My Crystal Ball Forecast for 2013

Forecasting reminds me of the quote attributed to one of our most famous philosophers of the 21^st century, Yogi Berra.  He said, “It’s tough to make predictions, especially about the future.”  But it’s that time of year when we all want to know what the new year is going to bring.  Specifically those of us in commercial real estate want to know, “How is commercial real estate going to do in the Pacific Northwest in 2013?” 

Well you’ve come to the right place because I’m bullish about the immediate future of commercial real estate.  Interest rates should remain low throughout 2013.  Commercial real estate should continue its upward trend out of our plunge into the abyss caused by the Great Recession of 2008.  Four years ago we were in a free fall, similar to a skydiver who waits as long as possible before he pulls the ripcord that opens his parachute.  It looked bleak.  Let me correct myself.  It was bleak.  But in 2010 we bottomed out and 2011 showed a modest improvement.  Last year was even better and there is no reason to believe this trend won’t continue into 2013.  

However there are three caveats to this prediction.  As James Carville once said, “It’s the economy stupid.”  And sure enough how well we do in 2013 assumes that the economy continues to grow at the modest pace that it has grown for the past few years.  If not, then all bets are off.  There are three things that could derail our economy. 

1.  The Slow Down of the World Economy 

Even though 70% of our economy is derived from domestic spending, the United States is not immune to what happens in the rest of the world.   And what is happening in the rest of the world?  Europe is in recession and the economies of other countries are slowing down.   This means that there will be less demand for our exports, which means our economy will begin to feel the affect.  However, I don’t believe that during 2013 we will feel the brunt of this slowdown to any real degree.   If the slowdown continues into 2014 and beyond then it is likely that it will slow our economy, maybe throwing us into recession as well but not this coming year.  

2.  Europe Muddles Through 

As I’ve discussed on several occasions, Europe’s sovereign debt crisis is not going to end well.  There is no satisfactory solution to their problem.  The only question is when, not if, it will implode.  The Europeans have been doing an excellent job kicking the can down the road these past few years and I’m guessing they will be able to further kick the can down the road through 2013.  If they can there will be little negative consequence this coming year to their sovereign debt crisis on the American economy. 

3.  Fiscal Cliff Outcome 

As of the time of my writing this blog post the Senate has just passed a bill to avoid the fiscal cliff but it has yet to be voted on by the House.  It’s hard to tell if this version will be acceptable to House Republicans.   At some point there will be an agreement, either this bill or one modified slightly to accommodate the House Republicans.  But let me let you in on a little secret, actually a big secret: It makes no difference which side wins the budget negotiation.  What both sides are proposing is equivalent to arranging the deck chairs on the Titanic.  They are haggling over nuance differences over how to raise tax revenues with almost no proposed spending cuts.  The proposed bill will raise about $1 trillion over 10 years.  That’s equal to $100 billion annually, which is an insignificant amount when compared to what is needed to right our fiscal ship.  So instead of having annual deficits of $1.2 trillion, we will have going forward $1.1 trillion in annual deficits.  So in ten years the total U.S. debt will go from $16 trillion to $27 trillion.  Sadly, no one in Washington has the courage to put our fiscal house in order.  Not the president, not the Republicans.  

Now the real question for 2013 is whether or not the stock market and the credit agencies perceive this miserable attempt at political theatrics as the sham that it is.  If not, then it will have no adverse impact on our economy.   If they do, the stock market will start to decline, possibly precipitously, and the credit agencies, such as Standard & Poors, may be forced to further downgrade the credit rating of our country.  That’s the potential fallout from the Fiscal Cliff.   Stay tuned.

If we can avoid these three pitfalls from happening in 2013, then our economy should continue to grow.  And with a growing economy commercial real estate in the Pacific Northwest should do quite well this coming year.   But the bigger issue is finding people on both sides of the aisle who have the political courage to get us out of our fiscal mess.

John Mitchell's Economic Forecast - Is It Going to Stop?

I had the opportunity to hear John Mitchell’s economic forecast at the October 19th Commercial Association of Broker's breakfast meeting.  John always does an excellent job making a boring topic interesting.  There were no surprises in his presentation about the current economic situation, the gist of which was, the U.S. economy is growing, albeit at a slower rate than one would hope.

John began with a quick review of where we are:

• In the 4th year of economic expansion (hard to believe that's true but it is)
• 4.5 million jobs below our January 2008 peak
• 4.3 million jobs above our February 2010 trough
• 73 days until the Fiscal Cliff (read my previous post if you want a quick primer on the Fiscal Cliff)
• Globally experiencing economic weakness - Europe, Brazil, China, Russia, India are all either in recession or their economies are slowing down
• In the fourth year with short term interest rates at zero
• The Congressional Budget Office and the International Monetary Fund are both warning of a U.S. recession looming within the next several months

But I didn’t go to hear John Mitchell talk about our current economic situation. I went there to hear what he thinks will happen going forward. Accurately forecasting future economic trends splits the men from the boys, which reminds me of the Yogi Berra quote: “It’s tough to make predictions especially about the future.”

