Economic recovery hinges on job growth

By John Restrepo, Principal, with John Donovan and Maria Guideng, Researchers, Restrepo Consulting Group LLC

Friday, July 24, 2009 | 6 a.m.

An epiphany is not necessary to understand that the health of the economy is the primary determinant of the health of the real estate market — commercial and residential. Accordingly, it is no great surprise that the economic turmoil in Southern Nevada following the boom that peaked in 2004-o5 has dramatically impacted the performance of the Las Vegas Valley commercial real estate market. In this issue of CRE, we focus on how this turmoil has affected the region and North Las Vegas. We start with an overview of the economy, followed by a discussion of the commercial real market indicators. Finally, we conclude with some further thoughts about where the national and Southern Nevada economies are heading during the next two years.

Total Job Change

In May, the Nevada Department of Employment, Training and Rehabilitation reported that Clark County had a net job loss of 58,600 establishment-based jobs compared to May 2008, dropping 6.3 percent to 871,200. This set another year-over-year record. Additionally, there were 300 fewer jobs recorded in May compared to this past April. The good, even great news, was that this represented a major improvement over the March-April decline of 4,100 jobs.

One month does not make a trend, but it is definitely a hopeful sign. We also note that May’s job total was 172,000 higher than that recorded in May 2000 (699,200 jobs). So, on a net basis, more jobs have been created in Clark County in the last eight-plus years than have been lost.

Regarding Clark County’s unemployment rate, the official reported estimate was 11.1 percent in May, higher than April, and almost double the 5.7 percent recorded in May 2008. Our research and anecdotal information indicate that Clark County’s actual rate is three to five points higher, if discouraged and forced part-time workers are included. In May, the Nevada unemployment rate was also 11.3 percent, and the U.S. rate was 9.4 percent.

The County’s labor force was 1,012,900 in May, up by .62 percent from April’s 1,006,600 people, and up by 3 percent from May 2008’s 982,600 job seekers. There are several reasons for this growth — college graduates entering the job market; retirees returning to work because of financial need; nonworking spouses seeking work to help their families; and population growth via in-migration, such as it is.

Job Change, By Industry

Job losses occurred in nine of the 11 major employment sectors this May compared to May 2008. The single gain was 3.2 percent (2,100 jobs) in Education (includes private colleges such as the University of Phoenix) and Health employment. Natural Resources saw no change.

Leisure and Hospitality, Construction, and Professional and Business Services continued to lead in these losses. The problems in these three industries are having a material impact on the demand for commercial space throughout the valley, as companies reduce business activity and spending.

So how did the valley’s and North Las Vegas’ commercial markets perform in Q1, 2009?

Inventory

The inventory of commercial space in the valley and NLV is presented in the table below. While most of NLV’s space is in industrial, the city has seen significant additions in office and retail projects in the past several years. Furthermore, our research shows that NLV is slated to receive almost half of the valley’s forward-supply of commercial space (under-construction or planned to begin construction during the next four quarters, as of Q1), more than any other of Resptrepo Consulting Group’s submarkets. At the end of Q1, NLV accounted for 19 percent of the valley’s commercial inventory (by square footage).

Vacancy & Rents

Industrial

Valley industrial vacancy rose for the 11th straight quarter, from a low of 3.1 percent in Q2, 2006, to 11.8 percent in Q1, 2009. The rise has been particularly steep in the past four quarters, with Q1’s vacancy being 4.9 percentage points above the 6.9 percent reported in Q1, 2008.

Overall, many of the industrial projects recently completed in the valley did so with much of their space yet to be occupied. For example, projects completed in 2008 and Q1 were, on average, 58.3 percent vacant.

NLV’s vacancy trend has closely followed the valley’s during the past five years. NLV closed Q1 with a vacancy rate of 10.2 percent, -1.7 points below Q4, 2008 (11.9 percent). NLV was the only submarket to see any improvement in Q1, while all other submarkets posted increases in vacancy. This was driven by positive net absorption in light industrial space (392,200 sf) and light distribution space (135,100 sf) in NLV. In addition, among industrial products, Warehouse/Distribution space continued to have the lowest vacancy at 6.8 percent valleywide. Notably, 41 percent of the valley’s Warehouse/Distribution inventory is located in NLV.

