space per employee than they would have in the past. The reason for this transition is the screwed up world of health insurance and government regulations, of course, not technology, but it’s a transition just the same, and one that brokers should pay attention to. Moreover, healthcare providers are moving into retail centers to get closer to customers and, more importantly, to probably pay less for rent.

Retail has other problems though, in the form of online retail. Shopping online doesn’t cost more, and it’s often more convenient (two generations of rampant narcissism has done nothing to make the shopping experience more pleasant), so it’s on the rise. More online sales means less demand for physical retail real estate – witness mass closures of Staples and Radio Shack, and shrinking retail concepts from grocery to electronics.

The big winner in all this might be industrial space. If the trend is towards spending less on commercial real estate, industrial product, which tends to be less expensive than either retail or office space, becomes an option. This is particularly true when it comes to online retailers. While they do not need physical retail space, they do need physical warehouse space, and giants like Amazon appear to be aiming to have warehouse space in every major and minor city in the country to allow them to ship to their customers, and accept returns from their customers, as quickly as possible.

The slow post-Great Recession recovery is not just slow because it’s slow, it’s slow because businesses are forging a brand new identity and are finding brand new ways to do business. Commercial real estate will adapt to this transition, but only if real estate professionals recognize it. Those who do will likely reap the reward of being ahead of the competition.

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.

Moving Targets

Think of the economy as a river. A river is water that is moving from a higher elevation to a lower elevation. If anything gets in its way, the water moves around it or, eventually, through it. There’s no thought process involved, or the act of a higher power. Water is driven by gravity to find the lowest ground it can.

Economies are likewise driven to be efficient. Producing the largest quantity at the lowest price. Why? Because human beings demand it. There is almost no end to what human beings want, and therefore producers want to produce as much of something as they can, and consumers, who have so many desires, want to pay as little as possible. Ultimately, the marketplace is where consumers and producers meet in the middle.

Hoover Dam, photo by Ansel Adams

Human beings can erect dams to manipulate the flow of water. Note that I said manipulate, not stop. The water cannot be stopped. Hoover Dam forces water through channels to spin dynamos, but it doesn’t stop the water from flowing. Other dams force the water into fields to irrigate crops, but they do not stop the water.

Likewise, human governments can erect regulations, taxes and other such things to manipulate an economy. They can make something artificially cheap or expensive, but eventually the market will work around those artifices to put that product at the “natural” market price.

I’ve recently read an article about innovations in healthcare. The supply of healthcare is, like a river, finding a way around artificial impediments. Because the old way of delivering healthcare, via individual doctors and surgeons, has been made artificially expensive with cost-sharing “health insurance” and government mandates, producers and consumers are finding a way to “meet in the middle” with medical groups, do-it-yourself treatment aided by handheld computers (let’s stop calling them cell phones – they’re really so much more), health clinics, etc. At the moment, the victim of this market-driven innovation is medical office space. Medical office space was designed to serve the old market of doctors and patients. At the moment, it is being negatively impacted by the change in healthcare delivery – a change initiated not by the free market, but by large public and private institutions.

Will we, at some point, return to a more traditional model? Perhaps. As healthcare delivery moves away from the very institutions that sought to dominate it, they will have to adapt or die. In the meantime, the medical office will have to adapt to the new way of doing things. It may do this by clever redesigns to serve medical groups and health clinics, or by re-purposing itself to other uses.

Thus the ebb and flow of commerce continues. Keep this in mind when dealing with developers and building owners. The consumer (in this case the potential tenant or buyer) is always a moving target, and forces much larger than they are in the driver's seat. Spend some time understanding the macro-economy to better understand the micro-economies you deal with when you represent a landlord or tenant.

Income and Expenses

You might have read that incomes have been stagnant in the United States for the last 30 or more years. The rich are getting richer, of course, but all of us folks in the middle and lower class have been held in place, no growth, for decades.

Of course, for those of us who actually remember the 1980s and 1990s, this impression might seem a little off. My middle class life in the 1980s wasn’t nearly as plush as my middle class life is now, but perhaps I’m just mis-remembering things.

A look online shows up a median household income in 1982 of $18,801. Adjusting for inflation, that’s about $46,123 in 2014. Median household income in 2014 … $49,486. So there has been growth, but not much growth. The median income does appear to have been fairly stagnant over the past thirty years.

Focusing on incomes, however, misses the other side of the coin … expenses. Let’s look at groceries. I found a few prices from the 1980’s. We can adjust them for inflation, and then compare to modern prices I plucked from the internet.