Not surprisingly, John Mitchell didn’t go out on a limb making any bold predictions about our economic future. Economists as a rule are not known for being risk takers. John Mitchell believes that our economy will continue to sputter along in the 2% growth range and that inflation will stay in check at about 2% for the foreseeable future as long as the Fiscal Cliff is handled responsibly.  

What was disconcerting to me was how negative his overall presentation was.  John by nature is an optimist.  He is always looking for a "silver lining." Normally if he says something pessimistic he tries to sugarcoat it with some positive news.  That was not the case this time.  My notes are filled with downbeat statistics.  The big three downers were:

• The economic recovery is growing at an historically slow rate when compared to all other economic expansions since WWII. 
• The Fiscal Cliff.  Congress and the president need to work together to avoid an economic crisis of their own making.  If not handled properly it will throw the U.S. economy into a recession.
• Monetary Policy.  The Federal Reserve is out solutions and nothing has worked.  Interest rates are at historic lows, Operation Twist, and Quantitative Easing have had only modest impact on the economy.  

When he got done, I had to fight the urge to give him a big hug and tell him things will get better. 

Whether that is true or not will depend in large part on who we elect in November.  I hold out no hope if President Obama is re-elected for another four years.  I'm not sure he even acknowledges that we have a serious debt crisis that will take us down the same path that Europe is traveling if we don't do something about it soon.  Mitt Romney talks a good game.  He at least says the right things but I'm skeptical he will have the courage to make the hard choices to get us back on track.  Is he a statesman or just another politican saying whatever is necessary to get himself elected?  I'm sure I've just offended both the Democrats and Republicans that read my blog.  Sorry.  I consider myself an equal opportunity offender.    

1st Quarter 2012 Sales Activity - How Did We Do?

From a sales standpoint how well did we do in for the 1st quarter of 2012 compared to previous years? Shown below are the criteria we used to tabulate the results:

• Sales information is from the CoStar database as of March 31st. My guess is that it will take a few more weeks before CoStar has all the 1st quarter sales activity recorded but this is what they’ve recorded so far.
• Transactions closed between January 1st and March 31st, 2012
• Investment properties only (no owner user)
• Property types - flex, industrial, mixed use, multifamily, office & retail
• Transactions with sales prices of $1 million or larger
• Arms length transactions (no partial conveyance of ownership)
• Transactions located between Kelso, WA and Eugene, OR including Bend

Based on these criteria the chart below compares the sales activity for the first quarter of 2012 with each of the preceding five years:

As you can see 1st quarter sales activity was less than last year but more than in 2010.  It gives me the impression that that we've bottomed out but we are bouncing along the bottom, ie, it's not getting worse and it's not getting better.  For the past four years, the first quarter sales activity has been roughly the same.   

We then analyzed the 47 closed transactions by property type:

Not surprisingly, multi-family leads the way with the most sales transactions in the first quarter.  What is a bit surprising is the number of office transactions.  This is significantly up from the past few years.  Is this a trend or an anomaly?  We'll have to wait and see how the rest of the year develops. 

Of the 47 transactions, 16 had broker representation on both sides of the transaction.  Eleven had no broker representation.  The remaining 20 transactions had only one side of the transaction represented.

If you add it all up, there were a total of 52 paydays (2 x 16 + 20).  So if you want to know your personal market share of all the broker paydays divide your number of paydays by 52. 

Shown below are the lending sources for these transactions:

The banks continue to provide the bulk of the acquisition financing for Oregon and SW Washington.  There is almost a complete absence by the life companies, Freddie & Fannie, and the credit unions.  A big surprise is the lack of seller financing.  Over the past several years seller financing was the predominant way most non-apartment transactions were financed. 

Shown below are the top 6 real estate brokerage firms based on total broker representation of closed transactions for the 1st quarter of 2012: 

The real estate brokerage community is not dominated by any one firm.  In fact, Joseph Bernard Investment Real Estate, who is ranked #1 on the list with 5 broker representations, represents less than 10% of the total market.  The top 6 firms present only 42% of the total market.

So how do I summarize the first quarter?  It's been surprisingly quiet.  I was expecting more activity than last year, and so far that has not materialized.  That's not to say it won't but it needs to pick it up a few notches if the market is going to show a sustained improvement over the previous couple of years.  Here's hoping that the coming quarter shows improved strength over the one we've just finished! 

John Mitchell's Economic Forecast - Opportunities to Be Seized

I had the opportunity to hear John Mitchell’s economic forecast at the Sterling Savings Bank November 3^rd breakfast meeting.  John always does an excellent job making a boring topic interesting.  There were no surprises in his presentation about the current economic situation, the gist of which was, the U.S. economy is growing, albeit at a slower rate than one would hope.  

But I didn’t go to hear John Mitchell talk about our current economic situation.  I went there to hear what he thinks will happen going forward.  Accurately forecasting future economic trends splits the men from the boys, which reminds me of the Yogi Berra quote: “It’s tough to make predictions especially about the future.”