Downward pressure on average monthly asking rents continued in Q1. At $.67 per square foot NNN, valley industrial rents fell 15 percent from $.79 psf in Q1, 2008. The sharp reduction in rents during the past three quarters reversed the gains seen in the past two years, heading toward levels last seen in 2006.

At the end of Q1, industrial rents in NLV were $.56 psf NNN. In the past five years, rents have been, on average, 19 percent below the valley rate. This has given NLV a competitive advantage over the valley’s other industrial submarkets, particularly in the big box sector.

Office

Vacancy in the valley’s for-lease office market has risen steadily since Q4, 2006 (9.3 percent), especially starting in Q1, 2008 (14.2 percent). In Q1, the vacancy rate surpassed the 20 percent mark, reaching 20.6 percent. The average vacancy in newly completed office projects (2008 to Q1, 2009) was 54.1 percent.

Vacancy in NLV’s office market has been higher than in the valley for most of the past 5 years. After hitting a 36 percent peak in Q1, 2007, vacancy levels declined for five quarters, falling to 19.1 percent in Q2, 2008. Vacancy has since been back on the rise, reaching 23.7 percent at the end of Q1, 2009. However, NLV has a relatively nascent and small office market — the area accounts for only 1.9 percent of the valley’s spec office space. Accordingly, NLV vacancy rates are susceptible to wide fluctuations from quarter to quarter.

The average monthly office asking rent for the valley at the end of Q1 was $2.33 psf FSG, down 7.5 percent (or -$.19) from $2.52 in Q1, 2008. This marks the fifth consecutive drop from the $2.69 peak in Q4, 2007.

The average rent in NLV was $2.22 at the end of Q1, down 11.2 percent (or $.28) from the $2.50 recorded a year ago. The five-year trend in rents in NLV has generally moved in the same direction as the valley. However, the average office rent in NLV, on a psf basis, has been below the valley average since Q3, 2007.

Retail

Vacancy in the valley’s anchored retail market has been rising for the past six quarters, reaching 7.8 percent at the end of Q1. This was driven by the closing of several national big box retailer stores (i.e., Circuit City, Mervyns and Linens ’N Things, The Sharper Image, Levitz), along with numerous grocery and drug store locations (Albertsons, Vons, Rite Aid, Longs Drugs). Overall, anchored retail project openings since 2008 have been restrained with much of the new space preleased before completion. Projects completed in 2008 and Q1, 2009 were, on average, 5.8 percent vacant.

NLV’s retail market makes up more than 9 percent of the valley’s anchored inventory. While average vacancy in NLV has been above the valley estimate since Q3, 2006, the gap between the two rates has narrowed in recent quarters. Retail vacancy in NLV was just above the valley average at 8.4 percent vacant in Q1.

The average monthly asking rent for the valley’s retail market fell for the third straight quarter to $1.91 psf in Q1. Rents were $2.03 psf in Q1, 2008. Rents in NLV had been higher than in the valley for the past several years, until Q1.

Demand

Industrial

Net absorption in Q1, 2009 was nearly -461,000 sf, the fourth consecutive quarter of negative absorption. This is in stark contrast to the 1 million sf absorbed in Q1, 2008, but a slight improvement over the -547,800 sf of net absorption recorded in Q4, 2008. In comparison, the valley’s five-year net quarterly absorption average was a little more than 1 million sf. NLV posted positive demand with 523,400 sf being absorbed, while the remaining submarkets all saw negative absorption in Q1.

