2008 Retail Market Overview

Posted by: Kelly Bland

Retail Specialist

775 336 4662

kbland@naialliance.com

Kelly specializes in anchor tenant representation and shopping center anchor leasing, acquisition and site sales for both retail land and shopping center sites. Additionally, Kelly is involved in investment sales of retail properties..

The Reno retail market continues to see new retailers moving to the area. Recent openings include Cabela’s, Scheel’s, Target, and Whole Foods. Others anchor tenants such as Wal-Mart, Lowe’s, JC Penney, Staples, CVS and Walgreen’s are finalizing new sites as well. Development has been focused in the growing areas such as Spanish Springs, the Marina in east Sparks, west Reno and South Reno. Even with a slowdown in the pace of residential housing developments, retail projects that are under development are continuing to march forward to completion.

Downtown Reno continues to see residential condo projects such as Palladio’s and the Montage finishing their build-out. Ruth Chris’ Steak House will be joining the mix of restaurant choices downtown with their new site in the Montage. A significant change to downtown is the recently approved new minor league baseball stadium to be located on the eastern edge of downtown. All of this new activity is expected to lead to a significant addition of new restaurants and retail shops.

As a result of mergers, national tenant bankruptcies and anchor store cut backs, Reno is seeing an up-tick in the vacancy rates. There have been a several announced closures of big box tenants including Wild Oats, Comp USA, Super Kmart, Mervyn’s, Linen’s and Things and Shoe Pavilion. It is a great time to be looking for good deals within the second generation space category.

NAI Alliance Market Report: Episode 1

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A podcast where we talk about commercial real estate, development and things going on in our market place here in Northern Nevada.

This week: MORGAN WALSH - Multifamily Specialist

All things considered, real estate still looks pretty good

Posted by: Scott Beggs

Investment Specialist

775 336 4644

sbeggs@naialliance.com

Scott joined NAI Alliance in March 2008 to assist the company with investment sales. Previously, Beggs spent over seven years with Dermody Properties as Vice President of Acquisitions and Port Management.

Despite the meltdown in the financial markets, well-located, fully-leased commercial real estate remains an attractive asset class relative to the universe of investment alternatives. This may seem like an odd statement in light of the problems facing some commercial real estate investors, but generally speaking real estate cash flows have held up well, even in this difficult market.

One of the most important attributes of commercial real estate is long term cash flows. Over the short term, real estate cash flows are dictated by the terms contained in the leases. Leases are legal obligations of the tenant to pay rent to the landlord for a specified term. Provided the lease terms are long enough and the creditworthiness of the tenant high enough, there should be somewhat limited risk of significant cash flow declines for an asset. If an asset is well located and well built, there should be somewhat limited risk associated with the long-term cash flow for a particular property.

Historically, investors typically focused on long-term cash flows with some modest expectation for value increases over the long term. This was exemplified by the use of 10-year IRR calculations where a large percentage of the return was generated by current cash flows. In recent years the market became inundated by “Value-Add” and “Opportunistic “ investors with higher return thresholds and shorter holding periods. The shortening of the investment horizon and a greater reliance on capital appreciation (as opposed to cash flow) has skewed the decision making process for these types of investors.

Adding to the difficulty, the commercial mortgage backed securities (CMBS) market bought into this hype. Many conduit lenders were more than happy to originate loans at unreasonably high loan-to-value (LTV) ratios, and unreasonably low debt-service coverage (DSC) ratios. And investors were more than happy to oblige.

It would seem that the problems faced by many investors are not the result of poorly performing real estate; rather they are the result of a poor capital structure and overly optimistic expectations for values. In fact, real estate returns are much more stable and predictable than many other investment alternatives. The problem is that some investors purchased real estate as a short-term trading asset, not as long-term cash flow investment. Nevertheless, the abuses and excess of the past two years does not invalidate the merits of a well-located, well-leased, appropriately capitalized real estate investment.

