Another Tool for your Toolbox – 1031 Exchanges

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.

Earlier this week I attended a two-part class covering 1031 Exchanges. I did this because I felt like there were more than a few aspects of this part of the IRS code that I did not understand. Am I an expert now? NO. But I do understand the topic well enough to know that when applied correctly, it is a very useful tool for many investors. At the heart of a 1031 Exchange is the ability to defer the tax on the gains realized, that is to say you are not avoiding this tax, you are deferring it. Someone joked with me that in this depressed market no one has gain on the sale of real estate. While transactions are few and far between right now and values are depressed from a few years ago, the 1031 Exchange is still an important tool that all owners (and brokers) should understand. And there are plenty of current sale situations where the 1031 Exchange can still be an effective tool in minimizing your current tax burden upon the sale of an investment property. One of the most basic, and unchangeable, aspects of a 1031 Exchange is the timetable involved. A seller has 45 CALENDAR days from the close of escrow on their sale of their property to identify a trade property. Further, a Seller has 180 CALENDAR days from the close of escrow to complete (i.e. close escrow) on the purchase of their replacement property. If you know nothing else about 1031 Exchanges, you should remember these time frames because the IRS does not allow any exceptions or extensions to these time frames (except by Presidential decree of a disaster area). At the end of the day the total dollar amounts involved in a single commercial transaction dictates that any owner of investment property should consult their tax attorney or CPA to ensure a successful transaction. If you get a blank stare from your broker when you bring up the topic of 1031 Exchanges, you should probably rethink your representation.

Housing Starts..."unexpectedly fell"?

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.

“The Commerce Department reported that housing starts unexpectedly fell in April, brought down by a large decline in apartment groundbreakings that offset a modest increase in single-family housing starts. Housing starts dropped 12.8% to a seasonally adjusted 458,000 annual rate compared to the prior month, the Commerce Department said.”

Housing starts "Unexpectedly fell? " With construction lines-of-credit that fund housing starts being withdrawn by lending institutions daily, new foreclosure filings surging beyond historic highs and the median sales price in most communities plummeting to below replacement cost; how can this be "unexpected?"

In order to compete with the distressed residential properties currently overwhelming the market, builders would have to price new housing starts with the intent of losing money; not a good business model…

Residential Land. Where are we headed?

Posted by: Ryan C. Judson
Land Specialist
775 336 4641
rjudson@naialliance.com

Ryan C. Judson works at NAI Alliance as an associate for the Land Department. His responsibilities include market data mining, researching and tracking distressed properties, and analyzing off-market vacant land opportunities. Ryan received his Bachelor’s of Science in the Business Administration Real Estate Program from San Diego State University in December of 2007. Shortly after moving to Reno in 2008, Ryan obtained his Nevada Real Estate License while working for NAI Alliance and now assists in the acquisitions and sales of vacant land in the Northern Nevada area.

According to Ticor Title’s recent stats, resales have been increasing for the past few months (starting with Feb 09). If this trend continues and foreclosures start to drop we will see median home prices settle on a bottom. Once this happens, new home sales should begin to increase and overall housing inventories should decline.

With inventories dropping, and an increase in demand, the remaining developers will snatch up any abandoned unfinished subdivision projects they can get for a steal. Only with a readjusted basis will most of these projects make sense to build. Bank financing will be available for only the most stable of companies and due to the difficulty of this, developers will need to find new equity relationships with investors who’ve been waiting on the side lines.

The national builders will most likely be slow to re-establish their land development operations as they increase their share of housing starts on their current projects, although, we are currently seeing LOI’s floating around on finished lots in the area from a couple of the publics. This is a good sign and could provide evidence for an earlier than expected market return. Could we see another Great Nevada Land Rush as we did for several years leading up to this mess, or will it be a more conservative process as developers and investors are weary as to not get ahead of themselves? With stabilization of housing prices, a leveling off of foreclosures and a continued increase in number of homes sold, the Reno Residential Land Market could start its return later this year into 2010?

Office Bootcamp

Posted by: Dominic Brunetti
Vice President Office Properties
775 336 4674
dbrunetti@naialliance.com

During his career, Dominic has worked with clients such as: Centex Homes, CTX Mortgage, Landmark Homes, 1st Premiere Mortgage, AG Edwards, Alere Medical, CHSI Nevada, The CFO Group, Ameriwest Financial, North American Title, Andregg Geomatics, Manhard Consulting, HDR Engineering, State Farm, Gizmo Wireless, The Corner Doc, First American Title Company, Stewart Title Company, GI Consultants, The Hilton Foundation, Hartford, PC Doctor and more.

We have been advising Landlords on many different creative office leasing and sales incentives. One of our Landlords, Basin Street Properties, has significant office holdings in the core business district of downtown Reno, Nevada. They are currently gearing marketing towards the abundance of current and future amenities. A perfect example, the new Reno Aces AAA baseball park. An additional incentive Basin Street Properties is considering is the offering of health club memberships.

A friend and former partner of mine, Joel Grace, just came back from Sydney, Australia and brought back a franchise that he was involved in. It is called Original Bootcamp. When he came back, he met with me to discuss the various office holdings in our area, and where was the need for a military inspired outdoor fitness program. It’s a great program, but he wanted to make sure that their first entrance into the US market was in an area in which the office population could take advantage of his companies’ services. In my opinion, this would be a great amenity to an office tenant, downtown or otherwise. Do you agree?

Seller Financing: It Might Be Your Only Option

Posted by: Chris Shanks
Investment Analyst

775 336 4620
cshanks@naialliance.com

Chris is responsible for analyzing, valuing and marketing properties for the NAI Alliance Investments Team. He is also involved in the disposition and acquisition of investment properties for clients.