Not surprisingly, John Mitchell didn’t go out on a limb making any bold predictions about our economic future.  Economists as a rule are not known for being risk takers.  But in fairness to John, he did identify several issues that could influence the economy for good or for ill.  I would like to focus on two of these challenges.  If these issues are handled properly it would have a positive long-term impact on our economy. 

Opportunity #1 – The Housing Crisis

As John Mitchell pointed out, 17% of all homes in Oregon and 22% of all houses in the U.S. are underwater, i.e., homeowners owe more than their houses are worth.  Until this crisis is resolved, house prices will not bottom out, let alone begin to appreciate in value.  And until house prices begin going up most Americans will not have the confidence that the economy has turned the corner regardless of what the economic numbers may say.

One proposal that would go a long way to resolving the housing crisis is writing down some of the principal on these underwater mortgages.  It is estimated that 10 million out of 55 million mortgages are likely to default. The single best indicator of whether a homeowner will default is the size of the imbalance between what is owed and what the house is worth.  Reduce the size of the imbalance and there will be fewer defaults.  Fewer defaults would be a major step in stabilizing house prices.  

Banks hate this idea and would rather continue with the status quo.  The solution: Leaders in Congress should propose legislation that will allow banks to quickly write down mortgages in a manner that doesn’t punish the banks’ long-term viability.  The alternative is continued stagnation in the housing market. 

Opportunity #2 – The Congressional Supercommittee

As you already know, the congressional supercommittee has been given the task of proposing a combination of $1.2 trillion in spending cuts or revenue increases over the next 10 years.  Their deadline to make their proposal before Congress is November 23^rd which is fast approaching.  Most economists believe that anything less than a $3 trillion package will be perceived by the market as little more than putting a band aid on a gaping wound.  Failure to come to some agreement will likely increase our chances of a further downgrading of our nation’s credit rating. 

I hope that those on the committee are closely watching the debt crisis in Europe unfold.  Just in the last week both the Greek and Italian leaders have been forced from office.  Europe is in the throes of a financial crisis.  We could be next.  Compromise, a word that is now considered a pejorative by many, needs to happen between Republicans and Democrats in order to get anything through the supercommittee that has a chance of passing both houses of Congress.   

Both of these issues are at major crossroads.  And both of these are opportunities to be seized or to be squandered. If those in political power show some leadership they could help turn our economic ship around.

Sources: Aftershocks, Oil Shocks and the Long Good-Bye, by John Mitchell, November 3, 2011; A Good Idea in Principal, by Joe Nocera, The Oregonian, November 8, 2011. 

First 9 Months 2011 Transaction Activity

The first 9 months of 2011 has come and gone!  From a sales standpoint how well did we do compared to previous years?  Shown below is the criteria we used to tabulate the results:

• Sales information from the CoStar database
• Transactions closed between January 1st and September 30th
• Investment properties only (no owner user)
• Property types - apartments, industrial, flex, office, retail, mixed use
• Transactions with sales prices of $1 million or larger
• Arms length transactions
• Transactions located between Kelso, WA and Eugene, OR including Bend

Based on these criteria the chart below compares the sales activity for the first 9 months of 2011 with each of the preceding four years for the same time period.

As you can see, the sales activity for the first 9 months of 2011 has almost doubled from last year and is almost back to the same number of transactions recorded in 2008.  We are definitely on the rebound!

We then analyzed the 205 transactions by property type:

Multi-family and retail properties continue to dominate the property transactions but other property types are beginning to make their presence known.  All other property types represented 35% of the total sales transactions compared to 28% for the first 6 months of this year. 

Of the 205 transactions, 96 had brokers representing both sides of the transaction.  Forty-nine transactions had no broker representation.  The remaining 60 transactions had only one side of the transaction represented.

If you add it all up, there were a total of 156 broker paydays (2 x 96 + 60).  So if you want to know your personal market share of all the broker paydays divide your number of paydays by 156.  Shown below are the first 9 months lending sources for the 178 sales transactions where the lender was identified:

Seventy-three out of the 178 transactions (41%) were either all cash transactions, assumed the existing debt or were seller financed.  Only 105 transactions (59%) used conventional financing.  Of these, the vast majority were financed by banks 67 (64%). 

Thank goodness owners have to refinance their properties from time to time or most of the mortgage brokers would be out of business.

The sales transactions for the first 9 months of this year strongly suggests that commercial real estate is on the rebound.  Let's hope for all of our sakes that this trend continues into the foreseeable future. 

