National commercial real estate trends continue to reflect weakness. Housingwire.com (Gaffney, 8/26/10) notes that 88 percent of respondents to a development survey stated that development was almost non-existent in their markets. Such is the case here in Las Vegas as well and while there is still some construction in office, retail and industrial, there is almost no planned product and no planned product that we are aware of in industrial.

Similarly, on REIT.com, Green Street Advisors analyst Steven Frankel also notes weakness in the industrial sector with "subdued net absorption." Rents are also expected to remain weak. A rebound may be a way's off. This is also the sentiment of many in the Las Vegas market. While Las Vegas' industrial market is very small compared to coastal cities, it is an important component of our economy and is very connected to the hotel & casino sector, since that is the key driver of activity in the region and since industrial space is often absorbed or vacated depending on the level of convention activity, slot machine manufacturing, food storage and whatever else you can think of. Until we see a stronger rebound in the hotel sector, we can expect some muted responses in net absorption.

Nevertheless, there has been leasing activity, often to lower occupancy costs by existing firms. There have also been investor deals. As always, as long as things are priced right, buildings can still sell. It has just been difficult to obtain a meeting of the minds between buyers and sellers, whose expectations about the future of the sector has been a wide chasm.

Overall, tenants are the ones who have been finding deals, sometimes within sublease space and have been able to drop their costs by substantial amounts by either finding cheaper space or smaller space that better suits the level of their current business activity.

We have discussed the buyer-seller disconnect several times. Few commercial transactions have been consumated in the past couple of years as sellers have either refused to lower prices due to a different read of the fundamentals, they cannot liquidate due to capital constraints (writedowns for bank owned) or that they simply do not understand what they own or just replace number driven judgements with hope. Similarly, some buyers are unrealistic about pricing. They often believe that everything is distressed and can be obtained at a price below the appraisal or opinion of value. This is often stemming from the belief that fundamentals are still too weak or declining.
 
Owner-users do appear to have a higher willingness to pay for commercial space, however they are not the largest component of the potential buyer pool unless we are talking about smaller spaces or some improved frontage since most of the space that is being purchased or leased in the result of owner/tenant churning within the Valley as firms attempt to either lower their occupancy costs or find a higher traffic area. Overall absorption of vacant space has still not turned positive.

So what has to happen for transactions to occur? Like housing, prices should decline as values are reset to new fundamentals. Interestingly, Moody's is measuring an increase in transactions as prices have fallen, with volume increasing from $2.1 billion from $1.5 billion for the month of June year-over-year (housingwire.com). Such price declines are necessary before any bottom can be obtained and the subsequent recovery can begin. The recovery cannot begin when nobody knows the price of anything.


Source:
http://www.housingwire.com/2010/08/20/commercial-real-estate-hit-with-41-price-drop-and-soaring-delinquencies

We have a bit of a fascination with real estate price indices. This is simply because of the disparity in different measurements. At Market IQ, we tend not to like average prices since averages are sensitive to outliers. However, when we go out with buyers and look for homes, we tend to "feel" the average more than any other number so it does have its utility in describing the market. Medians are useful but imperfect as well since like averages, they are affected by the changing mix of home sold in each sample period, such as size, age, finish level, location.

We find repeat sales measures to be more realistic in explaining the trend since median prices have masked a lot of the same home price changes, especially as builders began making smaller homes on very compact lots. These are indices however so they are a little esoteric for folks who are not numbers junkies. In addition, Morgan Stanley has noted that an increase in the prevalence of short sales, which we find to sell for higher prices than bank owned homes, are causing the Case-Shiller, RPX and Morgan Stanley's own index to jump so severely in some metros that it just didn't seem realistic. The Morgan Stanley analysts question the validity of these measures for looking at national trends (from housingwire).

The Las Vegas area has had enough REO (bank owned) activity to keep pressure down on the indices so we never noticed anything as severe as the changes in the San Francisco trends, for example. I am considering building a "constant quality" index that will attempt to control for whether or not the sale was a short sale, REO or equity seller.

CoStar has also developed repeat sales indices for Commercial real estate. This is a very welcome development and I am glad CoStar has taken this mission since it is certainly not easy work. Previously, we had noted the Moodys/REAL Commercial Property Price Index and it is nice to have an alternative to check against. These indices tend to be a little bit too regionally broad for our local use since our CRE is so related to the gaming industry rather than international trade or manufacturing, however, institutional investors might find this useful.                                  Source: CoStar.