If owners truly need to get properties off their books they may have to carry back the note to get the transaction done.The media might be telling us that banks have received a plethora of money to facilitate their lending and continuing of operations, but that doesn’t mean they’re giving it out. Many bank managers will tell you that they’re ready to lend, which they will if you have property that has 90+ occupancy, strong in place tenants, and long-term leases. The only problem is the owners of these properties don’t want to sell them in a down market, and therefore they represent a small percentage of the properties on the market. If owners truly need to get properties off their books they may have to carry back the note to get the transaction done.

Banks are requiring debt service coverage ratios of at least 1.35 and above. Often riskier properties have to achieve even higher ratios than that. This ratio is causing lenders to lower their loan to value amounts forcing buyers to come up with more equity. More often than not buyers can’t justify a high equity contribution because it would drastically lower their internal rate of return, which in these times needs to be 20%+ to justify the purchase of a riskier property. What all of this means to the sellers of risky properties is that their building probably won’t sell until banks loosen up their lending practices or they (sellers) provide the lending themselves.

Often times the sellers of property don’t need the proceeds from their sale to be a lump sum. Carrying back the note will provide them with an initial “pop” in the form of the buyer’s equity, and then they can claim loan payments for the entirety of the note. Being the issuer of the note sellers can negotiate the terms that need to be present for the deal to get done. Obviously there is more risk with this procedure because the sellers will need to do the due diligence and underwriting themselves, as opposed to the bank’s staff. However, real estate professionals and attorneys can help with the underwriting and drafting of the loan documents. While there are more implications to this process than I’ve mentioned (tax, legal, etc.) seller financing can sometimes be the only way a property is going to change hands. So if you’re having troubles getting you property to “move” consider offering seller financing.

Are we there yet?

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.

Anybody who has ever been on a long family car trip with kids has repeatedly heard this dreaded question. You feel the excitement and expectation — the longing of just wanting to be there. It turns to frustration because you know that no matter what you do, the journey will simply take as long as it takes. Sound similar to any conversations you’ve had about when this current economic downturn will be over? (Click here to view complete article)

CA Lawmakers Ask Economic Refugees Why NV

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.

California Legislators coming to Nevada to find out why so many California companies have left the Golden State is a great endorsement for Nevada’s business friendly philosophy (see full article here). While Nevada is internationally known as the place to come to play, it’s nice to continue to see recognition of the fact it’s a great place to live and work as well!

A lasting impact on industrial facilities throughout the Western United States

Posted by: Carl Zmaila
Industrial Specialist
775 336 4623

czmaila@naialliance.com

Nicholas Casey and Alex Roth of the WSJ recently authored an article that may have a lasting impact on industrial facilities throughout the Western United States.

They argue the Port of Los Angeles will be seeing increased competition. Why? For a multitude of reasons, from increases in regulation to companies looking for ways not to put all their eggs in one basket. One reason for the latter rationale is the labor dispute last year that handcuffed the Port of Los Angeles.

Casey and Roth are not arguing that the neighboring ports of Los Angeles and Long Beach will lose their dominance as the entry points to the United States for Asia, but other ports along the West Coast, for example British Columbia and Oregon, will see an increase in business.

This may benefit the Northern Nevada industrial market along with other industrial markets competing with the Inland Empire. By businesses choosing to diversify their ports of entry, inland distribution locations located along rail lines may well see an increase in value through the natural increase in demand.

Hopefully, more news like this will help push along infrastructure spending, for example the rail line improvements to accommodate stack trains being proposed over the Sierra Nevada.

To read the article by Mr. Casey and Mr. Roth please click here.

Capital Bribery

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.

NAI Global recently offered a webinar to their affiliate offices featuring a presentation by Dr. Peter Linneman, one of the leading real estate economists in the nation. During that presentation, Dr. Linneman described the current investment situation in which investors must be “bribed” into moving out of cash and into higher returning investments. The “bribe” comes in the form of a huge required risk premium on any non-cash investment opportunity. Basically, those entities with capital available for investment are choosing between two extreme investment alternatives: (1) a 0% real-return from cash equivalent investments, or (2) a requirement of 25%+ unleveraged returns over a three to five year holding period on equity investments in commercial real estate (regardless of the asset’s risk profile, which is highly problematic in my mind).

If an investment is not priced at a level that offers an investor these types of returns, those investors are staying away in droves. Investors justify this stance by pointing to all of the uncertainties inherent in commercial real estate at this point in the cycle. The most obvious risk being continued weakness in tenant demand which could lead to prolonged vacancies and/or deterioration in market rental rates. My first response to this view is that high-quality real estate investors should be able to underwrite and more importantly mitigate the risks of reduced demand in the space markets and should be able to weed-out those assets that possess undue demand risks. Secondly, this view suggests that the investor has a negative view of the resilience of the U.S. economy and a short-term perspective on investing. In that sense, these investors should maintain their cash positions because their view of real estate is too clouded by the anomalies of the last 4 years.

Another commonly noted risk of real estate investment is the fear of continued deterioration in the capital markets resulting in a prolonged (or worse, permanent) increase in cap rates. As for the risk of prolonged softness in the capital markets, those investors would seem to poses a fairly myopic perception of the long-term value of commercial real estate. (my·o·pic \ mi-ō-pik \ adjective: “a lack of foresight or discernment : a narrow view of something.”) At some point, the supply/demand fundamentals for commercial will moderate and eventually improve. Capital markets will begin to stabilize and the required risk premium on commercial real estate will decline. At that point competition amongst investors will grow and downward pressure on cap rates will build. And some investors will still have “dry powder” but they will have missed the opportunity created by this upheaval.

