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

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

Moving Targets

Are traditional doctors offices going the way of house calls?

Think of the economy – any economy – as a river. A river is just 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 be as low as it can be.

Economies are likewise driven to be efficient. Producing the most possible 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.

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 the flow of an economy. They can make something artificially cheap or expensive, but eventually the market will, by hook or by crook, work around those artifices to put the product at the 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”, 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, 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 repurposing 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 potential tenant or buyer) is always a moving target, and forces much larger than they are driving that movement. Spend some time understanding the macro-economy to better understand the micro-economies you deal with when you represent a landlord or tenant.

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!