Sources:

http://www.housingwire.com/2010/08/04/for-investors-sake-morgan-stanley-questions-power-of-home-price-indices

http://www.costar.com/about/article.aspx?id=7719

On this blog we have discussed several times about the amount of investors absorbing inventory in our market. We've bought a lot of homes for investors in the past year but it has really piled up in the past few months. Many of these properties obtain solid returns, especially among older properties which are often getting 8-14% ces. It is difficult to find these returns in any asset class in today's world. Inman News has a great article on this phenomenon in Las Vegas and elsewhere.

http://www.inman.com/buyers-sellers/columnists/stevebergsman/top-cities-absentee-buyers

Everyone has been curious about the impact of the tax credit on sales. We are seeing a dip but no cliff diving. We have expected that some demand would be pulled forward from the latter months of 2010. Since about half of our market has been investor sales that are not qualified for the credit, the effect may be muted more in Las Vegas than in other areas. The ultimate effect on sales post tax credit may end up being a popular question but with an academic answer. It is going to be hard to disentangle. So far continued low mortage interest rates have kept some in the game. Other macroeconomic factors may trickle down in some form to local housing sales and a lot of this may be mistakenly tagged to the expiration of the tax credit. We know that the expiration will have an effect but by how much is hard to estimate.

Here are the contingent and pending numbers up to May. Don't forget, a lot of the contingents are based on a short sale approval, so many of these will not convert to closings anytime soon.




                                                           Single Family Home Sales
.
Source: Mlxchange.

It is very common in the United States and elsewhere to use markets to hedge risk. Farmers, who are long whatever they grow, often sell futures on those same products. That way if prices slide by the time they harvest and bring to market, they have already sold at the higher price if a price decline indeed occured.

I have been surprised that in the United States that futures products like the S&P/Case-Shiller are still thinly traded on the Chicago Mercantile Exchange. Property derivatives are much more popular in the UK. After all of the misery associated with poor risk management in the past couple of years you would think interest would increase. Nationally, home prices may still have some slack towards the downside, although I think bubble areas like Phoenix and Las Vegas are already trading at discounts because they fell faster (with annual rent/sale price ratios higher than 10). Commercial appears to have even more slack and needs to reset lower. Right now some sellers are trying to price in a recovery, but it will take at least several years to fill the vacant existing space. You really shouldn't see price increases in a widespread condition for some time. Having an efficient method to hedge these risks would be great.

REIT magazine recently interviewed Robert Shiller about some of these concepts. Its a quick read and worthwile. Please click to find it.

Recently the Case-Shiller numbers for March were released. The low-tier index (under $125,000) continues to be show an apparent improvement. The middle-tier ($125,000 to $192,000) and the high-tier (over $192,000) continues to be flat or slightly downward bias. The Radar Logic RPX demonstrates a similar pattern. Median indices, which we can calculate more currently, demonstrate continued flattening.

Who knows how much of this was market held up by the tax credit that expired in April. In the Las Vegas market, we have had so many investors purchasing that they don't really factor in to the tax credit portion unless they planned to flip. Thirty-six percent of the MLS single family sales from January to April were closed with cash. Another twenty-four percent was conventionally financed, which requires a higher downpayment than FHA loans. FHA composed 31% o the financing on sales so that is really the proportion that may have needed the tax credit carrot to make their deals make sense. It may be a while to see the effects of the tax credit and it will also be hard to disentangle. Anecdotally, we are personally seeing even greater investor traffic, especially from foreign buyers. This may offset the weaker demand from the tax credit type buyers. In addition, banks have never released as many REO's as they said they would. Anyhow its hard to ignore 1990's pricing and often 10+ cap rates on rentals.


  Source: Standard & Poors.
 

This post dovetails off of a Wall Street Journal article printed today called "New Ways to Read Economy." I've seen the diesel fuel sales and the counting of train passengers but I think one of the neatest indicators (or at least a gauge of interest) is Google Trends, which shows trends in visitor traffic by search term.

Here are some examples.




You can see that the housing tax credit is still on an upward trend, though spikes occur around news releases.

The search for Las Vegas hotels has jumped substantially from the latter months of 2009 and then leveled off. The vertical jump in December was most likely a result of CityCenter's debut, although it looks like there is some sustained interest.