Revitalized by Aces

Posted by: Scott Shanks, SIOR

Senior Vice President Office Properties Group

775 336 4671

sshanks@naialliance.com

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

It’s been a long time coming…..and now worth the wait. The Reno Aces had their season opener on April 17th and the house was packed. The reception of the new ballpark has been tremendous and the attendance thus far has proved that this type of venue was exactly what the area has had a thirst for. How will this affect the surrounding area from a commercial real estate perspective? Well…the phone is already ringing and interest is coming in from both leasing and purchasing prospects looking for office, retail and service oriented company’s. With attendance of over 9,000 per game over the opening weekend, it’s hard to ignore the excitement and visibility that will be created for surrounding properties to the ballpark and the value that will be created as a result. Look for ground up development and rehab projects in the retail sector first, with office product to follow in the future.

When to Get Back in the Game

Posted by: Chris Shanks
Investment Analyst

775 336 4620
cshanks@naialliance.com

Chris is responsible for analyzing, valuing and marketing properties for the NAI Alliance Investments Team. He is also involved in the disposition and acquisition of investment properties for clients.

Many investors across the asset spectrum have found themselves, and their money, on the sidelines of the financial game. Most of these investors currently have a healthy percentage of their wealth in cash, money market accounts, or CDs. These little to no interest earning assets, while safe, won’t provide their owners with the long term returns they should hope to realize. I can understand why many of them withdrew their money from the market, however I believe in passive management as well as the long term hold approach to assets. Trying to time the bottom, or any point in a market, is a futile affair; to use a popular term, “It is like trying to catch a fallen dagger”. No one knows when the “bottom” will be reached, but the sooner we show confidence in our economy, by getting dollars into circulation, the sooner we’ll pull out of this trough.

There are more deals now than ever in a wide variety of asset classes that present great opportunities for investors. Many high quality assets have seen their values unfairly pulled down by the declining market and economic conditions. There are those assets that are arguably performing just as well as they were two (2) or three (3) years ago as they are now. High quality real estate properties that previously would have sold at a 6.50% cap rate are now trading at least 100 – 150 basis points above that number. While these properties may not see cap rates that low for a long period of time, if ever, they are still being unfairly discounted and represent a good long term position for many investors. 2009 should at least bring more lookers into the market, there are deals out there the only matter is identifying them.

More Good News?

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.

The latest stats are out from Ticor, and I like the trend. While I’m happy to see substantial increases in new home sales and resales, further review of the data shows a consistent uptick every year at this time (call it spring fever). I believe more impressive are the number of refis, up 230% from the start of the year. What else would you expect with rates at record lows, right? Remember that interest rates have been appealing for quite some time, however, the credit has not been available. I believe this is a positive indication that the credit markets are finally easing the strangle hold on the consumer.

Apartment Tenants Choosing More than Value

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 devepment and the development of affordable housing projects.

For Owners, managers and investors are carefully watching the spring apartment lease-up. Retaining good tenants is now a top priority for every complex. Especially interesting are the properties with low vacancy at market rents, and how managers are achieving that in the current rental market. Very well located properties seem to hold occupancy consistently, even in a downturn, and senior units typically have a stable profile with increasing demand despite recent increases in supply. Another category of units able to attract and hold tenants are properties near UNR, whose total student enrollment now tops 20,000. Owners of properties under twenty units quickly move rents down to fill vacancies. But rising, double-digit vacancy now affects 70% of market-rate properties over 50 units (and 55% of market-rate properties over 80 units) as managers re-set rents and concessions to attract and retain qualified tenants. Tenants with stable employment have choices and they know it.

So who else does well in a downturn ? Often overlooked in a soft market is the economic strength and stability of the true rental community, defined as an apartment complex in which most of the tenants emotionally identify with their apartment community as a whole, not merely the single unit they live in. Investors say they can spot such properties when they find a resident manager who knows the residents by first name, where residents congregate on the property and where residents respect and look out for one another. Tenant spaces opening onto common area reflect an unusual pride of place. Residents of the true rental community see their apartment home as unique, they often stay for years and recommend the property to friends, co-workers and family.

For landlords, a true rental community is an operating gem. Turnover can decline 50% and retention rates are the highest among comparable properties. Promotional costs are reduced as residents refer new residents to fill vacant units. In good times, a waiting list is common. The owner can easily implement pro-active unit maintenance that’s welcomed by residents. Common areas typically need much less maintenance, as residents see their home as a safe and caring place, so problems are corrected quickly in a virtuous cycle of property improvement. Loss to lease expense is almost non-existent, and insuring these properties is cost effective because liability claims are few and small. The true rental community delivers stable, consistent net revenue and operating costs with few surprises. Shrewd owners will visibly improve the property continuously, and so keep rents slightly above neighboring properties because the comparative value to the tenant is an emotional intangible beyond price.

Owners of the true rental community often act as owner-managers to systematically improve their property, especially its curb appeal, amenities, security and cleanliness. Their resident managers are usually long-term employees who know the property well, select residents skillfully and are superb at really listening to tenants. Quick to act on good ideas, these managers are highly creative in promoting the community. They build good will among the residents by being positive, friendly and reliable. Both owners and managers of the true rental community excel in attracting staff for maintenance, leasing and grounds who exhibit the personality traits that residents deeply appreciate. These communities evolve from a committed owner and long-term manager, through careful resident selection and retention over years, and the result is something you can sense immediately upon entering the property.

