As a real estate investor and advisor, it is critical to my success to know what is happening in the areas where I invest and the economic landscape of the local economy. It is also just as critical to understand the national economy and how what happens across the US and the World will impact the success of my investments. So in Part 2 of my ‘boots on the ground’ research I traveled to several communities in the Western US from Albuquerque NM to Napa Valley.
Starting in Albuquerque, New Mexico the effects of the decline in the energy sector continue to be seen. However, the oil sector may have finally bottomed out and appears to be on the upswing. Another source of optimism is the construction sector, which has been slow to recover in New Mexico. The sector is poised to grow as real estate inventory levels begin to dwindle, and customers demand more residences and commercial spaces. Tourism and health care service sectors have driven growth in 2016 and are expect to continue that trend. Other economic indicators, however, aren’t looking as positive. New Mexico’s unemployment rate is roughly where it was in 1980 and, overall, the state is still struggling to recover from the recession. While higher oil prices will likely be a boon for the state it’s unlikely that 2017 will contain rapid growth or a solution to all of New Mexico’s financial challenges. Economists have characterized the forecast for 2017 as modestly weak and it is predicted that employment declines in rural areas would continue. Even if the oil sector moves closer to a full recovery, the effect across the state is likely to be uneven. Modest gains in employment and population in metro areas like Albuquerque are largely offset by losses in more rural areas.
In Nevada, experts are bullish on the overall economy this year, anticipating continued recovery from the recession and growth. However I would best define their outlook as cautiously optimistic. Four key markers support their outlook: a 2.3% increase in average weekly wages, a 13% year over year growth in construction employment, a 55% decline in discouraged workers since mid-2012 and GDP has shown significant, continual growth over the past five years, exceeding that of the U.S. Further, the pipeline of development in Nevada is as robust as it’s been in the last decade, with $30 billion in projects planned, proposed or underway, which could drive additional demand for goods and services locally.
Nevada’s residential real estate market continues to improve. Apartment rents are at a record high, and there has been some renewed interest in condominiums and townhomes. It’s expected that some pent up demand could translate into new housing, particularly in commuter markets. However, concern exists for a potential market bubble as home prices are starting to exceed affordability. The Federal Reserve continues to raise rates and is expected to raise rates at least one more time this year. This will certainly have an effect on homeowners as well as home buyers. People paying more on their existing mortgages will cut into their household’s disposable income. As well, higher interest on mortgages for new home purchases will decrease their affordability for non-cash buyers which will exacerbate Northern Nevada’s existing high price problem. Many local economist in Nevada firmly believe that the current rising rate environment will throw a wrench into the housing market for sure.
Commercial real estate in Northern Nevada is doing well except for the retail sector. Industrial, like in many communities, has been going gangbuster. High vacancy rates in office and retail exist, so filling the existing inventory will continue. No new construction in retail is expected until much better absorption happens. New Class A office, however, which is in short supply, will be built this year. The Southern Nevada commercial real estate market should continue to see improvement. Industrial is expected to continue leading the way, primarily due to retailers moving to an e-commerce model, where distribution facilities are critical, as well as expansion activity on the Las Vegas Strip. In the office sector, despite high vacancy rates in undesirable locations, activity is expected to continue, driven by demand for better products in more attractive locations. The office market recorded another quarter of recovery in the first quarter of 2017. Net absorption was 127,479 square feet in the first quarter, which was an improvement from last quarter. This brought vacancy down to 17.0 percent, which is improved from a peak of 22.5 percent five years ago. Asking rates reversed their upward trend and dropped to $2.02 per square foot (psf) on a Full Service Gross (FSG) in the first quarter.
Despite these positives, however, the pace of job creation is slowing, which denotes similar movement of the economy as a whole. Local economists in Nevada feel that the timeline between the last economic downturn and the current growth cycle would suggest that the area is about due for another cycle to trend down.
In Bakersfield California, it’s all about the oil industry; in good times and bad. And unfortunately, right now it’s bad. Thousands of jobs have been lost in oilfield and oilfield dependent employment. Those jobs tend to be well-paying and therefore all the more significant as drivers of the local economy. Average price of newly sold homes had a 2.3% decline year-over-year to $286,892 per unit in September of 2016. This fall is a drop off from the 5.9% drop in August from a year earlier. Oil is recovering from its lows but it has a long way to go before the industry will start to recover. The last time oil crashed in 2009, it was back up over 100/bbl in around 2 years. The logistics industry is growing and expanding in Bakersfield and will likely continue to do so as other areas of California get more expensive. This is just one sector that is helping Bakersfield diversify its economy as opposed to being solely dependent on the Agriculture and Oil industries.
Moving further west, Napa County remains very resilient in the wake of the Great Recession. The area made a bet in 2006 that Napa’s future was to be that of an adult playground for the Bay Area and the world for wine and food. That plan proved successful and continues to pay dividends. Napa County’s employment barely moved in the recession, though construction and real estate markets did suffer; they shifted quickly to hotel properties and restaurants while costs of construction were relatively low. Napa is positioned for long-term growth, assuming no major change in demand takes place. Sonoma County is the most diverse and largest of the, North-Bay counties. There are elements of all neighboring counties: technology, life-sciences, agriculture, manufacturing, and a services hub for all communities above the Golden Gate Bridge. Sonoma County has had strong jobs growth since 2014. Growth of manufacturing has been largely in, food and beverage, as Sonoma County has become a craft beer hub in California, and the wine industry continues to grow. The key for Sonoma County in the long-term is whether manufacturing will come to Sonoma County and will life sciences be its tech play of the future.
As I have continued my national market research, I have begun to find many interesting similarities in the communities I have visited. First, all communities have for the most part recovered from the Great Recession, however the pace of recovery was very different for every community. Those communities that had more diverse economies recovered much faster than those whose economy was driven largely by one sector. Second, commercial real estate markets across the country tend to be doing well and improving with Industrial being the strongest sector and retail being the weakest. Lastly and most notably is the residential real estate market that appears to be in the beginning stage of a downward cycle. The key drivers of this shift downward are housing affordability, limited wage growth and rising interest rates. All three of the factors are present in every community and they are directly correlated.
As expected the Federal Reserve raised rates again by 25 basis points this month and are expected to raise rates again in December. The first couple rate hikes were relatively easily absorbed but this recent more aggressive positon of increases are going to begin having an impact on not only residential homes sales but commercial development as well. Higher rates likely will make it more difficult for developers to obtain construction loans because, in many cases, they already were struggling to make projects pencil out. Moreover, developers with 10-year commercial loans that mature this year may find themselves pinched if they can’t afford to refinance the associated project. So as the Federal Reserve attempts to keep control over inflation and an overheating economy will be the unintended consequence be a negative impact on the real estate market? How this all shakes out remains to be seen but one thing is certain, there is going to be an impact.
Our investment team does ongoing market research and site analysis to determine the best locations geared towards our investment strategy.
We perform site inspections and consult with general contractors and architects to identify property improvement opportunities and cost estimates.
We do extensive property analysis including underwriting property historical cash flow, three tiered income modeling, future cash flow projections and IRR and cash on cash return profitability models.
Our team underwrites the current tenants and reviews all current lease agreements to determine an appropriate credit grade of the property and identify opportunities for improvement.