So what should investors focus on when evaluating a possible real estate investment:

1. Focus on Current Cash Flow – While there will be opportunities to create value by leasing vacant property; this strategy is not for the faint of heart. Seasoned real estate investors will tell you that the timelines and cost associated with leasing up vacant property can spiral. Unless you have a coherent business plan focused on a value-add strategy and significant equity capital, then most investors are better off focusing on current return.
2. Credit is Critical – A long lease term is meaningless if the tenant goes bankrupt. Understanding a tenant’s current and future financial position is an important aspect of underwriting an investment.
3. Have a Downside Plan – Even with the most thorough underwriting, sometimes unforeseen things occur. Have a plan for an unforeseen vacancy. Know the likely cost of re-tenanting a space that may “go dark” and have a capital plan to employ the strategy (e.g. have some reserves)
4. Avoid Overleveraging – The use of debt is commonplace in real estate transactions, but recently debt has been abused. An appropriate amount of debt is a very reasonable means of enhancing your returns, but leverage is not a magic elixir. Leverage merely magnifies your return, both positively and negatively. Stress-test your cash flows under various downside scenarios so you can adequately plan your optimal capital structure.
5. Understand the Risks – If you are looking for a risk-free asset, buy US Treasuries. But if you want to earn an excess return, it comes at a cost – RISK. As long as the investor understand the risks and has a plan to deal with them as they arise, real estate risks should be manageable.

Some may argue that my insistence that real estate is an attractive investment is misguided. They quickly point to the distress some real estate investors are now experiencing. I would suggest that the problems these investors are experiencing are not necessarily the result of poor real estate, but rather the convergence of a poor capital structure with a historic credit crisis.

Real estate is obviously not the only asset class that is feeling the pain of this credit crunch and sharp decline in investor confidence. Year to date (as of October 6, 2008) the S&P 500 Index(^GSPC) was down 26.97%; Dow Jones Corporate Bonds Index was down 5.55%, and the US Treasury Index (^TNX) was down 12.17%, and the Financial Sector exchange traded index (AMEX:XLF) was down 37.24%. As you can see there is no safe haven for investors.

In light of the extreme recent volatility in the stock market and the expectation that this volatility will continue into the foreseeable future, fully leased commercial real estate looks pretty attractive on a risk adjusted basis. Even if cap rates continue to edge upward over the short term, real estate pricing historically has stayed within a relatively narrow range. Over the last 20 years, cap rates for fully leased real estate have generally stayed between 6.0% and 9.0%. Relative to the ever changing multiples in the equities market and the volatility of yields on fixed income investments, real estate still looks like a highly stable asset class. In addition to this stability of pricing, real estate has historically enjoyed the added benefit of increasing cash flow streams. In many instances rental growth is embedded in the leases and therefore contractual in nature.

So while excess returns cannot be achieved without incurring some amount of risk, the risks of commercial real estate can be investigated, understood, and to some degree mitigated. Given the balance sheet shenanigans that have taken place at some supposedly high quality companies, the risk/return tradeoff associated with real estate investing, doesn’t seem all that bad.

Accentuate the Positive | How does Northern Nevada compare ?

Posted by: J. Michael Hoeck, SIOR

Industrial Specialist

775 336 4621

jmhoeck@naialliance.com

Mike began specializing in industrial brokerage with Colliers International in 1999, and in May 2005, joined Alliance Commercial as a Partner and as Vice President of its Industrial Properties Group. In May of 2007 Alliance Commercial became NAI Alliance and Mr. Hoeck became a Senior Vice President.

We’ve all heard, “If it didn’t always rain in Seattle everyone would live there.” or “San Diego is the most livable city.” When a company analyzes where to locate a distribution or manufacturing facility there are many more factors to consider other than the usual rents, taxes, utilities and labor.

Companies are looking more in depth at what a region has to offer. Other factors now being considered include benefits, transportation, housing, health care, personal & income taxes, climate, crime, recreation, arts and entertainment, cost of living and education.

Recently a prospect for a medium sized (100,000 +/- sf) processing/distribution center with 25-50 employees requested a comparison between Reno and ten other cities: Boise, Seattle, Portland, Salt Lake, Phoenix, Las Vegas, San Diego, Ontario (CA), Fresno and Sacramento. The study was prepared in conjunction with EDAWN and SSPC and here are the results...

When facility costs are considered, Reno ranks right at the top with an average asking rate of $0.33/sf NNN. Only Fresno has an average lower rate ($0.29/sf NNN) and as far as the quantity of offerings, Reno ranks fourth behind the much larger markets of Phoenix, San Diego and Ontario. This bodes well for prospects looking for a competitive rate.

Reno ranks first with respect to state taxes, tied with Las Vegas. Employment taxes are in the middle of the pack with Phoenix, Portland, Boise and Seattle all slightly lower yet our rates are nearly 45% lower than California. We don’t fare as well with property tax rates, ours are some of the highest with only Boise and Phoenix being higher. Only Idaho, Utah and Arizona join Nevada as right to work states.