Office

Net absorption fell further to -236,400 sf in Q1, 2009, which is now the fifth straight quarter of negative demand in the valley’s spec office market. Quarterly absorption averaged 485,600 sf during the past five years. NLV saw -10,300 sf of net absorption in Q1, due to tenants vacating and downsizing of Class B space (-12,100 sf) and medical space (-2,900 sf). Class C saw 4,700 sf of positive absorption. (There is no Class A space in NLV as RCG defines it.).

Retail

Tenant move-outs drove retail net absorption into the red in Q1, totaling -416,200 sf valleywide. By contrast, average quarterly net absorption of anchored retail during the past five years was 406,300 sf. We do not track activity in nonanchored centers; however, discussions with industry players indicate that this sector is continuing to weaken at a faster pace than the anchored sector, and we expect that this will negatively influence the anchored market as the economy continues to contract into 2010. Demand for retail space in NLV was -84,800 sf at the end of Q1, most of which was in community center space (-3,300 sf) and the remaining in neighborhood centers (-11,500 sf).

Supply

Industrial

The 739,000 sf of valley completions in Q1, 2009 were well below Q1, 2008’s 2.1 million sf. New space was divided between light distribution (429,500 sf), light industrial (206,900 sf) and R&D/flex (102,700 sf) facilities, and was concentrated in the Southwest. No new industrial space was completed in NLV during Q1.

The amount of forward-supply continued to drop in light of reduced demand and heightened vacancy. This supply declined to 3.3 million sf in Q1 from last quarter’s 3.8 million sf. Of this amount, 19.5 percent (644,000 sf) was under construction, a mere .6 percent of existing industrial inventory. In contrast, the five-year (2004-2008) quarterly average was 3.2 percent. The remaining 2.7 million sf of forward-supply was in planned projects, concentrated primarily in warehouse/distribution in NLV.

Office

Valley office completions in Q1 totaled 712,100 sf. While this new space was higher than Q4’s 377,500 sf and Q1, 2008’s 216,000 sf, most of these new projects broke ground before the plunge in confidence by developers, investors and lenders about the local economy and the office market. New completions during the past five years averaged 695,700 sf per quarter. New space was delivered in just two of the valley’s eight office submarkets: Northwest (446,500 sf) and Southwest (265,600 sf). Class C space led (190,100 sf), followed by Class A (187,400 sf), medical (175,600 sf) and Class B (159,000 sf).

At 1.2 million sf, forward-supply continued to drop in Q1 as under construction projects progressed to completed status and many planned projects were canceled or delayed. More than 61 percent of this space was under construction, representing nearly 2 percent of the existing office inventory. In comparison, the five-year quarterly average was 5.6 percent. The remaining 400,600 sf of forward-supply was in planned projects.

No new office space has been completed in NLV since Q2, 2007. At the end of Q1, five projects were under construction in NLV, with a total square footage of 22,000 sf: one warehouse distribution project, one incubator project and three in light industrial.

Retail

During Q1, one anchored center was completed in the valley — Desert Marketplace, a 427,250-square-foot community center in the Southwest. For the past five years, quarterly completions of anchored center space averaged 460,000 sf.

Forward-supply at the end of Q1 totaled nearly 4 million sf, of which half was under construction and the other half was in the planning stages. Power centers composed 35 percent of this future space, 49 percent for community centers and 16 percent for neighborhood centers.

Two projects currently are under way in NLV: Deer Springs Crossing, a 312,099-square-foot neighborhood center and Deer Springs Town Center, a 687-713-square-foot power center. Also, a 351,300-square-foot community center (Las Flores) is in the planning stages.

Sublease Space

An important indicator of an economic downturn is the rise in sublease space. It reflects budget cutting associated with downsizings and other operating cost reductions. Given the lead time required for businesses to assess their labor and space needs, in order to downsize and relinquish space, it can take several quarters before these changes show up in the vacancy numbers.

For the industrial market, sublease space spiked (+140 percent) from 499,400 sf in Q1, 2008 to nearly 1.2 million sf in Q1, 2009. When the 992,600 sf of vacant sublease space is added to the direct vacant space in existing projects, the total industrial vacancy rate in the Valley rose to 12.7 percent in Q1 from the 11.8 percent noted previously.