In a downturn, the true rental community has several advantages. First, the communications between residents and management are open and frequent, so the retention conversation can occur early and comfortably. Tenants who need to double up, downsize, or blend rents to extend renewal don’t spend days getting an answer or make commitments to another property when the tenancy could have been rescued. Rather than drop the rent to meet the market on a vacant unit, the manager can blend the resident’s rate with an incentive to remain. Second, residents of the true rental community tend to be lifestyle renters with stable employment or income sources, not temporary renters in life transitions or young couples forming a first household. Such tenants tend to batten down in tough times, especially when their home is more than just a rental unit. Third, credit issues and revenue loss to lease both decline sharply in a downturn, as residents pare back non-essential spending and make sure priorities like timely rent payments are made as agreed. Fourth, the vendors who service these properties truly value the business, because the owner and manager are loyal to vendors who perform well, and both parties respond frankly to open discussions about costs and value in a downturn. Finally, these properties normally have low debt levels and manageable debt service, so basic capital expenditures and maintenance are not sacrificed to the burden of leverage.

Many properties in the Reno/Sparks region are now evolving into true rental communities, and some have long since matured into it, such as Dakota Crest, Vista Ridge and Kirman Garden. One excellent example is Water’s Edge Apartments, at 200 Booth Street, near Reno High School. Located in the premier school district of Washoe County, the property has been owner-managed for nearly twenty years. Built in 1977, the property has been continuously upgraded with modernized interiors and a common area that capitalizes on its site adjacent the Truckee River. But what can’t be easily described in facts and figures is an unmistakable quality of resident satisfaction in a true rental community.

Need: Office and Industrial Companies

Posted by: Dominic Brunetti

Vice President Office Properties
775 336 4674
dbrunetti@naialliance.com

During his career, Dominic has worked with clients such as: Centex Homes, CTX Mortgage, Landmark Homes, 1st Premiere Mortgage, AG Edwards, Alere Medical, CHSI Nevada, The CFO Group, Ameriwest Financial, North American Title, Andregg Geomatics, Manhard Consulting, HDR Engineering, State Farm, Gizmo Wireless, The Corner Doc, First American Title Company, Stewart Title Company, GI Consultants, The Hilton Foundation, Hartford, PC Doctor and more.

Last Monday, I met at the Economic Development Authorty of Western Nevada (EDAWN) to become part of an interim task force that will focus on marketing our community to California. EDAWN has done a great job over the past few years strategically marketing the benefits of the Nevada business climate and the Reno-Tahoe quality of life to Californian companies and executives. As we all discussed at the meeting, it is time to turn up the heat. Specifically for office and industrial companies, what recruiting tools would you employ?

The Fallacy of Distressed Asset Sales

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.

There is not an article on commercial real estate that does not mention the widely held belief that there is a title-wave of distressed deals that will be coming to market soon. But the price of anything is determined through the interaction of supply and demand. And this interaction cannot be avoided.

First to address the supply of distressed investments. There is absolutely no doubt in my mind that opportunities will soon emerge as the state of real estate pricing becomes obvious to owners, lenders and investors. Despite the likely growth in supply of these “distressed opportunities” I can envision a scenario where this supply is somewhat muted compared to the dire predictions of many. Banks may begin to work with owners and re-cast debt terms rather than bring the assets on to their balance sheets. Owners with additional equity who correctly have a long term view of real estate will add equity to the game in order to extend loan terms. Other owners will get in front of the situation and accept loses through a managed sale process rather than waiting until the debt maturity date. So while there is no doubt that the supply of distressed assets on the market will increase, it may not be as dramatic as some are forecasting.

Now to the more interesting side of the equation – demand. Many intelligent real estate investors have been preparing for this upcoming wave of distressed assets for some time now by disposing of weaker assets in their portfolio, lining up potential joint partnerships, retiring debt and otherwise scrubbing their balance sheets and preserving cash. These investors are waiting expectantly for the distressed deals to emerge. These groups are well-capitalized, highly-experienced investment firms with defined strategies for how they plan to execute their investment programs. Somehow, many investors with an appetite to buy distressed have the misguided and myopic perception that they are the only active buyers out there. These groups somehow fail to accept that they will have to compete with others for these opportunities. If distressed assets are priced low enough to provide a buyer with significant profit potential, then the pool of potential investors for that asset grows dramatically. A seller may very well be willing to part with an asset (or forced to sell) at a price that provides significant upside for a buyer, but if there are oversized profits to be made, there will likely be a variety of qualified and interested buyers. The winning buyer will have to be beat out these other suitors for the property. The selected buyer will have to provide an identified discretionary capital source, a strong demonstrated track record of closing deals, solid references from past sellers, and a willingness to outline the timeframe under which a sale can be completed. And if other investors are better, faster, stronger, etc., then that group is going to WIN the deal.

So yes, good deals will likely emerge. But just because a seller is “distressed” does not mean that potential buyers will not have competition. The interaction of supply and demand still exists – and there is demand for these investment opportunities.

Should Commercial Mortgage Backed Securities Be Mark-to-Market?

Posted by: Chris Shanks
Investment Analyst

775 336 4620
cshanks@naialliance.com

Chris is responsible for analyzing, valuing and marketing properties for the NAI Alliance Investments Team. He is also involved in the disposition and acquisition of investment properties for clients.

By definition a security that is mark-to-market is one that is valued continuously at a current market value. This accounting principle is what has arguably led to the downward spiral of the financial sector as well as the nationwide real estate market. Many companies who owned commercial mortgage backed securities (CMBS) have had to write down billions of dollars in assets because of the effects of subprime lending. Is it fair to value real estate the same as common stock?