First Half 2011 Transaction Activity

The first half of 2011 has come and gone!  From a sales standpoint how well did we do compared to previous years?  Shown below is the criteria we used to tabulate the results:

• Sales information from the CoStar database
• Transactions closed between January 1st and June 30th
• Investment properties only (no owner user)
• Property types - apartments, office, flex, industrial, retail, mixed use & specialty use
• Transactions with sales prices of $1 million or larger
• Arms length transactions only
• Transactions located between Kelso, WA and Eugene, OR including Bend

Based on these criteria the chart below compares the sales activity for the first half of 2011 for each of the last five years:

As you can see, the sales activity for the first half of 2011 increased significantly over the same time period for the last two years: up 17% over 2009 and a whopping 54% over 2010.  We are still well below the transaction activity that we achieved in previous years but the trend is going in the right direction.  Hey that's encouraging!

We then analyzed the 91 transactions for 2011, starting by property type:

Multifamily and retail sales comprise 72 percent of all the sales transactions which is similar to what we've seen in the past couple of years.

Of the 91 sales transactions, 75 of them identified the broker representation and 77 of them identified the lending source that was used.  The remaining transactions did not identify broker representation or lending source.  Shown below is a summary of broker representation fo these 75 transactions:

Assuming that the trend for the 75 sales held true for all 91 sales transactions, then there were about 73 paydays for all of the real estate brokers in our area in the first half of this year (91 x 53% x 2 + 91 x 15% + 91 x 12%).  So if you want to know your personal market share of all the broker paydays divide your number of paydays by 73.

Shown below are the first half lending sources for the 77 sales transactions that a lender was identified:

Thirty out of the 77 transactions (39%) were either all cash buyers, assumed the existing debt or were seller financed.  Only 47 transactions (61%) used conventional financing.  Both regional and national banks made up the majority of these loans.  Insurance companies only made 2 acquisition loans in the first half of this year.

Thank goodness owners have to refinance their properties from time to time.  Refinancing properties is not included in the figures above.  If we had to live solely off acquistion financing many of us on the lending side would be out of business.

Let's hope for all of our sakes that the upward trend in commercial real estate activity continues to improve so there are more paydays for all of us in the industry. 

Retail Is Coming Back Nicely

In my last post I showed the first quarter sales results by property type for our region.  Not surprisingly, 42% of all sales for the quarter were apartments.  What was surprising was the strong showing from retail: 29% of all sales in the first quarter.  So I thought this deserved additional investigating.

The CoStar Group recently had a webinar on the U.S. retail market.  The bottom line of their presentation - retail is coming back nicely.  Shown below are two charts that support their thinking:

As you can see from the chart retail has had 9 consecutive months of positive sales volume (people are buying more) and has been averaging about 6% annual growth since September of 2010. 

Absorption of retail space is also improving nationally as shown in the chart below:

After two negative quarters of negative absorption, we've now experienced 7 consecutive quarters of positive net absorption.  During this time period 80 million SF of retail space has been absorbed. 

Other interesting tidbits from the CoStar webinar were:

• Job creation, which spurs retail sales, has been positive for the past 5 consecutive quarters.
• Construction of new retail space has been almost nothing for 2010 and is projected to continue that way through 2011, which bodes well for further net absorption of retail space through the rest of this year.
• Sales of distressed retails sales is moderating.  Distressed retail sales peaked at 21% of all sales during the 2nd quarter of 2010.  During the first quarter of this year, distressed retail sales were estimated at 17% of all sales.
• Cap rates for retail properties have compressed significantly.  Retail cap rates peaked at 8.5% in the 2nd quarter of 2009 and are now averaging 6.5% nationally.

All of these statistics bode well for further improvement in the retail sector.  Let's hope this trend continues and that other property types can follow in the footsteps of apartments and now retail. 

1st Quarter 2011 Transaction Activity

The first quarter of 2011 is over.  From a sales standpoint how well did we do compared to previous years?  Shown below is the criteria we used to tabulate the results:

• Sales information from the CoStar Group database
• Transactions closed between January 1st and March 31st
• Investment transactions only (no owner occupied)
• Property types - apartments, office, flex, industrial, retail, mixed use & specialty use
• Transactions with sales prices of $1 million or larger
• Arms length transactions only
• Transactions located between Kelso, WA and Eugene, OR including Bend

Based on this criteria the chart shown below compares the sales activity for the 1st quarter for each of the last five years:

 
As you can see, the sale activity for the first quarter of 2011 increased significantly over 2010 but fell well below previous years.  The good news is that if this trend continues for the rest of this year, 2010 will have been the bottom of the market with a good possibility of improving sales activity going forward.   


We then analyzed the 45 sales transactions for the first quarter by property type.

As you can see apartments still are the most favored property type with 42 percent of the sales in the first quarter followed by retail.  Most of the retail sales were fast food franchises or single tenant buildings. 

Of the 45 sales transactions, only 35 identified the broker representation and only 38 identified the lending source used.  The remaining transactions did not provide sufficient information to determine the lender or if brokers were involved in the transactions.

Another way of looking at it, there were 45 paydays for all of the real estate brokers in the first quarter (17 x 2 = 34 + 7 +4 = 45).  So if you know how many of these transactions you were involved in, you can determine your market share. 

Shown below are the first quarter lending sources for the 38 sales transactions that a lender was identified.