According to this data, food prices are generally lower now than in the 1980’s. I remember eating lots of ground beef and tuna casserole in the 1980’s and not much steak, so this rings true to me. Steak was a treat when I was a kid. Heck, Shake-N-Bake chicken was a pretty big deal back in the day.

It’s not just food. In 1986, you could get a nice Commodore computer for about $400. In modern dollars, that’s about $864. A modern, base line Dell computer (with monumentally more computing power than that old Commodore) runs about $400 as well. A thousand times more computer at half the price. Not too shabby.

How about smart phones? A modern smart phone can replace all sorts of 1980’s technology – brick phones, the Sony Walkman, cameras, video cameras, digital watches, personal computers, GIS systems (to which nobody but the military had access). Add these together, and you’re looking at about $5,000 worth of tech (most of it from the mobile phone alone) in 1980’s dollars, and about $11,000 in today’s dollars. A new smart phone comes in at around $300 to $400.

Of course, this is not the case with everything we buy. Stamps in 1980, adjusted for inflation, were about $0.03 cheaper than then they are today. Comic books are more expensive (and smaller) now than then, but they’ve also shifted from being sold on newsstands to children to being sold to adults in boutique comic book stores. Books are also more expensive now than then (even on Kindle). A Camero Coupe in 1980 went for an adjusted $18,600. A modern Camero Coupe goes for $23,700 MSRP – a higher price, but for a superior automobile. Gas is cheaper at the moment (around $2.03 per gallon now vs. an inflation adjusted $2.96 per gallon in 1980), though that might change, and of course a year ago gas would have more expensive now than then. Note also the meteoric rise in the cost of education and health care – two segments of the economy with significant government involvement (just sayin’).

It is also enlightening to look at adjusting asking rates for commercial real estate. While I don’t have asking rates going back to the 1980’s, I do have asking rates going back to 2002. If we adjust those old rates to 2014 dollars, you realize just how inexpensive commercial real estate has become.

The story here is not just how much or how little incomes have changed, but the buying power of the dollar. The marketplace has knocked down prices on not only our day-to-day needs, but also on luxuries. Despite seemingly stagnant incomes, Americans today have much more buying power than they did decades ago, which begs the question … why are we so deep in debt?

Inside the Box

Cat in a box Calicocindy/ Public domain

We live in a world of “experts”. Many people opining every hour on the hour on every subject known to man ... and virtually none of them know what they’re talking about. Why? Because they’re universalists. Rather than just make statements about what they actually know, they take their limited knowledge and try to stretch it out to cover everything. Here’s where they run into trouble. Their reach exceeds their grasp.

“You should always think outside the box.” A universal statement. If we took these philosophizers at their word, it should apply to everyone in every situation all the time. Are you stuck on a roof and trying to figure out how to get down? Don’t climb down – that’s “inside the box” thinking. Try jumping off instead. It may get you inside the emergency room, but at least you’re “outside the box”. The statement was once meant to encourage finding new solutions to old problems, but I fear it has been transformed into pretending that old limitations no longer existed.

Wisdom is the synthesis of not just all of your own years of experience, but of thousands of years of human experience, transmitted through books, stories and, yes, sometimes cute little one-liners. Wisdom means taking in the current data, checking it against previous patterns, and then making a decision on how to proceed knowing full well that your decision may be wrong, and thus demands a “plan B”. When, during the early 2000’s, it seemed impossible that Las Vegas would ever stop growing, that the national economy would ever again experience a downturn, that land really should be selling for a bazillion dollars an acre, “outside the box” thinking was at play. The old rules, the old patterns – they no longer applied. Alas – some “inside the box” thinking would have helped quite a bit.

The universe is a very ancient construct, and it is governed by the same laws now as it was billions of years ago. Likewise, human beings. Irrational exuberance, greed and jealousy have been with us from the very beginning, and will always be with us. Every hundred years or so there’s a whole new humanity, but they’re constructed from the same old models and have to learn the same lessons their ancestors learned. The irrational exuberance of the 1920’s that resulted in people borrowing money to buy stock that would increase in value before they had to pay their loans was the same irrational exuberance in the 2000’s that resulted in people borrowing money to buy real estate that would increase in value before they had to pay their loans. The latest iteration might be large corporations borrowing money to buy back their own stock to juice the value of the stock.

When it comes time to predict the future of anything, crawl inside the box and see what those who came before you scrawled on the walls. You might save yourself some trouble (and money). You might even make a fortune.