Many will agree that a mark-to-market approach for real estate backed securities is not a perfect method, especially in light of what has happened in the last year. Many securities have the possibility of reaching a zero value, which is something that rarely, if ever, occurs in real estate. The main reason is that real estate has an intrinsic value; it costs money to be built, it is occupying land that is scarce, and it has the potential for future cash flows. Also, common stock trades on a daily basis in volumes that usually reaches into the hundreds of millions in transactions, a commercial real estate property may not trade hands for five years. The lack of real time data and an inherently lower standard deviation makes it difficult to truly value (CMBS) with a mark-to-market approach. I’m not naïve enough to say I have the answer and am ready to propose it, however I do think we need to take into account the nuances that separate the asset classes and devise a better method of valuation.

Don't Forget the Basics

Posted by: Scott Shanks, SIOR

Senior Vice President Office Properties Group

775 336 4671

sshanks@naialliance.com

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

In meeting with Landlords in recent months to give our marketing updates, the question that is most often asked is, “what are you doing in marketing my building that other brokers aren’t?” Immediately after that question comes the proverbial…think out of the box question. Well, the answer is we are doing both. In this day and age of high-tech computer marketing and the tools by which you can achieve marketing properties via web-based and media based vehicles, we are effectively implementing our property listings into technology based programs that effectively market our properties and get them in front of the eyes of the people that we want to attract to our listing opportunities. As effective as this may be, we also strongly believe that nothing replaces the ability to go back to the basics and simply do what is typically a tried-and-true practice of wearing out the shoe leather. Yes….cold calling. While everyone seems to be “tech savvy” these days, it seems that the younger generation of real estate sales and leasing professionals has forgotten how to simply press the flesh. In tough times, it’s even more important to have a pulse on the industry including; availabilities, rates, comps, sub-market data and who’s out simply “looking.” You will get more deals done, have a better working knowledge of the market place and impress your landlord with your blue collar work ethic in the market place by getting back to good old cold calling.

Market Timing Doesn't Work - Don't Wait

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.

When discussing current investment opportunities with investors, I have heard a lot of them say that they are expecting further deterioration in values and that they are going to wait for those opportunities to emerge. On the surface this seems logical. Why buy something today at a 10% cap rate, if you can buy a similar asset in a year for an 11% cap rate, or at a 12% cap rate in two years? Unfortunately, I think there is a bit of a flaw in this thinking.

Let’s test this strategy with a simple example. Assume that an investor has $1,000,000 and has the opportunity to buy an asset today at a 10% cap rate. Let’s further assume that the NOI grows at an average annual rate of 3.0% per year and that after 5 years the investor can sell the building for a 9.0% cap rate. Under that simple scenario, the investor would earn a 13.7% IRR. As an alternative let’s assume that same investor with $1,000,000 waits 1 year for cap rates to increase to 11.0%. In order to take advantage of that deal when it arises, the investors will have to put his or her money in a low yielding liquid account like a CD which is earning less than 2%. Under that acquisition scenario and assuming the same growth rate and exit cap rate assumptions the investor would earn an IRR of 14.1%. This is not a huge premium over the return that an investor could earn today without taking the risk that these future opportunities emerge. If you extend the waiting period out 2 years and assume that cap rates move to 12% (a 20% decline in values) the investor would earn the very same IRR as in the base case . . . 13.7%.

And what if the expectations for further declines prove false? Let’s say you wait 2 years and cap rates are still 10%. Under that scenario your IRR would be 9.5%.

The point is, you can wait and wait for the exact right deal, but there is no surety that that deal will in fact come along. And as you wait, your holding period return is being weighed down by the fact that in order to take advantage of those future deals, you’ll be earning a near 0% real return as the cost of liquidity. Be confident in your underwriting, capitalize the deal correctly, manage the hell out of the building and be confident that in five years, the world will be getting back to normal. I know that it is tough to have a long-term view in this very difficult climate, but don’t get so mired in the expectation of further value declines that you lose site of the goal of earning the highest total return you can given your current investment time horizon.

A Modest Suggestion to Landlords

Posted by: Chris Shanks
Investment Analyst

775 336 4620
cshanks@naialliance.com

Chris is responsible for analyzing, valuing and marketing properties for the NAI Alliance Investments Team. He is also involved in the disposition and acquisition of investment properties for clients.

In these difficult times it is important to realize that everyone is feeling the financial burden of the real estate market crunch. Many tenants are being forced out of their space because their reserves and revenues aren’t large enough to pay for their in place leases. As a landlord you should make it as affordable as possible to keep these companies in your building. Many of them will bounce back with the economy and will once again be able to pay a market rental rate. The reason I stress the importance of tenant securitization, is that the lease-up period for vacant space is getting longer and longer. If you, as an owner, need to sell your building within the next few years you are going to be much better off having a building that has tenants, even if lease rates are below “market”, rather than one with vacancy. It was said two years ago, that buildings were worth more vacant than occupied due to the wild speculation of lease up assumptions that were ever present in those times. In today’s market one could argue the exact opposite; buyer confidence has reached such a low point that almost any vacancy is causing them to unfairly discount high quality real estate assets. This causes me to stress again the importance of keeping warm bodies in your buildings. Even if tenants are merely covering operating expenses and debt service, it is a better alternative than foreclosure. Also, having tenants in your building will suppress some of the conservatism of buyer’s lease up assumptions. Higher occupancy will equate to a fairer sales price.

Posted by: Dominic Brunetti

Vice President Office Properties
775 336 4674
dbrunetti@naialliance.com

During his career, Dominic has worked with clients such as: Centex Homes, CTX Mortgage, Landmark Homes, 1st Premiere Mortgage, AG Edwards, Alere Medical, CHSI Nevada, The CFO Group, Ameriwest Financial, North American Title, Andregg Geomatics, Manhard Consulting, HDR Engineering, State Farm, Gizmo Wireless, The Corner Doc, First American Title Company, Stewart Title Company, GI Consultants, The Hilton Foundation, Hartford, PC Doctor and more.

