Valley’s anchored market falls victim to economic downturn

Monday, June 29, 2009 | 4:59 p.m.

The Las Vegas Valley’s economy remains in the midst of one of the most severe downturns in U.S. history. The culprits are the collapse of the local housing market, massive job losses and the frozen credit markets. Consequently, the valley’s anchored retail market, such as the office and industrial markets, has not been able to avoid the turmoil.

For many years, the region’s anchored market was one of the most vibrant and strongest in the region, if not the nation. That has now changed. The housing market crash, combined with the drop in consumer confidence and spending, has caused the valley’s anchored retail centers to see a steady rise in vacancy and a downward trajectory in rents. A look at our local economy should shed some light on where the valley’s anchored market is headed in 2009.

Total Job Change

In February, the Nevada Department of Employ- ment, Training and Rehabilitation reported that Clark County lost 41,400 establishment-based jobs compared to February 2008, dropping 4.5 percent to 880,000. Additionally, February’s jobs were 1,400 less than this January’s numbers, making the January-February decline a vast improvement over the 18,300 December-January drop, and while this is an encouraging sign, it is not a trend. Since the beginning of 2009, 19,700 residents of Clark County have lost their jobs.

Regarding Clark County’s unemployment rate, the official report estimate was 10.1 percent in February, a near doubling of the 5.1 percent recorded in February 2008, or a jump of 98 percent. At the same time, Clark County’s labor force grew by 4.3 percent, from 971,900 to 1,013,700. The reasons: college graduates entering the job market, retirees returning to work because of financial need, nonworking spouses seeking work and population growth.

Job Change, By Industry

The DETR reported the loss of 44,800 jobs in eight of the 11 major employment sectors (Other Services saw a gain last month) compared to February 2008. As noted, this is a slight decline compared to what we saw in January versus January 2007. Once again, most of the losses were in Leisure and Hospitality, followed by Construction; Professional and Business Services; Trade, Transportation and Utilities; Financial Activities; and Manufacturing and Information Services. Natural Resource jobs remained unchanged.

There were 3,400 jobs added in two of the 11 sectors, year-over-year. The largest gains were in Education and Health, followed by Government. As mentioned, the result was a net job loss of 41,400 jobs versus February 2008. In the case of Education (including private colleges like the University of Phoenix) and Health employment, there were 2,600 additional jobs compared to February 2008, representing 76 percent of the job gains.

Unemployment Claim Filings

The state of Nevada recorded almost 101,000 initial unemployment claim filings in Clark County during the 12-month period ending February 2009. Southern Nevada is now in uncharted waters, with annual unemployment claims exceeding 100,000 in February. This reflected the highest, largest, rolling year-over-year change (70 percent) in the last seven years. Additionally, the same-month, previous-year change in February was 75 percent above the February 2007-2008 period (the change this January was 70 percent). Until this indicator shows a persistent decline of at least six months, the state and local economies will remain in recession.

Again, the significant problems facing the Southern Nevada resort industry that emerged in February do not bode well for a steady decline in monthly unemployment claim filings in 2009 and probably into the first half of 2010. Time will tell, and we continue to monitor this indicator very closely each month.

Hopefully, the rates of monthly filings we saw in 2008 and into February will not be repeated for the remainder of 2009. However, at this point, we are not seeing a decline in the rate of increase each month.

Median New Home and Resale Price

Recent numbers released by Home Builders Research show a 38 percent drop in the median resale home price and 19 percent in the median new home price in Clark County, when comparing February 2009 to February 2008. As noted previously, until this essential indicator shows an upturn of at least six months, the housing market will remain troubled, prolonging the recession. That said, it is good news that the decline in new home prices is starting to moderate. This is largely due to the dramatic decline in housing starts.

As noted, the one bright spot in this God-awful mess, is that housing affordability has improved considerably. February’s median new house price of $220,700 is back to just below the March 2004 level of $225,000. In the case of resales, January’s price of $145,000 is now near the $145,900 recorded in April 2002. Essentially, five to seven years of equity, some of it real and some of it paper, has been wiped out by the housing crash. In the long-term, a return to some level of affordability is vital to the region’s quality of life. However, in the short to intermediate terms, it is very traumatic to consumer and business confidence, which are crucial prerequisites to Southern Nevada’s recovery.

