Catch 22 -- Logical Paradox of this Recession and The Recovery

An Economic Catch-22 —A Logical Paradox for Job Growth?

A recent report from the UCLA Anderson Forecast issued June 15th 2010, predicts that the California economy is expected to grow a bit slower than the nation's economy for 2010, and only slightly faster thereafter. This slow growth rate will result in only modest inroads into the state's high unemployment rate.

The report titled “A Homeless Recovery,” concludes that this time around, the economy can’t count on free-spending consumers to boost it along. The report cites today’s “frugal consumers” and describes “If the next year is going to bring exceptional growth, consumers will need to express their optimism in the way that really counts; buying homes and cars. And that is not going to happen if businesses continue to express their pessimism in the way that really counts by not hiring workers.”

In another element of the forecast, the economists predict the recovery will be “rocky” in the commercial real estate sector. “There is just too much debt that has to be worked through”.

The report cites an “Economic Catch-22.” (A Catch-22, coined by the author Joseph Heller in his novel of that same name is a logical paradox wherein a situation exists in which an individual needs something that can only be acquired by not being in that very situation; therefore, the acquisition of this thing becomes logically impossible.) The challenge is that significant reductions in the unemployment rate require real gross domestic product growth in the range of 5% to 6%, compared with normal GDP growth of 3%. As a consequence, consumers concerned about their employment status are reluctant to spend and businesses concerned about growth are reluctant to hire.
UCLA Anderson’s forecast for GDP growth this year is 3.4%, followed by 2.4% in 2011 and 2.8% in 2012, well below the 5% growth of previous recoveries and even a bit below the 3% long-term normal growth. In the California forecast they indicate that the state “will grow slower than the US and a slow recovery in jobs will leave unemployment at 12.1% for the year.” “The latter part of our forecast (through 2012) calls for health care, professional and business services, exports, construction and technology-related manufacturing sectors to generate a bit more robust growth in California.”

The Anderson report is another estimate of a “jobless recovery”. Their conclusion is that the state will grow more rapidly in the following two years but that job creation will not be fast enough to push the unemployment rate below double digits until 2012. “Unlike other deep recessions, the rapidity of the recovery, at least on the unemployment front, will be muted”…

To read more here is a link to additional coverage from UCLA Anderson:
http://newsroom.ucla.edu/portal/ucla/ucla-anderson-forecast-u-s-recovery-160346.aspx

Commercial and Investment Real Estate is both a global and local investment that is influenced by many factors including macro economic conditions. If we can assist you with commercial real estate in northern California please contact us at JimandNahz@ctbt.com or call us at (916) 375-1500

Western Real Estate Business Article on Sacramento Office Market

This month, June 2010, the magazine Western Real Estate Business has a profile on the Sacramento Market. With our colleagues at Cassidy Turley we contributed to the commercial real estate market review. Here are our particular observations on the office market in Sacramento..

Office

The Sacramento Valley office vacancy rose to 16.3 percent in first quarter 2010, as total availability increased 300,000 square feet for a total of 13.9 million square feet. Sublease space remained constrained, representing less than 3 percent of the total availability. The overall average asking rate for office space slid another $0.03 per square foot quarter over quarter to $1.85 per square foot full service in first quarter 2010.

Gross absorption was a mediocre 1 million square feet in first quarter 2010, about 25 percent less than its quarterly average in the past year and 40 percent below since 2005. Large tenants remain very scarce in the market, with most of the activity being dominated by smaller tenants less than 10,000 square feet. Net absorption, the change in occupied space, was a negative 368,000 square feet in first quarter after having reported positive 117,800 and 213,000 square feet in fourth and third quarters of 2009, respectively. Notably, during the past year, net absorption (which excludes new vacant construction) has actually held stable with just negative 50,000 square feet. The heavy dose of new unoccupied construction has really been a primary cause for the large increase in vacancy and availability in the past year.