Almost half of all sales transactions in the first quarter did not need new financing.  These results also explode the myth that life companies are back in the market.   After you take away the all cash buyers and assumed loans only 20 loans were placed in the first quarter, most of these from banks.  This paltry number of loans for the first quarter does not bode well for the mortgage brokerage community but hopefully we are on an improving trend.  I look forward to seeing how this quarter turns out.  Keep your fingers crossed.

The Six Immutable Laws of Real Estate Investing

James Montier, the well known author of "The Little Book of Behavioral Investing" recently wrote an article called "The Seven Immutable Laws of Investing."  In this article he identifies seven principles for sensible investing in the stock or bond markets.  I was intrigued by the title so I read the article and somewhere along the way I realized that 6 of these 7 "immutable laws of investing" also apply to investing in commercial real estate.  So I thought what the heck, maybe I should take a stab at writing an article on the "Six Immutable Laws of Real Estate Investing."  So here goes:

1. Always insist on a margin of safety.  In other words the goal is not to buy at fair market value but to purchase with a margin of safety as property performance, market conditions, etc. may not live up to expectations.  In our world of real estate this means finding properties that are under performing the market but with a change in ownership will turn the property's performance around. 
2. This time is never different.  The four most dangerous words in investing - "this time is different."  The dot.com bubble that occurred about ten years ago is a perfect example.  Investors were buying stock in companies that hadn't turned a profit on the expectation that they would be the next Google, or Amazon.com.  Stock prices soared and even though it made no logical sense the argument that was bandied about was, "this time is different."  The same was true of real estate.  How many believed that house prices could never go down?  In both examples a speculative fever resulted in a bubble causing stocks and house prices to plummet in value.  Whenever someone starts saying this time its different, get out of that investment as quickly as you can.
3. Be Patient and Wait for the Fat Pitch.  As Mr. Montier states in his article, "Patience is integral to any value-based approach on many levels... However patience is in rare supply."  In commercial real estate there is a time to wait and there is a time to act.  When things go bad, like they have for the last three years the tendency is to dump our real estate holdings as quickly as we can when the prudent thing to do is wait.  Most investors suffer from an "action bias" - a desire to do something.  But often times the best thing to do is to stand at the plate and wait for the fat pitch.     
4. Be Contrarian.  Humans are prone to the herd instinct.  When everyone is buying they buy; when everyone is selling they sell.  Last year the value of BP's stock plummeted due to the gulf oil crisis.  BP stockholders were dumping their stock and only a few contrarians were buying.  Less than a year later those that fought the urge to follow the herd have made a handsome profit while those who sold lost money.  Now's the time to be buying commercial real estate, especially those that have been hardest hit - office, retail and industrial.  Years from now we will realize that that there were bargains to be purchased in 2011.  Or we can go along with the herd and sit on the sidelines.
5. Be Leery of Leverage.  I really shouldn't have to say much of anything on this topic.  In many instances those owners with properties that were over leaveraged have paid the ultimate price - the loss of their properties.  Those homeowners who used their homes as ATM machines learned the hard way too.  Three years after the the collapse of the housing bubble about 1 in 4 homeowners have no equity in their homes.
6. Never Invest In Something You Don't Understand.  This is just plain old common sense.  It's not uncommon for for me to talk with real estate investors that are clueless about their real estate holdings which puts them at the mercy of their real estate advisors.  Many times these advisors have a different agenda than the owner but the owner not knowing the fundamentals of commercial real estate is unaware of the conflict of interest.  It's a simple truth: If you don't understand the investment concept, then you shouldn't be investing in it.

I personally believe that now is the time to be investing in commercial real estate as long as you follow these six fundamental principles.  Cap rates have risen significantly, the frothiness of the market has long since disappeared and  interest rates are low... at least for the time being.  Or you can be a part of the herd that sits on the sidelines waiting for a better day, a day that will likely never come.  

A Picture's Worth a 1,000 Words

By Doug Marshall

I recently came across the following U.S. employment chart which got my attention and should get yours too. 

The chart shows U.S. employment growth by decade from 1940 through 2010.  Every decade from the 1940s through the 1990s showed positive job growth of at least 20 percent.  But the decade from 2000 to 2009 showed negative job growth.   In other words the Great Recession we are currently coming out of has wiped out all employment growth that has occurred during the past decade.  Yikes!  The chart also shows that we've had some employment growth last year and if it continues through the end of the decade at the same pace it would increase employment by 8.7%.

As revealing as that chart is, more important to us is the employment growth rate in the state of Oregon.  Does it follow the national trend or does it chart its own course?  As much as we like to pride ourselves that Oregon travels to the beat of a different drummer when it comes to employment growth over the past decade we follow the exact same drum beat as the national economy. 

Last week I had the opportunity to hear Tom Potiowsky, the State of Oregon Economist, at the Sperry Van Ness Economic Forum indicate that our current level of employment of about 1.6 million jobs is about where we were in January of 2000.  So Oregon is in the exact same situation as the national economy: no net new job growth during the past decade.  At the peak of employment, which occurred in the first quarter of 2008, Oregon had about 140,000 more jobs than it does today.  