As a Tenant, are you worried about being offensive in asking for lease rate reductions, tenant improvement allowances or other concessions? An interesting dichotomy has arisen amongst the Tenant – Landlord relationship within the Northern Nevada office market. No, I am not speaking about the lease rate bid-ask spread dilemma. Although it may stem from this topic, the differing opinions of spiraling lease rates is a statistical conversation we can save for another time. I’m talking about the emotional fortitude it takes as a Tenant to address a current or potential Landlord with an offer that reflects the current state of the office market; economic terms reflective of a decade ago. As commercial real estate leasing specialists, we focus on preserving the Tenant – Landlord relationship while providing market knowledge based on factual data. Have you recently or are you planning on confronting a landlord, yet unsure about what strategy to employ? We want to hear your concerns and your ideas.

Vulture Investors

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 fact that the volume of commercial real estate transactions fell tremendously in the second half of 2008, there is still a fairly large number of real estate investors in the market looking for opportunities. That’s the good news for sellers. The bad news is that most of these investors fall into the category of “opportunistic” or “vulture” investors. These types of investors have very high return requirements which force them into being extremely conservative in their underwriting and offer what on the surface are very low prices for real estate.

A few weeks back I was having a conversation with a local commercial real estate investor. During our discussion he asked, “How can you make money in commercial real estate these days?” I responded to that inquiry with a question of my own, “How do you define ‘making money’?” My response was not intended to be flippant. Rather it was to suggest that from a long-run historical perspective the expectation for “making money” in real estate has been much more modest than the expectations of today. The return expectations of today are being overly influenced by the excess returns earned a few years ago during the run-up in values, and by the expectation of financial duress, which is not always the reality.

During the period of cap rate compression which ran from 2004 to mid-2007, considerable wealth was created. Many investors realized significant gains in the value of their real estate holdings during that period. The really smart investors (or lucky, depending upon your view) were able to realize those gains by selling their assets prior to 2007. Some investors mistakenly view the returns generated during that period as normal, and are now expecting to replicate and exceed such returns on new investments. The primary problem I have with this viewpoint is in thinking that those gains are “normal” and replicable on a go-forward basis.

I fully admit that the risk of real estate ownership has increased as a result of the current global recession. Finance theory would suggest that this increased risk should result in increased returns (i.e. a “risk premium”). The question becomes, “Should this new ‘risk premium’ be added to the excess returns earned during the run-up in values in the middle part of this decade or should it add to a more normalized average return? Further, what is the average return that investors should expect when investing in real estate.

Rather than state an unsupported opinion, I thought I would try to provide a factual context to the question of what is a “normal” real estate return. The National Council of Real Estate Investment Fiduciaries (NCREIF) produces an index of commercial real estate returns. This index measures both the income and appreciation of commercial real estate values based on reported returns from assets around the country. From 1978 to 2008 the average annual return on the index was 10.2%. If we assume that the income component of this return was 8.0% that would mean that the appreciation component was roughly 2.0%. This time period includes the severe real estate recession of the early 1990’s as well as the sharp run-up in values from 2004 to 2007. During this four year run-up the average returns were 16.7% or 650 basis points above the long-run average. I would suggest that investors should look to the long-run average return as their benchmark, not the excess returns enjoyed during a period of aberration in the commercial real estate market. I would suggest that investors looking for 25%, 35% or even 45% returns need to remind themselves of what is a “normal” real estate return objective.

During another conversation with a group that I would characterize as “vulture” investors, we started discussing some of the various assumptions in the underwriting equation for a project (i.e. Market Rent, Downtime, Absorption Periods, etc). This “vulture investor” took every market assumption that was suggested and then discounted it by 10%. By doing so, this investor effectively eliminated the risk of achieving each of these assumptions. This concept is fine if the investor then solves for the purchase price using a reasonable stabilized real estate return objective (cap rate, discount rate, etc.), but instead this investor solved for the price using an extremely high rate of return. I would characterize this as wanting their cake and eating it too. If all of the risk of a deal is effectively eliminated by applying highly conservative assumptions, why should that investor also earn an inflated return? I would suggest if you are not willing to take on normal real estate risk, maybe you should be putting your money in 5-year Treasuries and earning 1.93%.

The decline in transaction volume in 2008 is an indicator that the Buyer’s pricing model has diverged from that of the Sellers. Based on Washoe County Assessor’s office data, the number of commercial sales (non-residential sales greater than $1,000,000) declined from 255 in 2007 to 132 in 2008. The average price of those sales declined from $11,912,908 in 2007 to $6,211,398 last year. This drop-off is symptomatic of the divergence in valuation between Buyers and Sellers.

So who is right? As with many things, I think the answer is that they both are. There will likely be deals that get done over the next 12 to 18 months at what I would describe as “vulture pricing”. These deals will be driven by the lenders (banks, life companies, etc), not the equity stakeholders. There will also be deals that get done at what I would consider more stabilized pricing. These deals will be driven by real estate investors with a reasonable perspective as to the long-run average returns to be expected in real estate and sellers that can disregard the pricing aberration that existed just a few short years ago. In the meantime, both Buyers and Sellers should not be offended that the other has a different view as to the value of real estate in this market.

The Reno/Sparks Retail Market – Dealing with an Industry in Transition

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..

As we enter 2009, the one good thing we can say is, at least 2008 is over! If you are a retail tenant and survived 2008, congratulations. You’ve made it through one of the toughest years in recent history. Not everyone has been so fortunate. It’s been well publicized that a number of national retailers have gone out of business. The road is littered by the likes of Linen’s and Things, Mervyn’s, Shoe Pavilion, Comp USA, and Circuit City. More recently, Gottschalk’s filed for bankruptcy and I’m sure as the year progresses, more may join this unfortunate group.

