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Phoenix Area Retail and Office “Leading the Way”

“I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.”- Warren Buffett

The Phoenix Metro Area has seen robust recovery in commercial real estate values over the past 10 years. Things are as good as they have been in quite some time and it is fairly easy to find positive metrics to support the giddy feeling some are feeling. Subsequent quarterly increases in lease rates or sales numbers are recently being touted as whatshutterstock_724682302 some indicate to be a near perfect environment and closer to the economic utopia we are searching for. When you look at Q3 compared to Q4 or 2016 compared to 2017 most indicators are trending positively. However, when you zoom out you realize those numbers are only returning the same levels as they were at the end of last cycle or approximately 10 years ago. Ask yourself what is more likely; Prices and rents will continue to increase for years to come? I am thinking it is more likely that we are about to (or have already begun to) enter a period of contraction?

Two product types that I see “Leading the Way” in to the period of contraction are Retail and Office. I have summarized my perspective on some key indicators below:

Retail

Rents- up over the past 4 years but only returning to the levels of 2011. The median sales price is down 6% from 2016 near the 2009 levels.

Volume- down 4% in 2017 despite a robust Q4. And through the first three quarters of 2017 the average sale price was $131/sf compared to $164/sf for the same period in 2016 (Per CoStar Year End 2017 Report).

Cap rates- have seen a fairly significant increase from 2016 increasing from 6.9% to 7.3%.

Vacancy rates- are leading the headlines as they have continued to decline since 2011. However, some markets like North Phoenix stopped seeing declines in vacancy rates and stand a strong likelihood to see increases soon.

Absorption- is expected to decrease in 2018 (per Colliers 2017 Q4 Greater Phoenix Research and Forecast Report). The combination of these factors tell me that the market is peaked and beginning to point down. Specific markets and product type will endure longer than others, however investment and lending practices should be tailored to the point of the cycle we are in.

Office

Inventory- In my last post “Changing Perspective Dependent on Market Cycle” I recommend you keep an eye on the movement of unleased space being absorbed and amount of net product coming online. The previous two costar reports reflect the following for the first three quarters of 2018:

  • Q3 2017 Report projected 720,000 sf would be delivered with about 240,000 sf being unleased or 33% unleased.
  • Q4 2017 Report had projections of 1,100,000 sf projected for delivery over the same period with about 520,000 sf being unleased or 47% (yearend report also reflects that the subsequent quarter of 2018 Q4 would see deliveries of 350,000 sf all unleased).

These deliveries are the result of construction starts in Q4 2017 which were at theshutterstock_71686480 highest level since Q1 2015 (840,000 sf new starts and 1.7MM total under construction). Is there demand to offset this new inventory?

 

Vacancy- Phoenix rates are well above the national average; locally we have become accustomed to that. Rates are 14.7% similar to what they were in 2008, the end of the previous cycle. Is this the low point of the current cycle or do rates continue to creep downward?  Vacancy rates have benefited from absorption outpacing new deliveries helping eat away at the inventory created by last cycle’s overbuild. Bringing the current new inventory to market without the demand will surely have downward pressure on lease rates and value. Continue to monitor the future deliveries and the un-leased percentages of those deliveries.

In Conclusion

shutterstock_219690922Be Proactive, stay ahead of the cycle. Augment your underwriting to reflect the true microeconomics of the specific environment that your subject asset is most vulnerable to. Macroeconomics are not to be ignored and naturally make themselves far more evident, however be careful not to lose sight of the details when inundated with all the positive news that is being touted in our market.

 

Contact Proactive Consulting to assist with Distressed Asset Management and Mitigation

0 comments on “Changing Perspective Dependent on Market Cycle”

Changing Perspective Dependent on Market Cycle

I was sitting with whom I believe to be a very intelligent friend over coffee last week discussing general market conditions in the Phoenix Metro Area and where the “smart” money is going and where certain sectors are topped out. As I sat and listened to him describe a possible acquisition he was pondering I noticed him spend the next 15 minutes trying to talk himself into why this particular real-estate investment was a good target for his Investment firm.

His rationale was interesting. I watched him begin to talk himself into why they should pursue the acquisition, he threw around current; NOI’s, comparable values, cap rates, and upside potential on the rents, which were all generally positive indicators. He had clearly done his homework. His rationale included the major points to consider when making such an acquisition. I never heard him mention one negative factor, only a multitude of positive factors which he rattled off without hesitation.

After sitting back and letting him work out the deal verbally with himself I asked him a simple question; What happens tomorrow?

This is an obvious question and we all know risk is inherent with such transactions. However, we rely so heavily on current or recent statistics we lose sight of tomorrow. Projections and trends are helpful, however as humans I believe in good times we use forward-looking numbers formulated with assumptions that are often self-serving to the author’s point or formulated to encourage a transaction rather than push us towards the side of caution. Whether we are an Investor or a Lender we must look at transactions differently depending where we are in an economic cycle.

I use the following few examples on how you could look at an indicator differently based on what I consider to be the peak of the current cycle as I believe we will see more signs of contraction in the near future.

Population growth in the Phoenix Metro area has been strong, one of the strongest in the country. This is good, more demand for; real estate, goods, services, and general commerce. Per the US Census Bureau, Phoenix topped all cities in the US with a growth of 32,113 persons between July 2015 through July 2016. Although that sounds great, the shutterstock_129388370claim needs some context. Remember this when you hear your sales guy talking about record population growth and see if they forget to mention that the referenced growth more or less reflects the return to the population level achieved eight years ago.