Utility costs pose a sore spot for our region with electricity (8th) and natural gas (last) in the rankings. Only Southern California had higher electricity rates and when water and sewer are included, Reno has the highest overall costs with Fresno a distant second. Often we cite the other lower operating costs offset this disadvantage.

A positive factor in the comparison is labor. We rank favorably in wage rates behind only Boise, Fresno, and Phoenix. When factoring in fringe benefit costs, we rise to the top 3 passing Fresno. Our unemployment rate hovers near 4.2% and all of the cities were similar except Fresno 8.2% and Boise 1.7%. Jason Quintel of Panattoni Development in Phoenix cited a large labor pool, low wages and a secondary education feeder system as Phoenix’s strengths when costs are compared. Combined with a strategic location to California, Phoenix is a formidable competitor.

Transportation is becoming an increasingly important factor. Reno has the lowest number of trucking carriers (79) but is fortunate to have as good or better rail service than the competition. Boise and Las Vegas have the weakest rail service (1 provider) and Portland and Seattle each have three rail providers. Reno’s proximity to seaports is the closest of any inland city except Ontario. Increasing fuel costs are becoming more important when considering proximity to Long Beach/Los Angeles seaports, combined the nation’s largest. Air cargo ranking is significant when correlated to our city’s size and could become an untapped market for us to pursue.

While Reno clearly has the lowest housing rental rates in the study, we also have some of the most expensive home prices with only San Diego, Seattle, Ontario and Sacramento being higher. We rank #2 in per capita income (Seattle #1) Our sales tax rates are amongst the lowest (#4 with Portland, Boise and Salt Lake lower) and we rank best along with Las Vegas for (lack of) personal and income taxes. Overall cost of living ranking is in the upper middle ranks with Boise, Phoenix, Salt Lake City and Las Vegas being lower.
Crime rate statistics are relatively low with only Salt Lake, Boise, San Diego and Portland beating Reno. Our commute time is the shortest of all of the cities. Health care costs for individuals is in the lowest three (behind San Diego and Boise), we have the highest hospital bed count per capita and rank #2 in doctors per capita.

Recreational rankings are more of a personal taste but when considering golf, lakes and dining, Reno would tie for fourth along with Portland and San Diego and being topped by only the much larger cities of Phoenix, Las Vegas and Seattle. In arts and culture we rank in the lower percentile, but ahead of similarly sized Boise, Ontario, Fresno and Sacramento. When all of the above quality of life factors are considered we rate consistently high.

Excepting Las Vegas and Central California, Reno has the lowest percentage of high school and college graduates. When comparing elementary and secondary education levels, we rank second lowest in expenditure per pupil (Boise lowest) and have the second lowest graduation rate ahead of only Phoenix. These factors could cause concern for prospective companies.

There you have it. With several new large facilities available, northern Nevada is poised to compete with the best of the west’s cities. If you were able to select where to locate a facility (and possibly your family), northern Nevada ranks quite high and confirms what all of us Northern Nevadans have known for some time. When stacked up against the competition, not only are we strategically located to serve the eleven western states, but we offer a lower cost of living, low occupancy costs, great tax incentives, abundant recreation and an affordable labor force. We need to ensure we summarize and accentuate the positives that make northern Nevada special.

A Light at the End of the Tunnel

Posted by: Scott Shanks, SIOR

Office Specialist

775 336 4674

sshanks@naialliance.com

During his career, Scott has worked with clients such as: Barnes & Noble, GM, Merck Pharmaceutical, Henry Schien, Home Depot and Ahold to facilitate their real estate needs.

"The reports of my death are greatly exaggerated”

~Mark TwainIt seems you can’t read a story in the mainstream national press that doesn’t include a dire forecast about the state of the US economy. Many local reports follow that same line of thinking. I am not here to refute the facts of the current difficulties that the Northern Nevada economy is facing; however, I do take issue when the current difficulties are extrapolated to long-term forecasts. Such prognostications are particularly short-sighted when applied to commercial real estate and more particularly the local office market.

Too often in my career I have heard people mistake a short-term market correction for a long-term trend. In few other industries is this more problematic than the office sector of commercial real estate. The NAI Alliance office team, Scott Shanks, Dominic Brunetti and Matt Grimes, are reporting a current office market vacancy rate of 16.05%. When unoccupied sub-lease space is included in the calculation, the availability rate is 17.57%. While these statistics are very real and problematic, the Office Team will tell you that they do not reflect the whole picture. Looking at current occupancy statistics can be like viewing two minutes of a three hour movie; it doesn’t show you the whole picture.

