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.

Vegas Enjoys the Spring Thaw

Waaaay back in November of 2012, the Las Vegas economy, which had been in growth mode for a good 10 months, decided to take time off for the holidays. What followed, in terms of the CRE Recovery Index I maintain, was a pretty rapid slide, from an index value of 91 (a value of 100 represents the economy as it was in January 2006 – i.e. the “good old days”) down to 86, roughly the value we had in December 2011 just before the 2012 growth spurt began.

In March, though, the index began to grow again, and in April 2013 it stands at an 89, not far from the 2012 high and well above the low of 80 recorded in March 2010 at the low-point of the recession.

On a year-over-year basis, the following components of the CRE Recovery Index have posted growth, going from the highest growth to the lowest: New Home Sales (76.6 percent growth), Clark County Taxable Sales (5 percent growth), Gaming Revenue (3.1 percent growth), Employment (2.2 percent growth) and Commercial Occupancy (1.8 percent growth). With the exception of new home sales, we’re looking at very moderate growth in the economy. Depending on who you speak to, new home sales are either going to maintain their dynamic growth, or they’re at the end of it, but for now they are definitely driving the CRE Recovery Index higher. If new home sales do slack off in the coming months, it is likely the index will either turn flat or begin to decline once again.

Components of the index that experienced negative growth over the past 12 months were New Residents (negative 12.6 percent growth), Container Traffic in Los Angeles (negative 7.1 percent growth) and Visitor Volume (negative 0.6 percent growth). While a small dip in visitor volume isn’t much to worry about, the much larger dip in residents moving to Clark County is, as a lack of new bodies could disrupt new home sales.

Get It Together, Vegas

Have you ever known somebody who just couldn’t get it together, at least not permanently? They would get their stuff together for a few months, and then slide right back into their old back habits. If you work in Las Vegas commercial real estate, the answer is yes, and the friend is the real estate market.

2012 was a pretty good year for our CRE Recovery Index. There were a couple small dips in the index, but overall, things were looking up. The market did pretty well, as the index is supposed to predict, with office and retail putting up good, though not great, numbers, and industrial lagging behind until the first quarter of 2013, when it showed some surprising life. 2011 was a year of peaks and troughs, with things better at the end than the beginning, but 2012 was a pretty smooth ride in the right direction. And then 2013 showed up.

Just as the market posted its first all-around positive quarter in 5 years, with the industrial, office and retail markets all showing positive net absorption, the index was heading down. December 2012 saw the index fall from 91 to 88, inspired by lower visitor volume and gaming revenue and a less traffic through the port of Los Angeles. This wasn’t too worrisome, though, since tourism numbers can fluctuate and port traffic is, at best, a minor piece of the puzzle for Southern Nevada. January remained at 88; port traffic dropped again, but so did the number of new residents moving into the Valley, new home sales and, once again, visitor volume. These were balanced, though, by higher gaming revenue and taxable sales. February saw another dip in the index, down to 86, where the index stood in January 2012. New home sales were down again, as was gaming revenue, visitor volume, new residents and taxable sales. Is it time to worry?

If the index is accurate, it predicts a slow second quarter for commercial real estate, and perhaps a slow third quarter as well. That doesn’t necessarily means negative net absorption, but just less positive net absorption than we would like. While the office market has had three quarters of positive net absorption, the numbers have been on the decline. Retail has also been positive but weak. Industrial has the benefit of strong build-to-suit activity now, and will probably do well through mid-year. But, in general, the way ahead for commercial real estate could be a little rocky for the next few months.

The Future of Vacancy in Las Vegas

Image by Lasvegaslover, from Wikipedia article

Imagine if you will a car accident on a busy street. The accident is a big one, and it is clear that the street will be blocked for some time. Naturally, drivers on their own would begin searching for alternate routes. Before too long, the side streets would be filled with cars avoiding the accident scene, and though things would be slowed down for a while, eventually they would be back up to speed (or close to it). In time, the accident would be cleared, and life would go on just as it had before.

Imagine, however, if the accident could never be cleared. Cars would simply take to those side streets as the “new normal” and the old street would fall into disuse. What I’m getting at here is the concept of being left behind.

Commercial real estate in Southern Nevada may be going through a similar situation. When the market was overbuilt in the mid-2000’s, vacancy rates skyrocketed. Now, having trudged through 5+ years of recession, the market appears to be returning to some level of normal demand for product. The assumption by some, of course, is that vacancy will now return to where it was before the recession – perhaps slowly, but inevitably.