And where are all these people going to work, or should I say what Employment is going to keep attracting them here? Well the 32,000 jobs added in the 12 months from October 2016 through October 2017 should be a good start… right? Oh, wait a second, that number is less than half of the jobs added in the prior 12 months (65,000). These job numbers are according to Lee McPheters the Director of the JPMorgan Chase Economic Outlook Center and Research Professor of Economics in the W.P. Carey School of Business at Arizona State University. Should we use a number that represents a slowing trend in our rationale to support an acquisition or loan funding? Also, other cities are becoming more attractive to large corporations. Of the 12 largest metropolitan areas Phoenix is fifth in employment growth over the twelve-month period ending October 2017. Places such as; Atlanta, Boston, Dallas, and Miami show significantly more growth per the US Bureau of Statistics.  And let’s face it, along with a handful of other cities these are our competitors.

Moving on, I am told the Housing Market is a good indicator of things to come. Well your local agent will tell you how the Median sale price of new homes as of June 2017 is about $310,000 (Per Colliers Greater Phoenix Land report 1H 2017). And including previously owned homes the median price is only about 8% below the median price of 2006. Not bad at all, or is it? I don’t think I need to remind homeowners, investors, or lenders the pain that has been incurred over the last 10 years due to the inflated values of our last peak in the cycle. Well let’s look a little further into this segment. The price will surely keep rising, right? I mean people are moving here and there are only so many places to live. There are dozens of the ever-popular multi-family developments going up each year, not to mention the robust single-family construction, combined with leading indicators like the large land purchases by single-family developers. No doubt many new roof tops will continue to be added to the market, approximately 22,000 single-family permits will have been issued in 2017 along with 7,000 multifamily permits with an additional 12,000  multifamily units underway and 16,000 planned in addition to the already added inventory (per Colliers Greater Phoenix Multifamily Q3 2017 Report).

Question to consider; didn’t people have places to live in 2009? And now that the population level is roughly at the same level and new rooftops are being added daily, what will the impact be of the new inventory be on values? I am going to keep this month’s edition simple and not even address the lurking “Shadow Inventory”. Finally, median household income barely reflects the ability to afford the median home price as of now, and home prices are outpacing the median income growth, therefore affordability will start to play a bigger role in home prices in the near future.

Commercial Sales performance for the major sectors shed some light on where we are at in the cycle. Industrial is showing an increased sales price with a lower volume of properties trading hands. Wherein Retail reflects a lagging drop in prices as volume has decreased. Office space shows a steady volume of trading while price has been volatile over the last two years as variation in specific product type is a key indicator to price. Keep an eye on the unleased space coming online for both Retail and Office over the next nine months. I will be paying close attention to whether the amount decreases significantly or not over this period as an indicator of things to come.

The end of the world is not coming tomorrow, that is not what I am trying to convince you of. What I am trying to point out is that you need to be aware of what part of the cycle we are in and how you should alter your investment or lending practices to mitigate risk and still reach practical goals. Investors are beginning to see which phase of the cycle we are in as activity is slowing. Commercial sales are mixed depending on segment. The slowdowns have outweighed any increases with an aggregate reduction in activity in the first three quarters of 2017 compared to the same period in 2016. This makes sense as prices continue to rise the shorter-term rate of return is being compressed and investors and lenders are becoming more selective. In addition, Q3 2017 Cap rates have compressed in the Industrial sector while ticking up in office and retail centers both averaging about 7.6%-7.7% average this year.

Look I get it, Lenders need to lend and Investors need to invest. However, be mindful of shutterstock_78116614what phase of the economic cycle we are in. Things look pretty good today, as things looked pretty good in 2006. But in retrospect I bet those of you reading this can think of several instances in 2006 that were clear indicators that things were TOO good. Well now that a lot of various indicators have returned to the 2006 level shouldn’t you be viewing the numbers with a different perspective than you did a few years back?

In my career I have had the benefit of hindsight to see when and where errors are made when loans are originated, or acquisitions are funded. My suggestion for you is to be Proactive and Stress Test your existing portfolios and modify your investment or lending parameters based on the phase of the cycle we are in. Now is the time to be one step ahead and mitigate risk and possible losses when opportunities present themselves, not when it is too late.

Please contact our office to discuss how we may be able to assist you with developing or implementing a Proactive strategy to mitigate or eliminate your exposure.

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Eric Anderes

Principal

Proactive Consulting, LLC

www.Proactiveconsulting.us

eanderes@proactiveconsulting.us

480-370-7737

0 comments on “Wall Street Banks Warn Downturn Is Coming”

Wall Street Banks Warn Downturn Is Coming

Interesting article in Bloomberg, has business cycle peaked?

“Just like they did in the run-up to the 2007 crisis, investors are pricing assets based on the risks specific to an individual security and industry, and shrugging off broader drivers, such as the latest release of manufacturing data, the model shows. As traders look for excuses to stay bullish, traditional relationships within and between asset classes tend to break down.”

https://www.bloomberg.com/news/articles/2017-08-22/wall-street-banks-warn-winter-is-coming-as-business-cycle-peaks

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Colliers Market Segment Analysis

Click on the links below to see numbers from Colliers for 2017 Q2.

  • Office-

http://www.colliers.com/-/media/files/marketresearch/unitedstates/markets/greater%20phoenix/q2-2017/2017-q2-office-greaterphoenix-report-colliers.pdf

  • Retail-

http://www.colliers.com/-/media/files/marketresearch/unitedstates/markets/greater%20phoenix/q2-2017/2017-q2-retail-greaterphoenix-report-colliers.pdf

0 comments on “Top of Market Cycle?”

Top of Market Cycle?

Is 16th Street the newest commercial real estate hub? SVN Desert Commercial Advisor, Paul Borgesen III stated, “We are at the top of the market prices and numbers we have not seen in ten years.” Are we at the top of the market? Read this article for some insight on commercial development market in Phoenix valley.

http://azbigmedia.com/azre-magazine/16th-street-newest-commercial-real-estate-hub