The larger leases in first quarter 2010 included California State Board of Equalization for 76,502 square feet in Sacramento; ITT Technical Institute for 27,020 square feet in Rancho Cordova; Principal Financial Group for 24,645 square feet in El Dorado Hills; and Brown & Caldwell for 22,126 square feet in Rancho Cordova. There were also a handful of notable sales, led by CSAC Excess Insurance Authority’s acquisition of a 48,591-square-foot building in Folsom.
Office construction continued to trickle at the start of 2010 as projects funded more than 1 to 2 yearsr ago are now finally being completed. One building was delivered in first quarter: the 141,210-square-foot Sutter Health Facility in east Sacramento. This pace is already drastically cooler than last year when 1.9 million square feet were delivered and caused a massive swelling to the area’s vacancy rate. The development pipeline, however, is quickly diminishing as developers wait on the sidelines until market conditions become favorable. This slowdown is a double-edge sword, as it will help alleviate rising vacancy, but it will also take away construction jobs, a historical key source of job growth for the market.

The climate continues to remain favorable for tenants as there are still a lot of rental rate discounts being offered, plus concessions such as free rent and higher tenant-improvement allowance dollars from landlords. Lease terms also remain shorter, with the typical leases ranging between 1 and 3 years. The office sector will continue to battle the effects of the economic recession. The services and tech sectors lost a reported 10,000 jobs, and the job outlook ahead remains pretty grim. The forecast is that there will continue to be growing vacancy, slightly lower rents and very little new construction. The bright spots in the local office market have been and will likely continue to be owner-user sales financed with SBA long-term, low-interest loans and growth in healthcare and education.

Notably, the heavy majority of the 10 largest office leases transacted in 2009 were from the state’s government. Government is at risk as revenues from property and sales taxes continue to shrink, as the deficits become increasingly structural. Employees are being furloughed. Services are being cut back, and capital expenditures are being frozen. A great deal of the federal stimulus funds found their way to state and local government last year, but who knows what the political future holds? What happens to state and local government will have profound impacts. There is reason to be more optimistic, but being able to avoid a “double dip” is not certain.

— Jim Gray is a partner and Nahz Anvary an associate in Cassidy Turley BT Commercial’s Sacramento office.

Here is a link to the entire article:

http://westernrebusiness.com/articles/JUN10/highlight1.html

Sacramento Market Conditions

This month, June 2010, the magazine Western Real Estate Business has a profile on the Sacramento Market. With our colleagues at Cassidy Turley we contributed to the commercial real estate market review. Here are a few of our observations.

SACRAMENTO

Like most markets around the country, the Great Recession has severely impacted the overall state and morale of the Sacramento area in all facets and in some aspects even more so. Some of the effects have been dramatic job loss, wage losses, soft tenant demand, increased vacancy rates, plummeting rental rates, depressed housing values, rising residential and commercial foreclosures and tightened credit practices to a decline in consumer confidence and spending. Unemployment exceeded 13 percent in March 2010 from the mid-5 percent range pre-recession as a substantial number of jobs, more than 80,000 wage and salary jobs, have reportedly been lost in the area since mid-2007. Commercial real estate vacancies have climbed to new highs as rental rates have plummeted. It was reported in early 2010 that for every six businesses open, one was closed in greater Sacramento; this is a very staggering statistic.
New construction projects, namely office-oriented, that were funded a few years ago during the last market recovery were still being completed through 2009, which continued to add further strain to vacancy rates. Many retailers, from small shops to big box, have been forced to close their doors as a result of the difficult economic climate that has resulted in depressed consumer confidence and a drop in retail sales. Some large and small retail tenants have recently begun to emerge or re-emerge in the marketplace, but there still remains a lot of vacancy to fill.

Additionally, home prices have plummeted from their pre-recession levels, while foreclosures have climbed, with the latest figures showing more than 56,000 foreclosures since the start of 2007 in the Sacramento area. The city’s housing sector has been one of the most negatively impacted statewide although there are signs that it is beginning to right itself. In the commercial sector, a significant amount of foreclosures have been realized and a sizable number more are expected. In recent reports, the Sacramento metro area ranked No. 3 in the nation in terms of bankruptcy filings. However, the problems in the commercial sector are not anticipated to be as significant on the metro economy as the residential market.