Maybe more revealing is the following chart that compares this recession with previous recessions since World War II.  This graph shows the number of months it took for each recession to return to its peak employment.  For most recessions it took between 12 and 24 months for employment numbers to bounce back to pre-recession levels. 

Only the 1980 and 2001 recessions took longer, 86 months and 51 months respectively. The Great Recession of 2008 is currently in its 34 month and it is forecasted to rival the 1980 recession in length.

Why is this important to commercial real estate professionals?  Until the Oregon economy begins adding new jobs commercial real estate (with the exception of apartments) will be, for all intents and purposes, in the doldrums.  Employment growth fuels increases in office occupancy rates, it increases demand for industrial output and spurs retail sales.  They are all directly affected by job growth.  If Tom Pitiowsky's forecast for returning to pre-recession employment levels is accurate we have another 3 to 4 years to weather this economic storm. 

2010 Transaction Activity

By Doug Marshall, CCIM

Tanya Williamson in my office went through the laborious task of tabulating all of the transaction activity for the past five years.  Below is the criteria she used in compiling the data:

• Source - CoStar Group database
• Investment sales activity only, no owner occupied
• Property types included Office, Flex, Industrial, Retail, Mixed-Use and Multi-Family
• Transactions with a sales price of $1,000,000 or greater
• Arms length transactions only
• Properties were located along the I-5 corridor from Kelso, WA to Eugene, OR including Bend, OR

Based on this criteria, the annual transaction activity for the last 5 years is shown below:

As you can see, transaction activity for 2010 was slightly less than 2009, a decline of about 9% over the prior year.  Substantially more dramatic is the 65% decline in the number of transactions since the 2007 peak.  The good news is that it appears that we have leveled off and maybe we will actually see an increase in sales activity this year. 

As you can see from the graph below, multi-family properties closely followed by retail properties make up the bulk of the sales in 2010.  Combined these property types total 67% of all sales transactions last year.

The last tidbit we can glean from the data is the transaction broker representation.

Of the 153 sales transactions in 2010:

• 54% had both the buyer & seller represented by a real estate broker
• 27% had no buyer's broker
• 17% had no brokers involved for either the buyer or the seller
• 2% had no listing broker

That's the news from Lake Woebegone!  Let's hope that the market has bottomed out and 2011 will see a substantial increase in sales activity. 

Office Market is Showing Signs of Life

One of the best barometers of an improving economy is reflected by a positive trend in office vacancy. As reported January 4, 2011 by the Wall Street Journal, the fourth quarter of 2010 was the first quarter since the end of 2007 that office properties in the U.S. registered an increase in occupied space (see chart below).



Other important tidbits from the article:

• Business vacated 138 million SF of office space between January 2008 and September 2010.


• The national office vacancy rate is 17.6%.


• Nationally, 2.5 million SF (net) were absorbed in the fourth quarter of 2010 after having negative absorption for the previous 11 consecutive quarters.

Portland is following the national trend, so says Gordon King of Collier's International. Mr. King is probably the closest thing we have to a "resident expert" when it comes to the Portland office market. In a recent conversation with me he had these interesting tidbits about Portland:

• Last year the Portland MSA had 600,000 SF of net absorption of office space, two-thirds of which occurred in the 4th quarter.


• The vacancy rate for the overall Portland market is in the 15% range with the downtown core being the lowest at 8% and th suburb office market the highest at around the mid- to high-20% range.


• Rents have not yet stabilized but the rate of decline is slowing. Mr. King estimates that rental rates will decline another 5% before bottoming out.


• In order to get the office vacancy rate in the 7 to 8% range, which is considered a stabilized market, 3,000,000 SF of office space would need to be absorbed. Assuming net absorption of 800,000 SF annually, it will take about 3 to 4 years to achieve a stabilized market.

The Portland office market is showing signs of improvement though it has a long way to go. However, it's just one more indication that the local economy in on the mend.

Sources: Preliminary Q4 Trends Announcement, ReisReports; Fresh Signs of Life in Office Market, Wall Street Journal, January 4, 2011; Light at the End of the Tunnel (It's Not Another Train), Ted Jones Blog, January 6, 2011.

My Crystal Ball Forecast for 2011 Commercial Real Estate

Doug Marshall, CCIM
Market Assesment


Back in December I asked my reading audience to give their opinions about what the commercial real estate market would look like in 2011.

I was pleasantly surprised by the number of people who responded. Thank you. Generally those who responded had similar thinking about the coming year as I did. So here goes:

· It’s the economy stupid! Everything hinges on what the economy ends up doing. The good news is that the economy is on the upswing. I know it doesn’t feel that way but the economy is on the rebound, albeit ever so slowly.

Believe it or not, we have had five consecutive quarters of positive growth in the GDP averaging just under 3% annually. Job growth is a different matter. There has been virtually no real improvement in the unemployment rate during this time period, currently stuck at 9.8% nationally.