Short sales are the new big concept following a couple years of "REO" dominating housing headlines. A lot of people want to know how to short sell a home.

Luckily, for all of those short sellers out there (of homes, not stock), there are homebuyers too. I used the term, "how to buy a house" because I thought that's what a first-time buyer would type in. It's a clear upward trend with some seasonality evident. Searches jump in the beginning of the year and taper off towards the end. 2009 was a little different, with a peak in the middle of the year. That's about the time we experienced really good sales in Las Vegas and an end to the big price declines.

We've posted our 2009 Las Vegas Real Estate Report online. There is extensive information regarding the residential real estate market. Click here to view.

Today there was an interesting article in the Wall Street Journal regarding possible strengthening in mark-to-market rules. Banks have often been opposed to these rules because they are forced to write down values in times when they believe markets to be irrational, when investors flee a market based on fear. Conversely, banks may be holding loans at artificially high-values. Investors are tired of this, knowing that banks are holding some loans in la la land and are not moving forward in moving these loans and ultimately the collateral, like commercial buildings, to market. Many investors might be happy to see banks looking at their portfolios more realistically. On the other hand, can many banks find the provisions to offset the losses?

For the WSJ article, click here.

Ernst & Young recently released its Global Real Estate Investment Trust Report 2010: Against all odds. For U.S REITs, the report notes several key components that factor into their outlook. Firstly, after a horrible 2008 and a choppy 2009, REITs have been able to raise significant capital, mostly through the sale of shares. Another aspect of this sector is deleveraging, although many REITs still have significant debt. I would guess that many of these REITs will have to pay down some more of this debt before they can't begin aquiring more property.

Ernst & Young believes that in the 1990's commercial real estate had an excess supply problem. That is, myopic builders overestimated demand for commercial properties and way to much space was available based on current demand. In the current period, demand simply evaporated, causing an exodus. We saw this in our local market, Las Vegas as well. Not long ago we had record low vacancies in industrial and retail, almost to the point where only the obsolete space was left (one could argue that office was overbuilt). Now we have high vacancies in each main sector, office, retail and industrial. Ernst & Young believes that with a rebound in the U.S economy, absorption should be absorbed quickly. I think it will take a fairly broad national recovery before we see significant absorption in the Las Vegas Valley.

The next big feature of REITs today is the targeting of distressed assets, although some companies have been hesitant to purchase other firms with "legacy" issues like large debt obligations. In addition, banks have been slow to write-down values and dispossess themselves of commercial assets. Its not always that they don't want to, it is that they just can't. it will hammer their ratios too much and they need to raise capital to offset the loss. Nevertheless, M & A activity may increase as another avenue to acquire assets, along the lines of Simon Property Group's attempt to acquire General Growth Properities.

It's not all about distressed assets however, as performing properties are sought as well. Even these appear to be on sale, especially by foreign investors as noted by Reuters:

We see a pretty significant amount of interest by foreign capital into US real estate -- not necessarily foreign REITs, but private equity, sovereign wealth funds," Roth said. "There is a general belief that after the significant decline in values that now is the time if you have capital to (chase) risk-adjusted returns."  (Reuters: Global REIT values to grow in 2010-Ernst & Young, March 2010).

So far in Q1, we've seen a lot of genuine interest in assets in the Las Vegas Valley, not so much by REITs (although General Growth has a lot of exposure here) but by foriegn investors big and small, as well as by hedge funds and schooled, large investors raising money in private channels. If Q1 is any indicator for the rest of 2010, its going to be an interesting year.


For the Ernst & Young Report Click Here

For the Reuters article Click Here

We've discussed trends in median prices and Case-Shiller as well as IHS Global Insight's view that Las Vegas is the most undervalued large metro area but fundamentally, where are Las Vegas home prices? While fundamental values are unobservable, we can use proxy indicators such as the price-to-rent ratio. One can think of this like a price/dividend ratio in stocks.

As the exhibit below demonstrates, the recent price/rent ratio is far below the baseline, which we've established based on the 2001-2002 years before the ridiculous run-up in prices. We have experienced severe declines in prices, driving the ratio down. The mechanism of the market can bring this ratio back into line by a combination of rent and price adjustments, which we are seeing now. Rents appear to be declining due to the amount of available inventory as well as weak employment and diminished household formation. However, rental prices have been quite sticky. Home prices have not been sticky and we saw massive adjustments.