HBR reported 2,606 resale home closings this February versus 1,529 in February 2008, the same rise as January (70 percent). However, according to Salestraq, 63 percent of home sales were bank-owned in February. That’s why we continue to see a decline in the median price. In the case of new home closings, there were 375 units sold in February 2009 versus 786 in February 2008, a 52 percent drop. This is largely a sign of the significant resale inventory and commensurate dramatic drop in new home construction.

Additionally, total home sales for the 12 months ending this January were 40,882 compared to the 37,361 during the 12 months ending February 2008, a healthy rise of 9.4 percent. The burning off of inventory is critical to the return of price stability, as long as we recognize that not all closings are created equal. In other words, purchases by investors and speculators are not what are needed. What is needed are purchases by homebuyers, and that only will occur in any meaningful way when the job market improves.

Las Vegas Valley Anchored Retail Market

The valley’s anchored retail market is being significantly challenged by a number of factors: The principal one being significant job losses, which has led to plunging consumer confidence and spending. For example, the nation’s aggregate savings rate (as a percent of personal income) was .3 percent in February 2008. By comparison, this February’s rate was 4.2 percent. Clearly, consumers are conserving cash to rebuild savings and retirement plans devastated by the recession. Additionally, Clark County has seen a sharp fall in taxable retail sales. Moribund consumer confidence and spending are the causes. That is why taxable retail sales in Clark County dropped to $2.3 billion, or by 13.2 percent, in January 2009 from $2.7 billion in January 2008.

Retail Space and Vacancy

Our research shows the valley closed Q1, 2009 with an anchored retail inventory of more than 42 million square feet in 258 shopping centers. Of this amount, 3 million square feet stood vacant, resulting in a direct vacancy rate of 7.2 percent. This represents a more than doubling of the 3.4 percent recorded for Q1, 2008.

At the end of Q1, 2009, Neighborhood Centers (usually anchored by supermarkets and providing convenience shopping for day-to-day needs) had the highest vacancy at 7.9 percent and comprised 36 percent of the valley’s total retail inventory (in square feet). Community Centers (generally anchored by supermarkets and discount department stores selling apparel, home improvement, furnishings, toys, electronics or sporting goods) followed with a 7.3 percent vacancy. This group accounted for 42 percent of the valley’s anchored retail inventory. Finally, Power Centers (dominated by several large anchors) had the lowest vacancy at 5.8 percent and comprised 22 percent of the remaining inventory.

Demand

The steady rise in vacancy was driven by the drastic drop in absorption. Leasing during Q1, 2008 was at a record high with 1.2 million square feet of space absorbed that quarter (just short of completions). Since then, tenant demand for retail space has been in free fall, with three of the past five quarters recording negative net absorption, including the -367,300 square feet recorded for the first quarter (see chart).

In Q1, 2009, the only submarket to witness positive absorption was the Southwest (364,000 square feet). The remaining submarkets saw negative net absorption, with the largest amount being in Henderson (-195,000 square feet), followed by Northwest (-133,400 square feet), West Central (-83,800 square feet), University East (-66,000 square feet), Northeast (-53,800 square feet) and North Las Vegas (-15,260 square feet).

Community Centers were the only product type to see positive net absorption in the first quarter (394,700 square feet). However, this is attributed to the leasing up of space in one submarket — the Southwest — which was enough to offset the declines in the remaining areas of the valley. Power Centers had -188,700 square feet of net absorption for the quarter, while Neighborhood Centers experienced -211,300 square feet.

Supply

The only new project completed in the Q1, 2009 was the 427,000-square-foot Desert Marketplace community shopping center in the southwest portion of the Las Vegas Valley. Despite bleak economic prospects for the remainder of the year, the amount of forward supply (under construction and planned) in the valley remains relatively significant. At the end of Q1, almost 1.9 million square feet were under construction, with an additional 2 million square feet in planned space. Of the under-construction space, half is slated to be in community centers (49 percent), and is concentrated in the North Las Vegas and Northwest submarkets. Much of the planned space recorded in the Southwest submarket in previous quarters either has been canceled or delayed during the past few months, because of ongoing weak consumer demand and the inability to get financing.

An important measure of the near-term health of the commercial markets is the potential number of years of inventory. We calculate this amount by comparing the amount of vacant space in existing projects plus forward supply to average quarterly absorption. The average quarterly absorption during the past 16 quarters was used to account for the ups and downs of the market between 2005 and 2008.