The recent compromise tax bill maintaining the Bush era tax rates for another two years and lowering the payroll tax by 2 percent will have a positive impact on the economy. So I’m expecting a modest improvement in the overall economy by the end of the year.

· Rising interest rates. No one expects interest rates to stay at the current level. We are all predicting them to rise, the only question is how much. If they rise gradually over time we’ll be OK. If they rise dramatically over a short period of time, like they did from early October through mid December of 2010, it will shut down our industry until real estate prices adjust to the higher rates.

The consensus is that rates will rise slowly. Let’s hope we’re right. The alternative would be disastrous

· Will there be more lenders in the market? Yes. Absolutely. And their rates will be more competitive too. I am beginning to see this especially for apartment financing. I get calls from lenders saying that they plan to dramatically increase their loan volume in 2011 and asking what they need to do with their rates and terms to get more deals.

I also see a few lenders getting back in the retail side of the market. Lenders are showing more interest but underwriting will continue to be difficult. I think there will be more lenders in the market as their balance sheets improve. We are not over the banking crisis but we are beginning to see a light at the end of the tunnel.

· What property types will show increased sales in 2011 over the prior year? Everyone agrees there will be increased sales transactions in 2011. That’s probably because to be in commercial real estate you have to be a cockeyed optimist!

However there wasn’t a consensus as to which property types will show the most improvement. This is my take: I believe all property types except for land and hotels will show improved sales activity this year.

However for most property types, office, retail and industrial, the properties that are distressed with blood in the water will be in demand and those that are strong credit tenant properties will also be in demand. Everything in between will likely have very little sales activity.

Lenders have shown little appetite for properties that have any “hair” on them whatsoever, i.e., high vacancy, rental rates trending down, short lease terms, etc. Apartments, being the exception will do fine regardless of size, condition, and location as there are several lenders wanting to finance apartments with more recently coming into the market.

· Where are vacancy rates, concessions and rental rates heading? Improvement in vacancy rates, concessions and rental rates will be dependent on job growth, especially for office and industrial properties. Apartments and retail are less dependent on job growth but they too would show improved demand if the unemployment rate were to dip a bit.

The unemployment rates for Oregon and Washington, 10.6% and 8.9% respectively are not expected to improve significantly this year. At best I think we will see modest improvement in the unemployment rate, but probably not enough to affect real estate values.

· What will cap rates do? I think rising interest rates will stop any fall we might have seen in cap rates due to improving fundamentals and demand. They will counterbalance one another.

I believe it is possible that the top of the line properties may see some improvement in cap rates but all other properties will see either have a flat or slightly rising cap rate during the year.

A special thanks to Mike Baron, Mark Barry, Charles Conrow, Tom Davis, Alan Evans, Tom Hanacek, Cliff Hockley, Steve Morris, Marc Rogers, Dan Rodriguez, and Christian Trandum who gave valuable input for this article.

What’s Going On With Interest Rates?

by Doug Marshall, CCIM
Market Assessment

Over the past 60 days, the yields on 10-year Treasury notes have increased from 2.41% on October 8th to 3.53% as of December 15th, an increase of 1.12%.

What's going on?

Let's begin with a US Bonds 101 class. The 10-year Treasury note has become the security most frequently quoted when discussing the performance of the U.S. government bond market and is used to convey the market's take on longer-term macroeconomic expectations.

All of the marketable Treasury securities are very liquid and are heavily traded on the secondary market. The treasury yield expresses the relationship between the face value of the security and the amount of return the investor receives.

If there are more investors selling bonds then those who are buying bonds, the value of the bond declines (the law of supply and demand). A reduced price on the bond results in an increase in the yield or return on the bond.

Another name for “treasury yield” is “interest rate” which those of us in commercial real estate follow very closely. When US Treasury rates jump up significantly, like they have since early October, it means that investors are dumping their bonds in huge quantities. I can’t recall the last time I’ve seen interest rates jump so dramatically over such a short period of time.

So the $64,000 question is, “Why are bond holders selling off their bonds?” I have surfed the web for an answer to this question and unfortunately there is no agreement among the experts.

Depending on who you like to read there are a variety of answers. But being fearless and little bit stupid I am going to give you my opinion (take it for what it’s worth).

But before I give you my assessment of the situation let me muddy the waters a bit with some conflicting information.

Data released by the Treasury Department yesterday indicated that the Federal Reserve, China and Japan have recently been on a U.S. bond buying binge. The Fed is now owns $972 billion in Treasury holdings which surpasses China’s $906 billion (now the 2nd largest hold of U.S. treasuries).

And with more Quantitative Easing 2 purchases on the horizon it is highly probable that this lead will be greatly extended.

At the very same time, the debt crisis in Europe with what has happened in Greece and Ireland is continuing. Adding to the problem, on Tuesday Moody’s downgraded Spain’s sovereign debt causing further turmoil in the bond market. There is a very real debt crisis going on in Europe which is resulting in European investors transferring their wealth into (you guessed it) U.S. treasuries.