Some may point to occupancy statistics as an indicator of ill-health in the local office market. In my mind this situation is nothing more than a short-term disruption in the supply and demand for office space – not necessarily an indicator of long-term problems. The demand for office space during 2006 and 2007 was artificially inflated by the “irrational exuberance” surrounding the residential housing boom. National and regional home builders entered the market and rapidly expanded their operations. Mortgage companies, engineering firms, contractors and sub-contractors, fueled by the perception that the housing expansion would continue, increased their office needs. Developers brought new projects on line to meet this growing demand, but compared to past boom cycles, developers remained somewhat restrained, partly due to the fact that the housing boom was severely impacting their cost of construction thus making some projects too uncertain. The result was that demand outpaced supply and prices (rents) increased dramatically. Now that artificial demand created by the housing bubble has vanished, we are left with a complete reversal in the supply/demand equation and we are experiencing downward pressure on rents.

But does this mean that the demand for office space has completely gone away? Absolutely not! New lease transactions and expansion continue. The NAI Alliance Office Team is currently assisting a number of new and existing clients to address their growing need for new office space. The same fundamentals that drove the economy of Northern Nevada prior to the housing bubble will continue to propel this market in the future. Population based office demand will continue to grow as banks, insurance companies and other financial service companies will expand to meet the demands created by a growing population base. Efforts to attract new businesses like Microsoft Licensing, Charles River Laboratories, and Intuit will be met with success. Most importantly, small companies will continue to grow and flourish here due to the entrepreneurial spirit and quality of life this area possesses.

This may all sound a bit overly optimistic given the current state of the economy, but that is exactly the point. When looking at an asset class like real estate, it is important to have a long term view of the economic fundamentals. While the long term supply of well located office space is not fixed; it is constrained. And while short-term demand for office space is cyclical; long-term, demand for such space should (at a minimum) grow at a pace equal to the population. Demand can potentially grow even faster if new business is attracted to the area.

While I accept the statement that the market for office space in Northern Nevada is facing a disruption in the relationship between the demand and supply for such space, I do not accept that this disruption is due to a fundamental problem in the market. Rather, it is a short term correction creating opportunities for smart investors and space users. Rumors of the demise of the office market in Northern Nevada are greatly exaggerated.

Reno Apartment Investment Returns | Where do they come from ?

Posted by: Morgan Walsh

Multi-Family Specialist

775 336 4646

mwalsh@naialliance.com

Morgan Walsh is a commercial broker with 20 years experience in investment sales, multifamily and specialty sales, representing buyers and sellers, institutional and private developers in market rate apartment sales, mixed-use residential development and the development of affordable housing projects.

Apartment buyers today will tell you they expect returns to come from current cash flow and appreciation in the range of 8 to 11% per annum. But do the assets really deliver that in a normal market?

Owners of apartments in Washoe County built before 1985 have held their asset on average more than 8 years. Almost half the owners have held more than 10 years. The median holding period for product built after 1984 is now 5 years. Nearly 25% who own the newer product have owned fewer than 3 years. The result is that 80% of the assets currently held did not change hands when owners might have exploited the benefits of extraordinary appreciation during the recent period of historic low cap rates. The remaining 20% of assets were acquired at a cap rate owners may not see again for years.

Historically, apartment appreciation tracks rent growth. From May, 1998 through May, 2008 median monthly rent in Washoe County rose from $696 to $910, a nominal compounded annual rate of 3.5%. But adjusting for inflation using the Western regional index of CPI (All Items/ Urban Wage Earners) rents actually declined slightly in real dollars. (Figure 1) To have kept pace with inflation, median monthly rent should have reached $925 in 2008. The cap rate compression during the recent boom was driven by rates, not rents. Nearly everyone in the industry expects cap rates to be higher within the investment horizon of most owners, because the cost of financing is expected to rise at a compound rate significantly higher than nominal rents. Clearly the winners who disposed of assets during the boom reaped comparatively high rates of appreciation, and for them compounded assets returns were in some cases above 10%. In the past 18 months, 14 sales of properties above 50 units in Washoe County showed a median annual adjusted appreciation of 6% for units with a median age of 31 years, held for 7 years and bringing a price of $112 per square foot. One property was sold at a loss.