As mentioned previously, there were 3.1 million square feet of vacant space in existing projects and nearly 1.9 million square feet of under-construction space at the end of the first quarter, 2008. Comparing these figures to the past 16 quarters’ average absorption of 416,900 square feet results in a three-year supply of anchored space. Factoring in the prospect of another 2 million square feet of planned space, the absorption period potentially grows to 4.2 years. The big question is, how much of this space will actually come online considering the health of the economy and the unwillingness or inability of lenders to lend? It is highly possible that many of these projects will either be foreclosed on, canceled or delayed until economic conditions improve. This will lessen the cannibalization that is already occurring, as centers compete for tenants.

Retail Space and Rents

Anchored retail rents reported by RCG are based on information provided by owners and brokers about available vacant space in specific projects. Las Vegas recorded an average monthly retail rent of $1.91 per square foot NNN at the end of Q1, 2009, down $0.13 from Q4, 2008 and down $0.12 from Q1, 2008.

Based on the age of projects at the end of Q1, 2009, retail centers completed between 2005 and 2008 had an average asking rate of $2.45 per square foot, 8 percent below the $2.66 per square foot that was recorded in Q4, 2008. Projects built between 2000 and 2004 averaged $1.99 per square foot, 3 percent below Q4, 2008’s rents of $2.06 per square foot. Projects built between 1995 and 1999 averaged $1.58 per square foot, representing a 10 percent drop from the $1.76 per square foot reported the previous quarter. Those built prior to 1995 averaged $1.57 per square foot, which is 3 percent below the $1.61 per square foot in Q4.

Rents dropped in all of our submarkets, with the biggest decline in North Las Vegas (12 percent from $2.30 per square foot in Q4, 2008 to $2.03 in Q1). The Southwest had the highest rent at $2.34 per square foot, followed by Northwest ($2.19 per square foot), while the lowest was in Downtown ($1.21 per square foot) and West Central ($1.44 per square foot).

The U.S. consumer price index reported by the U.S. Department of Labor for March 2009 has risen by 20.8 percent since 2001. Adjusting the first quarter’s average monthly rent for inflation resulted in a rent of $1.58 per square foot. Comparing this rent with the asking rent in 2001 ($1.47 per square foot), results in a change is $0.12 per square foot or 7.5 percent over the eight-year period.

Moving Forward in 2009 and 2010

While the recession continued to worsen in February, there was a dramatic slowdown in the rate of job losses compared to what was recorded this January. Even though employment change is a lagging indicator, we continue to believe that we will not see a sustained recovery in our local economy until the job market improves, most likely in late 2010 or early 2011. The issues currently facing our resort industry, and the imminent wave of commercial real estate defaults (that we think will peak in 2010) in Southern Nevada, are very worrisome.

Deutsche Bank recently reported that commercial delinquency rates, nationally, rose to 1.8 percent, four times the rate seen a year ago. The firm also thinks the numbers could get as high as 6 percent by late 2010. Moreover, according to Real Analytics, there are almost $19 billion in commercial loan defaults, along with properties in foreclosure or bankruptcy around the country.

The U.S. economy has lost nearly 4.5 million jobs since the recession began in December 2007. 1.2 million of these jobs have been lost in 2009 through the end of February. In February alone, U.S. employers shed nearly 651,000 jobs, and the unemployment rate reached 8.1 percent.

What is our forecast for Southern Nevada in 2009?

1. The resort industry is likely to see one or more major restructurings before the end of the year.

2. Deflation, not inflation, continues to be a very real concern, because of the disintegration of consumer spending and business investment globally.

3. Whoever thinks that Southern Nevada will escape the national tidal wave of commercial real estate loan defaults will be disappointed . . . very disappointed. On the other hand, 2009 is a great year to be a tenant or a buyer (assuming you can get the capital).

4. The rate of new home and resale closings has 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 home prices.

5. Oil and other commodity prices will continue to remain low, because of the worsening global economic outlook, functioning as a tax cut for Nevada residents.

6. Nevadans could see the greatest tax increase and greatest spending cuts in its history when the Legislature convenes.

7. As we’ve repeatedly written, Las Vegas and Nevada will not be a V-shaped recovery this time around. Think an elongated Nike “swoosh” instead.

As to the impact of these trends on the valley’s anchored retail market, in our opinion, the market will see growing vacancies and declining inflation-adjusted asking rents throughout 2009 and into 2010. The three key factors driving this expectation are: little if any population growth, a very weak job market and a severe lack of consumer confidence and spending.

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John Restrepo is Principal of the Restrepo Consulting Group LLC.