Currently we have been settling and have observed median prices bounce between positive and negative on a month-to-month basis. Based on the price/rent measure, it is reasonable to expect that when employment rebounds and in-migration resumes with force, we will again see home price appreciation and a return to fundamental values. When could this happen? Thats difficult to say. When prices were above our measures of fundamental values it was pretty easy to make a forecast. For a monthly forecast, as long as it was in the single digits and had a negative in front of it, that was a reasonable forecast. Now that prices are undervalued but you still have underlying economic weakness, its difficult to forecast. Monthly forecasts have not been what our investors are looking for however. A typical strategy (not by flippers of course) is to hold with the expectation that you will own it for at least five years. What do you think will happen in five years? Ask yourself that, frame it in the context of your risk tolerances and carry costs and take a look at some of the residential assets in the market today. It might be very worthwile.

For a slightly academic discussion of price-rent ratios Click Here.


             Source: Mlxchange, Coldwell Banker Premier Realty.

The S&P/Case-Shiller home price index came out this morning. Unfortunately it is so popular that the site crashes and I have just obtained the data. We do observe seasonality in prices in Las Vegas so I like to use the seasonally adjusted indices. Interestingly, the most current observation, December 2009, registered a month-to-month increase in all price tiers. A positive change has occurred for both November and December. Was this a purely organic increase? Probably not. The tax credit has been a relevant motivator of purchases and we have probably brought some demand forward. Nevertheless, pricing has appeared to reach an inflection point away from declines. This is encouraging, even if we do skip along a bottom characterized by positive and negative month-to-month changes.

As we have noted before, there are several encouraging characteristics of today's market that point to a good time to purchase homes. The tax credit does provide a lot of folks the necessary financial buffer to make the downpayment outlay hurt less. Yes, you fork out some cash now but if you are qualified you get a check in several months. Further, the tax credit buffers any posible price declines. If you buy a $120,000 home, that home could decline in price by 6% a are still net positive. But that is not a reason to buy but is an offset in risk. There are other reasons to buy. Mortgage rates are low, however many mortgage market observers are predicting rates to increase, especially after the completion of the Fed's program of purchasing mortgage backed securities (if they spiked prices could decrease, however a massive spike is unlikely). Go with what you know and not with what you hope. You know rates are historically low so wishing for lower rates is probably going to lead to disapointment.

In addition, you can often buy cheaper than you can rent. The decision to buy may not be a consideration for everyone since some households are still in a transitory position, unclear of their job prospects or where they would like to spend a significant portion of their lives. But for households that choose to make Las Vegas their home for a longer-term, purchasing may be a reasonable option.

Another feature of the Las Vegas residential market is the high returns that you can get on rental properties. Returns this high should not be sustainable and implies that sale prices are way out of wack. While we see a softening rental market, sale prices and rental prices should move to where these returns are lessened. Part of that will likely come from appreciation. Significant appreciation may not happen tomorrow or even months from now but for investors; they can get positive cash flow, then appreciation later on. Would I tell everyone to buy a home? No, because renting make sense for some people. However, for stable households or investors, the data points to a really opportunistic time for buying. Buying this far below trend is another attribute that makes this era encouraging for home purchases.

Source: Standard & Poors.

 

Seeking Alpha has a good article today regarding bond market expectations of inflation. The author notes that 4.7% yelds seem massive in todays low interest rate environment but 30 year bonds are still selling poorly. The weak investor appetite for these bonds implies that market participants are expecting inflation since 4.7% yeld in a deflationary market would be supurb.

If this author is correct about inflation expectations, what does that mean for real estate? My take is at these low interest rates, I would not mind owning more real estate, especially income producing. Something that could be expected to rise with inflation but still covers costs like taxes and insurance, with enough left over for that sometimes elusive feature called positive cash flow. If you buy smartly, this can be done. Factor in your purchase price a much higher vacancy rate and lower lease rate and if it covers the note at those levels, there is good chance you have preserved some upside for yourself. As always, there are no certainties and you must do your homework. Nevertheless, opportunities are abundant. Also note: The Fed's program of buying MBS is near conclusion. Higher mortgage rates could be on the horizon. Click for the article cited