In the Reno Sparks Market, we have been hit with the closure of all of the tenants mentioned above, not to mention the numerous local shops that have closed. We had a very interesting occurrence last year in that the area’s Gross Absorption, which is a measure of the total number of deals that occurred, was tied for second highest in more than 18 years of our keeping record. In fact, there was 947,000 square feet of new occupied space last year. Now the interesting part: Net Absorption, which is the square footage of all new deals minus the square footage of spaces being vacated, was actually a negative 11,000 square feet. We actually had a net loss in retail square footage occupied during the year. This is the time Net Absorption has been negative since we’ve tracked the market starting in 1990.

Included in the square footage of new deals in the area is the new Scheel’s Sporting Goods and Target, both of which opened in the Legends at Sparks Marina. These two stores accounted for over 400,000 square feet of the 947,000 that was completed. Just think how bad the numbers would have looked like if these two stores hadn’t opened.

The overall vacancy ended the year at just over 13%, anchor vacancy was 10.6% and line-shop vacancy was 16.8%. So how do these numbers compare to previous years? Well, this is the highest overall and anchor vacancy rates our area has had in over 18 years (since we have been tracking the market). The good news is that the line-shop vacancy hasn’t hit the high watermark, at least not yet. The illustrious year to hold that record was in 1990, after years of overbuilding in the late 80’s, coupled with the savings and loan crisis and a national recession.

The pundits tell us we entered this recession in December of 2007. At that time, we had relatively healthy vacancy numbers. During the good years, developers didn’t overbuild the market with unoccupied shopping centers like they did in the late 80’s. What they were doing was building as many shopping centers as retailers wanted to occupy. If there was excess in this last bubble, it was with the retailers who kept increasing their store count by 6-12% each year to prove to Wall Street that they were “growth companies”.

In analyzing the past, we see there were cracks that started to show in 2007-2008. Wall Street analysts started telling retailers they were not seeing increased return in net profit that was expected with the new stores. Some of the biggest names across the nation including Wal-Mart and McDonald’s gave notice they were trimming their capital budgets for future store growth, at least in the domestic market. Looking back, I think these signals were some of the first signs that something was afoot. The old ways of doing business for these retailers was not working any longer.

These warnings correspond with the beginnings of the residential downturn. What started slowly in the “Alt-A” housing market has culminated in a torrent of foreclosures. Consumers have been swamped with bad news on their housing values, stock market portfolio’s and even the future of their jobs. Of course the consumers cut their spending. Any rational consumer would look for ways to insulate themselves from this constant barrage of bad news. This translated into some of the most dramatic cutbacks in consumer spending in recent history. In Washoe County, the taxable sales for October 2008 were 13.9% lower than the previous year. Although statistics for November through December have not been released, it is expected that those figures will show a continuation of the dramatic decline in sales tax revenue. The same thing is happening across the nation, to a greater or lesser degree depending on the local economy. When it comes to retailers, some of the retailers who were already precarious as they entered this recession have been taken under, which gets us back full circle to the vacancies.

We have 1.6 million square feet of vacant space in the Reno/Sparks market. We expected this figure to climb during the first half of the year and perhaps longer. No doubt, it will take us quite some time to work our way out of the excesses of the past. The most challenging part is that there will be fewer retailers left to fill in the gaps. However, the strong retailers will survive and even thrive in a less cluttered field. New retailers will eventually emerge to satisfy new consumer demand, which will no doubt re-emerge. There is a good case to be made that there could be a snap back at some point as consumers realize they need to replace their cars, washing machines, computers and a myriad of other items they have become accustomed to having. The consumer has been knocked down and trampled on, but they will recover.

We are already 14 months into this recession, while most recessions have lasted no more that 16 months. I think we are in for a longer downturn than most of the previous cases, but my hope is that we are closer to the end than might be apparent from what we can see right now. If a floor in the housing collapse can be found and job losses subside, it will give consumers a chance to catch their breaths. The consumer will no doubt recover with time, but their future spending may stabilize at a more conservative level than during the years of excess.

Speculative Industrial Construction Unlikely in 2009

Posted by: Carl Zmaila
Industrial Specialist
775 336 4623

czmaila@naialliance.com

All is not bad in the northern Nevada industrial market. The fundamentals for distribution and warehousing space to serve the eleven western states are strong.

One article in particular highlights this very subject. Rob Sabo, a journalist from the Northern Nevada Business Weekly, wrote “Speculative Industrial Development Unlikely this Year.” Mr. Sabo spoke with local experts about the northern Nevada industrial market and received a clear message. We are down, but not out.

Mike Hoeck, Senior Vice President at NAI Alliance pointed out in the article that people are looking but it is a lot of tire-kicking. Basically, interest in distribution and warehousing remains but everyone has been taken back by the aggressive deterioration in the national and global economy.

People are having a hard time finding rational arguments for predicating future revenue. Therefore the northern Nevada industrial market is experiencing a deer in the headlights effect. People know a good deal is out there but without solid predictors for their company on the macro scale they are frozen. But, experts in the northern Nevada industrial market believe that as the economy unthaws this industrial market in particular is well poised to bounce back quickly.

All predictions point to a strong 3rd an 4th quarter for the northern Nevada industrial market; relative to the position of the national and global economy of course. To read the entire NNBW article by Rob Sabo please click on this link Northern Nevada Business Weekly.

In Recession, the Smartest Owners are Renovating

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.

For apartment owners trying to manage in a recession, the textbook approach is to cut costs, retain tenants, refinance debt and dump under-prforming assets if necessary. In the current recession, widespread job loss means that vacancy in some submarkets is threatening to destabilize operating performance for some owners. The reaction has been to hoard cash and line up small capital loans to make it through.