— Ken Reiff is a managing partner with Cassidy Turley BT Commercial’s Sacramento office and Jim Gray is a leasing and sales specialist.

Here is a link to the entire article: http://westernrebusiness.com/articles/JUN10/highlight1.html

Steady and Stable... Don't chase quick hits...

Unreasonable Expectations?

We received a phone call the other day that got us thinking. The call came in from a former client who was an acquisitions specialist for a developer. He no longer works for the company that he used to work for ---that developer is still trying to liquidate the surplus of units that they overbuilt in 2005-2009. This person is now working for a “value investor fund”. He called us to tell us about his new job and to solicit our help looking for real estate investments. He engaged us in conversation. He is looking for deals--- he is now what we call a “Scout”.

He outlined what his new company’s investment criteria. “We are ready to buy… We will buy Office, Medical Office, or Retail.” “We have a group of investors that are ready to fund.” “We have promised our investors a 20% return…”

Oh really? I reply… I then wonder; why are you wasting your time and ours? If you are looking for 20+% annual returns from commercial real estate you might as well be buying lottery tickets…

Here is why we believe that. Let’s look at a bit of math… Assume you have a million dollars to invest. If you are seeking a 20% compounded rate of return that means that a million dollars invested for five years with no cash flow for the first five years would have to be sold for and net $2.488 million dollars. So in five years the Asset has to appreciate nearly 2.5 times. But that doesn’t even consider the “value add expenses”. Say the subject property is 10,000 square feet. Assume you do cosmetic and tenant improvements that cost $30 per square foot and leasing commissions that cost $5 per square foot. Initial Investment plus improvements are now $1,350,000. To achieve a 20% return in 5 years, the property now has to be sold for $3.359 million.

To us it is difficult if not impossible to imagine a scenario in which a $1 million dollar property will become worth $3.359 million in five years. The income to justify a $3.359 million dollar sales price at a 9% cap rate 5 years from now would be more than $2.51 per square foot per month triple net.

To imagine a scenario like this occurring we’ll have to go through another cycle—money will freely flow, lending restrictions will ease, prices will increase, more money will come in, and things will get out of control again. It has happened before –and probably will happen again --but we doubt this is the likely scenario any time soon.

Scouts are likely to become frustrated and begin to question whether the chance for quick money and high double digit returns will be attainable at all this time. My gray hair and experience in the commercial real estate business leads me to believe it’s probably more reasonable to expect that a combination of extended consumer de-leveraging and ongoing economic funk will temper lending practices and hamstring demand for years to come. Financial reform will likely bring more restrictions on deal making too. The speculative bubble has burst and very few dollars are going to be made in “distressed real estate” in the short term.

We wish all investors happy hunting and there certainly may be one-off opportunities in the distressed market… We suspect that real estate investors will be better served to stop looking for the distressed quick trading hits. We’re just not going back to the “crazy good old days of 2005” anytime soon. At this point of the real estate cycle we believe that most investors should be focusing on building good core portfolios of well-leased income producing properties, grounded in good fundamentals. Investors should focus on achieving year-in, year out returns in the high single digits where annualized real estate returns historically perform. If values escalate again, these properties will almost certainly jump ahead of the curve so you’ll be in a great position to sell out. That’s why the top properties in the best markets make sense.

People can try to play the yo-yo game of finding rare jewels. But let’s face it--right now the economy and lenders just won’t cooperate. This time around we believe that conventional wisdom may take a lot longer to play out. Steady 8% returns not quick 20% returns is the more likely bet!

If we can be of service reviewing evaluating or finding commercial investment real estate or if you would like to continue the debate over which type of commercial real estate will achieve the best performance please call Jim Gray or Nahz Anvary (916) 375-1500 or at jim&nahz@ctbt.com.

Great Coach Great Teacher --Pyramid for Success

Good bye and thank you Coach…


Arose today to hear that John Wooden one of the most revered people in basketball, coaching, and leadership died at the age of 99. Thank you for all that you have done and rest peacefully.

Wooden’s life and legacy has inspired millions. I have read his books and became familiar with his Pyramid of Success. I am a huge fan of basketball and a huge fan of his lessons on Leadership, on Preparation, and on Life.