So in recent weeks bond purchases have been exceptionally strong by the major holders of U.S. debt and by the Europeans concerned with their own debt crisis but not nearly enough to offset all the little guys out there who own bonds and who are running scared.

Why are they running scared? There are two reasons that I think make the most sense

1. The Fed’s policy of QE2 is not working as planned. The printing of money by the U.S. Treasury and the purchase of these bonds by The Fed is perceived by the holders of bonds to be inflationary which makes their modest fixed yields less desirable if inflation is going to come roaring back
2. The other issue spooking bondholders that’s surfaced recently is the possible agreement by the Obama administration and Congress about extending the Bush era tax rates for another two years.
   

The compromise between the White House and Republicans included extending employment benefits for another 13 months which combined with extending the existing tax rates will increase the national debt by another trillion dollars. This means the U.S. Treasury will need to issue more bonds to cover the debt.

That being said, I believe that Ben Bernanke will do everything in his power to calm the bond market. What tricks he still has in his bag is anyone’s guess but he will do whatever he can to avoid runaway inflation.

Stay tuned. It’s beginning to get interesting.

Sources:
Fed Surpasses China in Treasury Binge, The Street by Eric Rosenbaum, December 15, 2010;
United States Treasury Securities, Wikipedia;
Bond Prices Fall Sharply after Federal Reserve Says It Will Continue to Boost Economy, The Associated Press, December 14, 2010.

What the heck is Quantitative Easing?

Doug Marshall, CCIM
Market Assessment

If you’ve listened to the news or read a newspaper in recent weeks there is a new buzz phrase being bandied about: Quantitative Easing. So what is it?

The term Quantitative Easing (QE) describes a form of monetary policy used by The Federal Reserve to increase the supply of money in an economy when the bank interest rate, discount rate and/or interbank interest rate are either at, or close to, zero.

The Federal Reserve does this by first crediting its own account with money it has created ex nihilo ("out of nothing") or some would say, by “printing money.” It then purchases financial assets, including government bonds and corporate bonds, from banks and other financial institutions in a process referred to as open market operations.

The purchases, by way of account deposits, give banks the excess reserves required for them to create new money by the process of deposit multiplication from increased lending in the fractional reserve banking system. The increase in the money supply thus stimulates the economy.

What is the purpose of Quantitative Easing?

The Federal Reserve has been given two mandates:

1. It is charged with ensuring full employment in the United States; and,

2. It is also charged with ensuring price stability. Inflation, in recent months, as measured by the CPI (Consumer Price Index), has declined to almost zero which is well below its target of two percent annually.

The Fed hopes that QE will stimulate the economy and thereby ease unemployment.

The Fed also hopes QE will bring the U.S. closer to its stated long-term inflation target.

The primary risk of QE is that it can spark inflation greater than desired or even hyperinflation. Or it could have no impact whatsoever.

Ben Bernanke, Chairman of the Federal Reserve, may be the “smartest guy in the room” but when he’s tweaking the largest economy in the world it is near impossible to really know what the impact The Fed policies will have on the economy.

What has been the impact of Quantitative Easing so far?

The first round of Quantitative Easing took place at the height of the financial crisis in late 2008 and early 2009. What impact did QE have on the economy and interest rates? Good question. I’m not sure anyone knows for sure.

Just recently the Federal Open Market Committee announced another round of Quantitative Easing called QE2. The Fed plans to purchase over $600 billion of long-dated Treasury securities over a period ending in June 2011.

Economists are debating what impact QE2 will have on interest rates. Ted Jones, PhD, Chief Economist for Stewart Title, says it has already significantly increased interest rates and uses the following table to support his position.

The table details the changes in constant-maturity Treasury rates since August 1, 2010. While rates are still comparably low, they have risen significantly in recent weeks.

As noted below in the table three-year Treasury yields are up 80 percent from the low just two weeks ago while two-year notes are up 60 percent. Even the 30-year Treasury yield has jumped 24+ percent since the end of August.

As convincing as this table is in supporting Dr. Jones’s opinion, I don’t think anyone can know for sure if the recent rise in interest rates can be directly attributed to the announced purchase of $600 billion of treasury securities over the next several months.

It seems to be too sharp of a rise in rates and it happened too quickly after The Fed announcement to be attributed to QE2.

But then again, who am I to disagree with such a distinguished and well qualified expert? We should know though in the next few months whether Dr. Jones is right or not. Let’s hope for all our sakes he’s not.

Sources:
Quantitative Easing by Wikipedia;
Does Quantitative Easing Work in Boosting the Real Ecomony? by Edward Harrison, November 4, 2010;
'Quantitative Easing': What Does It Really Mean for Investors?, Jeff Cox, CNBC.com, August 23, 2010;
Quantitative Easing Already Goosing Interest Rates, Ted Jones, Jones on Real Estate blog, November 14, 2010.