The truth, however, is that it might not. Buildings that were completed during the boom may, in fact, never be filled with tenants. Location and designs are two reasons, of course, for why these buildings may remain unpopular with potential tenants, but age is now becoming a third. Some of these unlucky buildings are not 5 to 6 years old. Potential tenants of these buildings may begin opting for newer buildings – build-to-suits, of course, but also the new speculative product that is bound to be built over the next 5 years. What happens to these “lost buildings”?

On the one hand, they may find favor with tenants looking for second generation space; in essence, they can fill a temporary niche of virgin second-generation product – old enough to be had at a discount, but not carrying the baggage of former tenants and tenant improvements.

On the other, they may find themselves candidates, in due time, for redevelopment. The market, finding it has no use for so much single-tenant office or light industrial, decides it needs land for the developments that it does need in the future. If the latter is only partially true, we can expect to see a new floor on just how low vacancy rates can go for commercial product. Ultimately, though, we need to investigate whether theory is reality.

During the boom, we discovered vacancy “floors” of approximately 4 percent for industrial product, 8 percent for office and 3 to 3.5 percent for retail. The industrial market now has approximately 3,000,000 square feet of space that has been vacant for 4 to 6 years, corresponding roughly with the final phase of the construction boom and the initial phase of the Great Recession. If we were to assume that this space was so undesirable that it would never be occupied, it would represent about 3 percent of the total industrial inventory, and would thus push that vacancy “floor” from 4 percent to 7 percent.

For office product, about 2.5 million square feet, or approximately 6 percent of office inventory, has been vacant for 4 to 6 years, potentially increasing office’s vacancy floor from 8 to 14 percent. Clearly, office product has a more serious problem than industrial. For retail, the figure is 3 percent, potentially increasing the retail vacancy floor from 3 to 6 percent.

A full break-down of vacant commercial space based on its time-on-market follows:

While this investigation is not as thorough as it would need to be to classify it as fact, it is suggestive that even with normal demand for product Southern Nevada’s commercial market is likely to see elevated vacancy rates for the foreseeable future.

Three Recoveries

Are we in recovery? That’s the question I keep hearing, but there’s a flaw in the premise. When the house of cards fell in 2007, Southern Nevada was hurt in three distinct segments of its economy, and while they are to some degree connected, each is going through its own recovery cycle.

So, when we wonder about the pace of recovery, we need to think about three different recoveries: The gaming/hospitality recovery, the residential real estate recovery and the commercial real estate recovery.

Before we examine those recoveries, though, we need to also examine the concept of “recovery”. When a minor recession hits, it is followed, eventually, by a minor recovery. A minor recovery leaves an economy looking much as it did before the recession. Think of it as recovering from the flu – you aren’t fundamentally changed by the illness when it’s finally over.

An economy that suffers a major recession, however, is often changed in important ways when that recession transitions into recovery. This makes major recoveries a tricky thing to track, as we’re waiting for the facts and figures to “return to normal”. Unfortunately, there is a new normal, and we might not realize we’ve reached it right away, since it’s unlike anything we’ve ever tracked before. Southern Nevada is now recovering from a major recession, so expect change.

Now, we examine the three recoveries of Southern Nevada. First and foremost is the big dog in Southern Nevada – gaming and hospitality. At its depths, visitor volume was 7.8 percent below its height in 2007, while gaming revenue suffered a 23 percent decline. From these figures, we can say that visitor volume went through a minor recession, while gaming revenue suffered a major recession. By the end of 2012, visitor volume was 1.3 percent higher than in 2007, while gaming revenue was still 15.6 percent down.

I think it’s safe to say that visitor volume is recovering, but gaming (can’t we just call it gambling?) revenue, which has shown growth, remains weaker than we would expect given the visitor volume. This is one of those transitions we need to look out for. New Vegas visitors are spending less money, overall, but are also shifting their spending towards food and entertainment (sure things, one might call them) from gaming. Just the same, with growing taxable sales and visitor volume, it’s a pretty safe bet that the “engine of our economy” is recovering.