If you need some inspiration or you want to know more about the philosophy and teachings of Coach Wooden here are two links you will enjoy. http://www.coachwooden.com/ and http://en.wikipedia.org/wiki/John_Wooden

Wooden is famous for a seven point creed. Given to him by his father and printed on a card and carried in his wallet:
1. Be true to yourself.
2. Make each day your masterpiece.
3. Help others.
4. Drink deeply from good books, especially the Bible.
5. Make friendship a fine art.
6. Build a shelter against a rainy day.
7. Pray for guidance and give thanks for your blessings every day.

And here is a reprint of his Pyramid of Success.

Impact of Distress on Class A Office Valuations

We saw a question posted on a commercial real estate web site inquiring about pricing differences and impacts that Distressed Real Estate is having on valuing Class A Properties. Here is the exact question that was posted on Loopnet. "How are brokers valuing class A properties with so many distressed properties thrown into the mix?"

Here are our thoughts:

The performing "Class A Market" is different than and priced differently than the "Distressed Market".

Recommending a value or proposed sales price takes a disciplined approach, comparing market trends and market demand. Our job as investment brokers is to be able to thoroughly evaluate the property-- including recent comparable sales, an evaluation of income and expenses to determine net operating income, replacement cost, and competitive positioning within the market. In addition understanding the motivations of the Seller, macro conditions in the marketplace, and financing costs and availability, also need thorough consideration today.
In our opinion, there are two distinct and different markets today. Class A properties, those that are stabilized with good tenants and good income, are scarce and are trading at surprisingly low cap rates. Distressed properties -- with income that won't support the debt service, or properties that are unfinished, or poorly performing, in areas with little demand, are being sought by a different category of Buyer. (The property with a "story" that was built or bought at the top of the market.) Distressed vs. Class A Institutional are really different markets and should be and are priced differently.

Class A doesn't just mean "expensive finishes" it means strong demand. In the current market environment, the best income-producing properties—those distinguished by superior quality of construction and the right location are likely to hold their value, keep their tenants and appreciate sooner and more than others. Early in this recession, pricing correction affected all properties, including those with the strongest operating performance and, in the case of new developments, the potential for such performance. But now it is back to fundamental evaluation and underwriting. Location, rent roll analysis, expense benchmarking, strong management and the like makes a real difference.

The relative attractiveness of good buildings to tenants and investors should allow them to stay ahead of the rest even in the challenging years ahead; their values have hopefully bottomed out as the broader market continues to find the bottom. Anecdotal evidence suggests that cap rates on scarce Class A properties with real income and good lease terms are therefore much sought-after assets attracting multiple offers and those cap rates have already come down.

The current cap rate decline starts with that fact that there is more capital (debt and equity) in the market than there is product. That factor alone has pushed values up and cap rates down-- but only for strong assets. Distress Buyers and Distress Prices are different than most well performing Class A properties. Distressed deals get picked over and trade at dramatic discounts to replacement costs; if they trade at all. For many of these deals the owner has no equity and getting quality information and timely decision making is very problematic.

Institutional investors are seeking quality NOI. We are reading reports and hearing about deals in northern California where pricing with cap rates as low as 6+% based for good assets. But if it isn't class A -- and if the lease terms are short and there is any scent of distress or credit quality risk -- or if the likelihood of vacancy and rent-up risk is high --then the cap rate is more like 9% -- and or price per square foot-- well below replacement. That said, there is a great deal of anxiety out there as to how far cap rates have fallen and does it make a risk adjusted sense for them to stay low? The current imbalance of available high quality class A properties and the amount of capital seeking to invest in them has created what a number of analysts and market participants call a "scarcity premium." We believe that the distressed properties that are coming to market are those with little hope of value recovery for the foreseeable future (more than three years). These are two distinct markets -- priced differently for different categories of buyers.

If you have a question that is more specific to a particular property or market - or if we can help you assess the value of your asset -- Class A or Distressed -- or something in between, feel free to contact us. We promise you professional and friendly service. jgray@ctbt.com or nanvary@ctbt.com