The smart operators are also looking ahead and planning or executing strategic renovation. What's crucial to understand is how those operators define a 'renovation. ' It is not a capital expenditure to reduce operating costs, although such investments might be prudent if the reduction pays for the investment within two years. Ideally, the owner has already put such economies in place during the fat years when refinancing cash was readily available.

Likewise, renovation is not the replacement of building systems, structural components or new construction which preserves asset value, extends the useful life of the physical plant, increases ad valorem tax cost and disrupts the residents-- these steps will be deferred until borrowing is readily available to finance the work, a new owner steps in, or a casualty occurs for which substantial insuirance proceeds can be used for the purpose.

The renovation which owners have in mind is what will garner an immediate increase in monthly rent. In recent years, the median renovation for Washoe County was less than $ 5,000 per unit, bringing in a median rent increase of $ 85 per month and had a pack-back averaging 4.5 years. Assuming that 85% of the rent increase showed up in the bottom line, net operating income increased 9% on average, with building value climbing $11,000 per unit at an imputed 8 cap. Return on renovation investment approximated 45 % if the asset were sold and had a payback of 4.7 years.

Admittedly, some owners who want to renovate are skeptical they can increase rents anytime soon and have work planned but want to feel the bottom of the soft rental market first. Others lack the cash, and still others are hoarding cash against the worst case of operating performance. But three of the five conditions for the timng of optimal renovations are here: (i) units are readily available for renovation; (ii) labor is patient, flexible and hungry; and (iii) material costs are flat or falling, with trade vendors willing to deal. Seldom have renovations been cheaper or faster to install than now. And tenants, who have choices, are value-conscious.

The smart operator is working through the following process:

• What's my serious competition and how do my units stack up ?
• What work should I do to avoid functional obsolescence ?
• Realistically, what amenities or improvements does the location justify ?
• What improvements are most prized by the tenants I really want to retain ?
• What can be done to continuously improve the curb appeal of my units ?
  
  

One highly sophisticated apartment owner we work with uses a clever technique to lock in the benefit of a renovation. Systematically, he asks the best residents, "We're going to raise rent for your unit by $100, and we want to know what improvements you would like us to consider that would make the extra rent worthwhile." And then , he follows through. It's the best mix of resident relations and value-add you could imagine.

As a broker, when I raise the issue of renovations with owners, I like to ask if the owner would spend $ 225,000 to acquire units worth $ 500,0000. Not one would turn down that opportunity. A skillful renovation delivers that level of return, without transaction cost, legal expense, financing risk or substantial delay..

Calling all Vulture Funds: A discussion on the current land market...

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.

What is a good deal in today’s market? While we continue to see opportunities at “distressed” pricing, what exactly does that mean? Real estate doctrine concludes market value is a function of willing seller – willing buyer. In the current market dynamic the willing buyer has been replaced with the “opportunity buyer” (a.k.a. vulture) and while willing sellers exist, the current market is providing a multitude of financially insolvent people or projects that require disposal on someone else’s terms (not willing). The downward pressure on pricing, forced by the financial woes of some, is affecting the value for all. Therefore, can the deals being done in today’s dollars be considered distressed, or rather, should we consider them an indication of market adjustment and appropriately refer to them as today’s value?

The reality is that distressed assets make up a small portion of the total inventory and there are many more factors in determining market value. Just as sales of foreclosed homes are putting downward pressure on median home price thus effecting residential land values, increases in commercial sector vacancy and sublease availability are driving down rents and negatively effecting asset values. Couple that with the underwriting criteria and return expectations of today’s buyer and it becomes a game of “how low can we go”.

For example, a quick review of Q3 2007 commercial land activity shows 16 transactions totaling 403 acres at an average of $201, 609 per acre. Compare that to closings in Q3 2008 (Xanax please) adding up to a paltry 3 for a measly 13 acres at a dismal $92,291.

Since no one is willing to stake their reputation on whether we’ve actually hit the bottom of the current market decline, when is the right time to buy? The reality is that the bottom is not realized until we’ve passed it and are headed back up. For this reason, purchases should not be timed on corresponding to a perceived bottom but rather a fair and objective evaluation of the opportunity in current terms and expectations.

The current market conditions have led to an explosion of private equity opportunity funds creating intense competition. This leads us back to the situation of willing buyer and not so willing seller. Most of the perceived deals currently in the market involve a lender. Therein lies the problem, between loan officers transitioning to asset managers and the fear of a surprise knock on the door by the FDIC, the industry is in flux (understatement). Further complicated by the federal bail out discussions, banks can’t decide what to discount, how much to discount and when to get it off the books.

This uncertainty is leading to a new trend in lender-involved opportunities through loan acquisition. The assumption is that lenders would rather unload the nonperforming loan (at a steep discount) rather than go through the foreclosure process. Once the note is secured, the investor (new lender) then obtains the property through foreclosure while removing any secondary debt and equity on the part of the owner. As it relates to declining land values, this process helps adjacent properties by not actually proving a comparable sale.

Where does this leave us with respect to quantifying market adjustments and current land values? It is nearly impossible to quantify the actual market adjustment in terms of percentage decline per industry sector, however, I offer the following observations: Based on transaction volume, buyers appear optimistic with residential land adjustments while commercial land transactions have slowed considerably as vacancies continue to rise; The rural communities are taking a beating with affordable options returning to the metro area; Land values have become very specific to submarket offerings and activities.

Some would relate the recent land value roller coaster to the stock market (ironic that both are causing such despair); however, I would submit that having a tangible asset in today’s market provides a certain sense of security.

This article was printed in the December 17, 2008 issue of the Nevada Red Report and can be found online at www.theredreport.com.