Residential construction is the segment that put the “major” in our “major recession”. There are now fewer construction workers employed in Southern Nevada than 20 years ago – pretty much says it all. Fortunately, we are seeing some recovery in this segment, with inventories of new and used housing falling and many developers looking forward to starting new developments in the next couple years. Southern Nevada’s population is again on the rise, after a first in 30+ years dip in 2008. There have also been reports of median home prices rising in Southern Nevada. So – housing is in a slow recovery in Southern Nevada, but definitely heading to a new normal. Demographics are changing – extended families, more apartments for young folks who are burdened with paying for their elder’s retirement (I love hearing about those hover chairs that don’t cost the elderly ONE CENT).

Commercial real estate may not be the third pillar of the local economy, but it is related to residential real estate and it’s obviously important to this office. I can happily say that commercial real estate is recovering, slowly perhaps, but is also heading towards a new normal. Expect much higher than usual vacancy rates for the next decade, as thousands of square feet of old space are ignored and new projects are started. Commercial real estate is still a mess, but it’s getting better!

So, three recoveries are needed, and three recoveries are happening. What we're in the process of discovering is how quickly these recoveries are happening, and what we're recovering to.

What Lies Ahead for Medical Office?

After a strong third quarter, medical office fell back into negative net absorption in the fourth quarter of 2012. For the year as a whole, medical office returned 61,723 square feet to the market, net, despite a steady increase in health care oriented employment. Why such a discrepancy between jobs and net absorption? Health care in the United States, and the medical practitioners who deliver it and occupy medical office space, are going through a transition period. Not only are the days of private practice falling to the rise of medical groups, who require less space to do the same work, but the need for efficiency and lower prices are shifting medical resources from the traditional medical office buildings (MOB’s) of the past to new concepts that often take space in retail centers to be closer to their patients. The times are changing for medical office.

The rise of medical groups, such as Accountable Care Organizations (ACO’s), and alternative vectors of providing healthcare are putting the squeeze on medical office right now. Doctors, insurers and patients are all going through a slow discovery process of just what the Affordable Care Act means to them, and doctors and insurers are especially trying to come to grips with what these government-mandated changes will mean to their business models. Owners of medical space also need to come to grips with the changes that are on the horizon for medical care. With group practices and urgent care facilities set to dominate healthcare delivery in the future, medical office buildings will need to be retro-fitted to accommodate these tenants, and that requires a capital investment. With margins likely tightening, passing these tenant improvements on to the tenants will be tricky.

The uneven application of “Obamacare”, compounded by balking among members of the president’s own party regarding associated taxes, should insure a bumpy road for medical office over at least the next four years. More importantly, while the government-medical complex is working out the kinks, private enterprise will continue to innovate in the health care arena. From Wal-Mart’s foray into small pharmacies on medical campuses to health care in Targets, more and more medical office dollars are going to flow into non-medical real estate, putting the crunch on landlords already dealing with consolidations and downsizing among physicians. We think we will continue to see the medical office market bounce along the bottom in 2013 while medical office users survey the new medical landscape and prepare for the future.

Colliers International Q4-2012 Report

2013 - Are You a Good Year, or a Bad Year?

As we bid a fond farewell (or good riddance) to 2012 and usher in brand spankin' new 2013, it is natural to wonder just what we're getting ourselves into.

After all, 2011 was a pretty decent year for Las Vegas CRE, so it was a bit of a shock when 2012 hit us like a ton of bricks. Fortunately, 2012 got a bit sunnier at the end of the year, but will the trend continue? Will 2013 be a good year for Las Vegas CRE, or another washout year like 2012? Well, let's look at the index ...

The CRE Recovery Index was on its way up through most of 2012, predicting that positive movement towards the end of the year. But in September, the index began to go flat, and in November and December it began to fall. In and of itself, this is not odd – it usually does begin to fall towards the end of the year, and on the positive side, the decline in 2012 was not as severe as in the past two years. In general, the rise of the index in 2012 was more stable than in 2011, and there is every reason to believe that this slow and steady rise will be seen again when January and February numbers become available to us.

On a year-over-year basis, the December 2012 New Home Sales index and Taxable Sales were up sharply, and increases were also seen in the Commercial Occupancy index (finally), Visitor Volume and Employment. Port traffic in Los Angeles was down considerably on a year-over-year basis – a minor factor in the overall CRE Recovery Index – and Gaming Revenue was down as well.

In general, the cycle appears to be operating as usual. Growth was slower and steadier in 2012 than in 2011, and at the moment we can probably expect 2013 to look similar. Higher taxes and increased costs for healthcare and health insurance, along with the currency wars that are being fought between the industrialized debtor nations of the world, might hamper that growth, though, so keep your head on a swivel.