Buyers say they purchase apartment buildings to obtain cash flow but the skill set required to maximize cash flow prudently over time is very rare. Buying right in a buyer’s market gives an immediate yield advantage. But the problem buyers find immediately in trying to buy right is the sheer volume of capital chasing deals and the skepticism of sellers trained to expect yesterday’s low cap rate. For product under third-party management, the working assumptions commonly found are that rents will rise 3% per year against expenses rising at 2%, with cash on cash return expanding at just over 1% per year with normal leverage. Achieving an average monthly gross rent of $925 per unit represents a 6% cash on cash return with normal leverage at current rates, without regard to a capital improvement program put in place to preserve rentability. Owners may try to force gains by cost effective renovations in popular submarkets. Others reduce expenses, often jeopardizing the units’ future rentability for current income. Ultimately, the most influential factors driving revenue and expenses may be beyond an owner’s control—net regional immigration by retirees and other tax refugees, inflation, ad valorem tax advantages and regulations that inhibit new home ownership for some and subsidize it for others. Of all the sources of yield to an apartment owner, cash flow is the most difficult to forecast with confidence, especially as operating expenses begin to widely reflect the fuel cost wild card.

Frequently overlooked is the most effective and predictable source of investment return for apartment owners—the forced savings of principal reduction through amortization. Over a typical holding period, the median equity build-up is 5% per year in real dollars. Ironically, the decision to achieve this yield is in the hands of the lender.

Where, then, do apartment returns really come from? (Figure 2) Except in extraordinary markets, returns come fairly equally from cash flow, appreciation and amortization.

How much is enough ?

Posted by: Dan Oster

Industrial Specialist

775 336 4665

doster@naialliance.com

As a member of the Industrial Properties Group, Dan has participated in the sales and leasing of a wide variety of Industrial properties from 1,000 to 700,000 sqft in Northern Nevada. Dan's primary goal is to provide unsurpassed customer service to the clients he represents..

One of the first questions a real estate broker asks any prospective tenant is, “How many square feet are you looking for?” Some folks have a definitive answer, but oftentimes this simple question can elicit a vague response. This uncertainty is understandable. The consequences of committing to a lease in a space that doesn’t fit a company’s needs is far more painful than an ill-fitting pair of shoes and can even threaten the very life of your firm. So, how do you decide how much space is appropriate for your needs? There are many different ways to approach this problem. While no one way is always correct, the following methods (or a combination of methods) can provide some insight into this dilemma.

Competitive analysis, or how green is my neighbor’s grass? Few businesses have a truly unique and revolutionary business model. Start by visiting your competition or companies engaged in a similar business. Estimate the space they occupy (measure the outside walls or count ceiling tiles — most are 4 feet by 2 feet) and look for signs of under- or over-utilization, such as excess product moved outside. This is a sure sign they are busting at the seams because no one wants to pay employees to move product in and out of the building each day. On the other end of the spectrum, dark offices, wide open spaces, or signage advertising space for sublease indicates less space is needed for this type of business. Finally, ask yourself if you can operate your business over the next three to five years in this size space.

Budgetary analysis or how much can we afford?

Rather than simply pick a budget number out of the air that feels good, consider the following: you don’t want to pay more in expenses than your revenue can support. The ratio of lease expense to gross revenue is called a rental factor, and it differs by industry and by the size of the business.

To determine the rental factor other companies of your size and in your industry are paying, try visiting the free website, bizstats.com. This site collects the information provided by publicly traded companies and allows you to enter your annual gross revenue, select your industry, and see the average expenses similar businesses are paying. For example, choose “Manufacturing – Printing & Related Activities” and enter $5 millioin for annual revenue. Hit submit. A table will return showing the average profitability and expenses paid by similar companies. The “Rent – Office and Business Property” line reveals 3.2 percent is the average rental factor for this size and industry.

Armed with this information when looking at spaces in the market, perform a simple calculation: Lease Payment divided by Rental Factor equals Required Revenue. So, if you are looking at a space that costs $10,000 per month, then $10,000 divided by 3.2 percent equals $312,500 per month in revenue required to support that space. Ask yourself if your gross revenue is more or less than $3.75 million annually. If not, you may want to pass on that space. You can also take your gross revenue for the past year, divide by 12, and divide the answer by your rental factor. This provides a monthly budgetary number to use when determining your target space.

Demand analysis, or where am I going to put all this? Call it what you will — “production area”, “company roster”, or “inventory” — identify the factor driving your requirement for physical space. Use one or more of the following heuristics to arrive at an estimate of the size space you need.

• Workroom – if you manufacture, assemble, or otherwise produce a product, it makes sense to identify how much room your production process requires to operate at optimal efficiency and acquire only the space required to do so.

