Real Estate Among the Bubbles

Commercial real estate does not exist in a bubble. A well-worn phrase, yes, but what does it mean? In this instance, it means that commercial real estate is one of a spectrum of investments, and must compete with all of the other investment vehicles out there – stocks, bonds, Hummel figurines, scarves bearing the sweat of the sainted King of Rock n Roll, etc. – for the money of investors. In other words, it’s not enough that you’re selling the best Class B office property investment in Las Vegas, or even in the world – that office building must compete with every other investment vehicle in the world as well. On some level, your building needs to compete with Microsoft stock, pork bellies and Elvis' scarf.

Why is this important? Because the goings-on in those other investment worlds has an impact on Southern Nevada’s commercial real estate. We might wonder why more money isn’t flowing into Southern Nevada’s CRE market when that market appears to be on the mend, but if you consider all the other places that money could go, its absence in our market is not so surprising. If investors can make more money in stocks, money is going to flow into stocks. If they can make more money in commodities, money will flow into commodities. Granted, the time frame of the investment matters as well, as does the investor’s expertise in various investment vehicles – an investor who knows commercial real estate, but who doesn’t know a pork belly from a jelly belly might not want to put money in commodities, even though that market might, on paper, look better than commercial real estate. Still, in aggregate, investment money tends to go where the yield is best.

At the moment, yield appears to be hanging around those aforementioned stocks and commodities. Why? There might be numerous reasons, of course, but the loose money policies pushed by central banks is probably one of those reasons. All of that money must go somewhere, and the folks placing it want to realize a profit on their investment now, rather than later. Commercial real estate is usually a “later”, not a “now” in terms of investment. If we are in a deflationary mode at the moment, long term investments like real estate are more attractive. If inflation is looming on the horizon, as some people fear, those long term investments are less attractive.

Still, things do change. The latest intel suggests that stocks and commodities might be overvalued. Some corporations are taking on cheap debt to make themselves look more profitable than they really are, thus goosing their stock value. As with all unorthodox business strategies, some businesses are going to get away with it, others will not. Eventually that debt must be paid. Meanwhile, Japan’s central bank seems to have decided that Thelma and Louise had the right idea, and it’s now going pedal to the metal towards one heck of a cliff. The term kamikaze might be politically incorrect in this context, but it is probably appropriate nonetheless. What Japan is doing now will lead to currency wars in Asia and then worldwide, and then who knows? Our own Janet Yellen seems determined to keep things loose in the U.S. of A., but Fed chair-people don’t often serve for long these days, so there’s always the possibility that three years from now, our own central bank may start tightening things back up (then again, maybe not – we should be overdue for a cyclical recession right about then).

The point is that if commercial real estate is not the most attractive option today, it might be tomorrow. If you see the stock and commodity markets turn bearish, expect to see the smart money head once again towards the commercial real estate market (except for the smart money that’s shorting those other markets). Hopefully this shift, if it occurs, will occur while Southern Nevada’s market still looks healthy, so we can capture a share of that money. Listen to your clients and understand their investment strategy, and where commercial real estate might fit in. Property prices are still relatively low in Southern Nevada, and that should make them more attractive to long-term investors. Short term investors are probably slowing down for the time being, unless we see that new wave of foreclosures finally break on our shores.

Oh - and when you see the stupid money head into commercial real estate, cash in your chips and batten down the hatches, because it means our 3 hour tour is just about over.

JMS

How Well Have the Values Held?

I'm glad you asked. A week ago, I decided it might be interesting to look at the most recent crop of commercial sales and compare their most recent sales price to their last sales price - assuming they had one. The results were enlightening:

This graph illustrates the Sale Price in Q2, 2011 as a percentage of a properties last sales price, organizing it by the year of the last sale.

My Take Aways ...

Properties that sold pre-boom (i.e. 2000-2003) are now selling for about 70% of their last sales price.

Properties that sold during the boom (2004-2007) are now selling for about 45% of their last sales price.

Properties that sold post-boom (2008-2010) are now selling for about 65% of their last sales price. This suggests that properties purchased in 2008 (50% rate of return) and 2009 (65% raste of return) were still over-priced. Those few brave investors who entered the market then did not appreciate the scale of the slow-down.

Properties that sold in Q1-11 sold in Q2-11 for 143% of their last sales price. This suggests that prices hit bottom sometime in late 2010/early 2011.

Among property types, Industrial seems to have held its value better than office or retail. Industrial properties had an average rate of return of 70%, compared to 54% for retail and 49% for office.

Owner-user properties have sold, on average, for 63% of their last sales price, compared to 53% for investment properties.
Henderson properties have sold, on average, for 60% of their last sales price, compared to 59% for Las Vegas and 54% for North Las Vegas.

In terms of Q1 to Q2 property flips, the highest returns have been on investment properties (169%) and office properties (153%), and lowest on properties in North Las Vegas (54%). All categories other than "North Las Vegas" had a positive return.

When did each category show its lowest rate of return? For Industrial it was 2008, Office 2006, Retail 2006, Owner-User 2007, Investment 2006, Henderson 2006, Las Vegas 2006 and North Las Vegas 2010.