The Tesla effect on the investment market in the region

tfennell By Tom Fennell The national and regional news of Telsa and other viable companies relocating to the area is creating an interesting market dynamic for commercial investment property in northern Nevada. Prior to the Tesla announcement and during the throes of a nasty recession, we saw discounted pricing and higher capitalization rates than we are seeing today. Is this created by the Tesla affect, a healthy economy, or a combination of both? During the recession, Reno and other tertiary markets similar to our demographic were viewed as risky markets to invest in real estate in comparison to major markets. As is typical during economic recovery, the major metropolitan areas around the country were the first markets to see recovery in leasing, development, and investment activity. Nationwide investment volume was up almost 40 percent in the first quarter of 2015. But as the national economy has come back, the ability to achieve desired returns has gotten more competitive in major metropolitan areas, and real estate prices have increased dramatically. This has caused national or regional developers, investors, and landlords to look at smaller markets for higher yield opportunities. Another factor in the increased investment demand has been historically low interest rates for an extended period of time. The Fed has maintained a stance of keeping interest rates low, which helps investors and users of commercial real estate leverage to a higher price point in their search for their real estate purchases as a result of lower borrowing costs. Analyst have kept saying interest rates are going to go up for years, however after the latest Federal Reserve meeting, the Fed said they may not have any increases until December, and even then a potential increase will be incremental. Combining the Tesla announcement with up-tick in our local economy, and we now have serious interest on investment demand. Apartments and Industrial Investment in commercial real estate was certainly not at a standstill during the recession in northern Nevada. There were active investors in our market that were able to acquire assets well below replacement value. The most sought after asset classes for investment in our region have been apartments and industrial. Those two sectors were the better performers during the recession as compared to office, retail, and land. Apartments and industrial have long had the lowest vacancies in our area and have been the first assets to see cap rates compressing. Apartments have also had the most flexible lending terms as banking institutions saw the multifamily market as one of the safest. This ties back into low borrowing costs, and has added to the competition of the apartment market. Low interest rates, more favorable terms from banks as compared with other sectors, and good indicators (low vacancy, high demand) has brought a highly competitive mentality into our apartment market as compared with some of the other asset classes. Can apartments in our market still be a good investment? Absolutely! But finding quality product and desired yields is, and will continue to be, very challenging. Industrial is seeing some of the same trends with institutional buyers completing large transactions in the market. Another factor in our industrial market is that the majority of market is controlled by institutional owners that have a tendency to pursue large dispositions, so the number of true investment transactions for one off product can be limited. In comparison, apartment transactions involve more regional and local owner/operators. Office and Retail The cap rate compression we are seeing in the apartment and industrial markets has caused investors to consider other asset classes such as office and retail. Demand for investment deals is also causes investors looking for quality, low risk deals to adjust their expectations of returns, furthering interest into other areas. As prices go up, yields go down, and product is limited in traditionally sought after assets classes and areas, investors are increasingly looking more at value add scenarios than in previous years in our region, which is driving renewed interest in the office and retail markets. According to the 2015 Pension Real Estate Association Investment Survey, 77 percent of investors who responded said they expect to buy value add investments in the U.S. this year. What is the downside in all of this investment demand and growth? Due to reported increases in future job growth and the “Tesla effect,” owners have a perceived value in their real estate holdings that is far exceeding normal valuations. Rental rates are a key component in valuing and underwriting commercial real estate, and we haven’t seen the economics of our commercial rents change enough to warrant the inflated expectations of value. From an investor standpoint, if you are buying an asset at a low cap rate, and you don’t achieve the rent growth you are projecting, the results can be punitive. Financial underwriting adds to the investment stress with difficult terms and problematic appraisals not matching up with anticipated property values. We certainly have seen speculation in real property increase, and out of the area investors are now looking at northern Nevada as a viable region to place capital. However, the perceived rent growth, job growth and property economics have not yet changed to warrant some of the asking prices that we are now seeing in the marketplace. Though there is still plenty of product and repositioning in the market, realistic growth and value expectations will be the key in successfully disposing and/or acquiring an investment property. Over the next several years, we anticipate that the abundance of job creation will significantly impact to our area, which will fuel new development in all real estate classes.  ]]>

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