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.

Any Diversification Today?

In today’s post, I want to examine how the landscape of commercial real estate had changed over the past three years in terms of tenant industry (i.e. what line of business the tenants were in). This is new ground for me, so I decided to begin with the industrial market, examining what share of industrial lease and user sale activity different industries held.

If you think this graph did not help increase my understanding of the situation, you are correct. Different industries have, on a quarter by quarter basis, had their ups and downs, but the only industries to show a trend were manufacturing and construction, and those trends were pretty slight.

To get a better handle on the situation, and gain some context, I decided to abandon my relatively small sampling of lease and sales activity data for a much broader store of data – employment.

When we look at jobs in Southern Nevada, we see surprisingly little change over the past twenty years in the share of jobs between different sectors. The only significant changes have been in the construction sector and leisure and hospitality sector.

The construction sector held 9 percent of the region’s jobs in 1994, swelled to a colossal 12 percent in 2005/2006, and has now fallen to just 6 percent of the region’s jobs. While a farmer with nine cows and one pig could create the illusion of farmyard diversification by killing eight of his cows, he certainly would not be better off than when he started. Having 2,000 fewer construction jobs now than in 1994 has not improved economic diversification in Southern Nevada.

The leisure and hospitality sector, on the other hand, has added almost 107,000 jobs over the past 20 years, but has seen its share of the job market shrink from 35 percent to 32 percent. Perhaps this is not a massive drop, but one that is indicative of some diversification of employment. Over the same period, the share of employment in the professional and business services sector and the education and health sector have both increased by 3 percentage points. Again, this may largely be a matter of the draw-down in construction jobs, but both sectors have shown percentage growth in excess of 140 percent over the past twenty years, adding a combined total of 113,900 jobs. It seems likely that the leisure and hospitality sector has lost some of its employment share to these two service industries.

This may not be the diversification some folks want, but it’s the diversification we have for now.

Once Bitten, Twice Shy

After surviving an impressive housing bubble that burst just 5 years ago, many Las Vegans are eying the current housing recovery with a suspicion. The sales figures look good, but with prices increasing by 20% or more year-to-date, are we just entering a new housing bubble?

First, let’s examine the market of yesterday and the market of today. In the period 2005 to 2007, Las Vegas saw an average of 2,625 new homes sell per month, while the median price of a new home increased 5.8 percent over that period. In the past twelve months, new home sales have averaged 573 per month, and the median price of a new home as increased by 11.5 percent. So, obviously, even if a bubble is forming now, there is a magnitude of difference in scale between what was occurring then and what is occurring now.

The activity of investors is often pointed to as another similarity between then and now, but this is not quite so. The investors that caused heartache a few years ago were often over-leveraging themselves to buy homes that they thought they could re-sell at a tidy profit in just a few months. Unfortunately, they discovered that the amazing price increases they were seeing were all due to the activity of other investors, and even with very low interest rates and the willingness of traditional home buyers (or lack of knowledge) to borrow far more than they could afford, the investors priced the occupiers of homes out of the market, found they could not keep up their mortgage payments, and the market collapsed. Home builders, working feverishly to keep up with the perceived demand, built many more houses than were needed, and thus the housing crisis and the Great Recession.

How are things different today? The investors of today are not the investors of yesterday. Having spoken to people within the housing industry in Southern Nevada, I have found that the individual investors of today are coming in with plenty of cash and are not over-leveraging themselves to buy investment homes. Moreover, many of the investment sales we are seeing in Southern Nevada today are by institutional investors, buying hundreds of units, often directly from banks.

How are things the same? When housing sales are driven by investors, they leave a gap in the market. From the perspective of home builders, a house sold is a house that is off the market. In fact, though, an empty house is still effectively on the market. When tracking commercial real estate, vacancy is the thing that matters! An investment property must eventually pay for itself, either by means of rent paid by an occupant, or by the value of the property appreciating past the value of the loan taken out to buy the property in the first place. The last bubble was driven by such appreciation of value, not by renters occupying houses, but the appreciation could not keep pace with the prices being paid for houses.

More importantly, when home builders saw houses selling a few years back, they took it as a sign that more houses were needed. Home builders today are gearing up to begin building houses in earnest once again in 2014. The question is whether they are building for investors or for occupants? Unfortunately, the vacancy rate for single-family homes is notoriously hard to determine, with different groups (the U.S. Census Bureau being one) coming up with wildly different numbers. This is unfortunate, because it would fill a crucial gap in our knowledge of the home market.

One clue to whether Southern Nevada is once again getting ahead of itself might be found by comparing household growth in Clark County (based on information from the Clark County Demographer and Claritas) to new home sales (based on information from Dennis Smith’s Home Builders Research). Demographic data from Claritas states that 42.9 percent of households in Clark County rent homes or apartments rather than own single family homes or condos, so we’ll adjust the household growth figures by 43 percent to get a better idea of how many buyers were entering Clark County each year.

What does this graph tell us? First and foremost, in-migration into Southern Nevada dropped sharply in 2008, 2009 and 2011, but has generally been on the rebound in the past two years. Second, we see that new home sales decreased substantially in 2007, at the beginning of the housing crisis, and continued to plummet in 2008 and 2009; in 2012 they began a slow recovery.

In 2005 and 2006, Southern Nevada was selling approximately three times as many new homes as it was adding new households that were likely to own homes. This suggests that most of these new homes were purchased by investors rather than occupants. The percentage declined in 2007, reaching what would be the lowest percentage in the nine years covered by this chart. In 2008, the first full year of the Great Recession, almost five times as many new homes were sold as new households moved into Southern Nevada, despite a steep decrease in the number of new homes sold. Since 2009, Southern Nevada has gained an average of 1,300 households per year and sold an average of 5,400 new homes per year, again, more than 4 times as many new home sales as new households likely to own rather than rent entering the region.

In 2013, Clark County is projected to expand by 3,200 households and sales, if they remain steady, should reach 7,200 new homes, approximately a 2:1 ratio. While this is not as high a ratio of new home sales to new households as recorded in 2005, 2006 and 2008, it is higher than in 2007 (when the market began to cool), 2010 (when the federal government juiced the housing market) and 2012. This suggests that investors once again are beginning to dominate the housing market. Fortunately, they are buying new homes at lower prices (28 percent lower) than they were in 2005, but the median price of a new home has increased by 13 percent in the past five months. While this is good for house flippers (though we know how that story ends), it is bad for owner/users and problematic for landlords, as they must still compete with multi-family projects and cheaper, existing homes that are on the rental market.

If Southern Nevada’s population was expanding more rapidly, and if the median new home price was expanding much more slowly, I would feel more comfortable about the current expansion in new home sales. As it stands, home builders must be very careful about new home construction in 2014, as they might once again find themselves building more homes than they can sell if investors once again cool on Southern Nevada.