• Office space per employee – 250 square feet per employee or 1::250 is a good rule of thumb for general office space. If you have folks in cubes or in a call center the ratio is closer to 1::100. If you have a law firm, financial services company, or medical use, the ratio is closer to 1::400. Space planners or office furniture companies can give you a more specific idea of how much space you’ll need for your employees based on the type of workspace they utilize.

• In a warehouse, the space your average amount of inventory occupies is a good starting point. Keep in mind, however, that your annual peak inventory must be accommodated somehow. If you have a great deal of variance in inventory throughout the year, consider finding an outsourcing partner who can take your overflow in peak periods, allowing you to pay for only the amount of space you most often use. Otherwise, you’ll have to lease more space, pack your product in tighter or higher at peak periods, and/or manage your supply chain more efficiently. Sophisticated warehousing and distribution companies use a number of metrics to monitor the number of inventory turns, warehouse efficiency, and space utilization they achieve. Based on the changes in these metrics over time, they are able to forecast the amount of space they will likely require into the future.

Strategic analysis, or what am I going to be when I grow up? One of the most significant challenges of picking a new space to lease is that most commercial leases require a three- to five-year commitment. Inevitably, business owners must ask themselves if the space that fits their need today will still work three to five years from now. An interesting paradox presents itself in this discussion. On one hand, nimble companies who are most able to adapt to changing business environments often achieve the greatest rewards; however, operating efficiency, which includes limiting expenses like lease payments, also contributes to profitability. Ultimately, the lease decision is one more example of an important factor dependent on the strategic direction of the firm. Suffice it to say, that the space you commit to in a lease will either limit or enhance your achievement of your strategic goals.

In conclusion, “How much space are you looking for?” is not as simple a question as it may seem. The answer depends on more factors than one might expect. However, with the consequences of a bad decision as dire as they are, careful consideration is warranted. Competitive analysis, budgetary analysis, demand analysis, and strategic analysis will provide insight into finding the answer to this question, resulting in a lease which is appropriate to the amount of space your company needs.

A discussion of the current residential market and it’s effect on land values.

Posted by: Aaron West-Guillen

Land Specialist / Land Entitilement Consultant

775 336 4674

awest-guillen@naialliance.com

Aaron West-Guillen has 15 years of land acquisition, entitlement and development experience in northern Nevada.

Everyone in the industry knew the market was going to adjust at some point; the question was when and by how much. In a declining market it’s not applicable to point to last years numbers, or the year before that, as an indication of where we should be; unless you’re a masochist. One would hope we don’t have to go a whole year to realize that we missed the bottom, thus a month-to-month analysis is more applicable. With all the focus on the housing woes and increase in foreclosures has anyone noticed that residential home sales in the Truckee Meadows increased over the last three months and housing prices are on the rise? Don’t be confused by the national media, check the facts. Sales increased 3.3% nationally and 23% regionally and that’s just in the last month.

While we can make the argument that housing prices have bottomed out, the demand is currently being met with standing inventory and plenty of finished lots ready for the next round of construction. Because the demand is still waning, the builder (wholesale purchaser of land) in this market have been non-existent, but wait. We can look to recent activity in Las Vegas as a barometer of things to come, several large tract purchases have recently closed and public builders are now in back in acquisition mode. For those land holders that can’t hang on the only apparent outlet is the private equity funds, a.k.a. vulture funds. In order to park this asset with a fund, who has very aggressive return requirements, the value must be so low that they will be insulated from any additional market adjustments. This typically means selling at 20%-30% of investment because an accurate value cannot be established. Here is the catch, the banks are the ultimate decision makers and have declined such aggressive cuts to date. Professionals in the market are looking for that first transaction that establishes the true market correction to land values. Some would point to Lennar’s transaction with Morgan Stanley but the reality is that this is an internal joint ventures for the purposes of getting the asset off the books and into a holding company. For those of us guiding our clients the safest approach is to back into a land value from a pro forma driven by house price, which is very sensitive to specific submarkets.

Where does all this leave us, discussions with many local lenders indicates a willingness to discuss very creative options to protect their investment. Large national banks will continue to try and collect on nonperforming assets for disposal within the market. This type of asset has been the target of the vulture funds, but with builders stepping back into the arena those funds could miss out. Those builders with significant land holdings and a need to diversify can look to land banking with joint-venture partners, change in land use to reach a different market segment or reaching out to merchant builders looking for a position in the rebound. Either way, don’t miss the proverbial boat because of the doom and gloom projected by the national media; many great land deals are to be had…