Speculative office sublease space jumped (+167 percent) from 279,200 sf last year to 744,500 sf in Q1. Factoring in the 675,000 sf of vacant sublease space at the end of Q1, the Valley’s office vacancy rose to 22.3 percent from 20.6 percent mentioned above.

For the valley’s anchored retail market, there was approximately 107,100 sf of anchored space available for sublease in Q1, 2008. At the close of Q1, 2009, this number had risen to 269,900 sf (151 percent surge). Adding the 244,300 vacant sublease space to the directly vacant space, the valley’s retail vacancy moved to 8.3 percent from the 7.8 percent noted above.

At the end of Q1, sublease space in NLV accounted for 43 percent (504,500 sf) of the valley’s industrial market, .4 percent (3,000 sf) for office and 6.2 percent (16,800 sf) for retail.

Further Thoughts

While we are seeing some slight improvements, or at least “declines in the rates of decline ” in the national economy, a return to prerecession long-term trends is still some time away. As we noted in the May issue of our Economic INsight™, economist Paul Krugman recently put it best: “In some sense we may be past the worst, but there is a big difference between stabilizing and actually making up the lost ground.” Unfortunately, he is right, because the breadth and depth of the economic turmoil in formally superheated markets like Las Vegas (let’s not forget Phoenix, Miami and Southern California) will slow the overall economic recovery here.

The recession is doing a job on the Southern Nevada and national commercial real estate markets. For example, Real Capital Analytics recently reported in its June 2009 report that there are almost $10 billion in troubled real estate in Las Vegas, comprising apartments, hotels, industrial, land, office retail and miscellaneous properties. According to the firm, that number puts Las Vegas in the lead position nationally (The properties covered by RCA are typically valued $2.5 million-plus.). This should come as no surprise to anyone, and until the job market sees a sustained (at least six months of growth) improvement, this situation is likely to worsen.

Real gross domestic product in Q1 dropped at a yearly rate of 6.1 percent, according to the U.S. Commerce Department, almost as severe as the 6.3 percent drop in Q4, 2008. This two-quarter contraction was one of the worst declines since World War II. While consumer spending saw a bit of recovery during Q1, the collapse of business spending was the primary reason for the GDP drop. Let’s see what happens in the second quarter.

According to the Bureau of Labor Statistics, “Nonfarm payroll employment fell by 345,000 in May, about half the average monthly decline for the prior six months. The unemployment rate continued to rise, increasing from 8.9 to 9.4 percent. Steep job losses continued in manufacturing, while declines moderated in construction and several service-providing industries.” Accordingly, at the national level, the contraction of the economy appears to be slowing. However, recovery could be hampered by certain core indicators. Companies are likely to start hiring again at a snail’s pace, causing the unemployment rate to stay above recent historical norms for some time, even after GDP growth returns. That said, consumer confidence definitely improved considerably since March, as reported by The Conference Board (54.9 in May, 40.8 for April and 26.9 in March). Also, according to The Conference Board, the May number is the highest since September 2008 (61.4).

What does this mean for Nevada — and Southern Nevada — in particular?

1. Our resort industry appears to have avoided the major restructurings in 2009 that initially were expected at the beginning of the year, but it is still struggling.

2. The rates of new home and resale closings have been improving each month since March 2008, and we expect this to continue through 2009, because of historically low interest rates. This will go a long way in stabilizing falling home prices, but we still need more primary homeowners.

3. As noted above, the wave of commercial foreclosures in Southern Nevada is imminent. It is starting to be eerily reminiscent of the Resolution Trust Corp. days of the late ’80s to mid-’90s.

4. As we repeatedly have written, Las Vegas and Nevada will not see a “V”-shaped recovery this time around. Again, it’s all about job growth. And a sustained recovery is not likely to be seen in Southern Nevada until sometime in 2011 — assuming the job market improves dramatically.