Federal Income Taxes

As you are no doubt aware, the tax cuts that were put in place early last decade are set to expire at the end of this year. Among other things, the tax cuts brought the tax on longterm capital gains down to 15%. Without an extension, rates would revert back to 20%. However, there had even been discussion about moving that rate even higher.

This was one of the big issues leading up to the election. Prior to the election Congress and the Administration looked poised to let the cuts expire or at least limit the extension of the cuts to certain income brackets.

With the election results in, it is anyone’s bet what will happen. Keep a close eye on this issue. If the lame duck Congress does not act before the next Congress is sworn in, it will take a bill with retroactive application to ensure the cuts remain without a break. With a divided Congress that will not be an easy task.

Commercial Condos

No where in the market are properties flying off the shelf, but one area that has expanded appeal is the commercial condo market. We continue to see interest from buyers in owning their own spaces. With many properties too large for most small businesses in town to buy, the idea of breaking space down through the condo process has opened more opportunity for buyers and sellers alike.

The sellers get an expanded market, with larger and smaller scale buyers looking at the properties. As a bonus, a condo project gives the owner an incremental exit strategy. Often times we find sellers are caught between wanting to hold and wanting to sell. Owning a large project makes it an all or none proposition when considering a sale. Having condo units means an owner can sell portions over time.

The buyers get the opportunity to own a space that is a comfortable size for their operations. And with the owner-occupied loan programs mentioned above, the chances for commercial loan approval are greatly enhanced.

Converting an existing property to condos is not always the right thing to do. Market and legal conditions may suggest a different approach, but an owner considering this strategy will find the process relatively easy. If you are interested in discussing this approach, we’d be happy to talk over the pros and cons.

Banks Are Getting Healthier

The credit markets are healing themselves too. The banks with troubled assets are starting to move them off there books. As earnings stabilize and replenish the losses from real estate losses, capital levels are returning to levels that will allow more lending on real estate projects.

The most troubled banks are still being closed - expect still more banks in Washington to be shut down. While this weighs on the market in the short term, ultimately it is necessary for a healthy return to more sustainable times in the long run.

This process will take many months, if not years, to completely run its course. However, the local community banks and many of the national banks tell us they have money to lend on the right projects backed by the right borrower. This means skin in the game and projects that are priced right. Gone are the days with no money down and betting on the come. Bankers want to see real security in real estate deals. For those projects that can demonstrate it, we are seeing money readily available to borrow.

The most attractive projects for lenders continue to be the owner-occupied deals. Not only are these consider lower risk of default, they also are eligible for government loan programs that further mitigate a bank’s risk.

Programs like the Small Business Administration loans and USDA loan guarantees have been used extensively in our marketplace over the last 12 months on commercial real estate projects. We have reported on these programs in the past, but suffice it to say if you are in the market it is worth speaking with your lender about how these programs might work for your project.

Movement Starting to Happen Again

This year may mark the first time that fourth quarter market activity is higher than spring and summer quarters. We are seeing market activity pick up ever so slightly. Many properties across most product lines, including office, industrial, retail, and multi-family, are starting to get some activity again. The common factor of success today is price.

Any experienced retailer will tell you that when supply is high and demand is soft it is time for a sale. Because retailers control so much inventory they can quickly adjust to current market conditions to move inventory off their shelves.

Real estate too must yield to supply demand shifts and the attendant impact on prices. The biggest difference is how quickly the market reacts.

For the most part, one piece of inventory is controlled by one owner. With so many people controlling price adjustments the real estate market is, not surprisingly, slower to adjust. It is not unusual to see a year or two gap between a drop in demand and then the corresponding drop in prices.

Consider the California real estate market, one of the hardest hit in the country over the last five years. (See Chart 1) The median sales price in the state did not drop until two years after the number of sales plummeted. Once prices dropped buyers started to come back to the market.

Click image to enlarge

Locally, we are seeing tenants and buyers start to take note of the price adjustments made on many properties. While demand slackened a great deal over the past two years, supply has ballooned. It is hard to remember a time with more product on the market.

Sellers and Landlords looking to move product today are now starting to adjust prices that reflect today’s economic realities. For the buyer’s and tenant’s part, good business people know that the down cycle is the time to invest. This is creating more activity than we’ve seen in the past 18 months.

When leasing, landlords are smartly looking at opportunities to help cash flow and bridge to better economic times. This means that lease terms might be shorter or other creative structures are negotiated to create win-win relationships over the longer term. For example, there may be lower rent offered in the near term with flexible rent steps in future years that can return rents to higher levels when market conditions shift.

This renewed activity is still not at a pace that suggests we are through the woods, but it is progress. The market may be further challenged as the state legislature grapples with the growing budget deficit. Until the private sector is in a more palpable expansion mode, prices must continue to be sharp to get the attention of today’s buyers and tenants.

Local Economy Improving

Thurston County is showing some signs of economic recovery according to the local Economic Development Council. The article below is from Tuesday’s Business Examiner and it discusses the EDC’s latest economic survey. While we are not out of the woods yet, many segments are showing positive signs. Still, the best moving commercial real estate is still priced with the current market conditions in mind. Those owners and sellers who price competitively are seeing activity. Those who are priced with assumptions of more favorable economic conditions than actually exist are seeing very little activity.


Thurston consumers, businesses confident in economy

Thurston County's economy has turned the corner and is in a growth stage, according to the findings of the Economic Development Council's first quarter Economic Vitality Index.


The Thurston County Consumer Confidence Index now stands at 102, which is its highest value since its inception in the first quarter of 2008. The Present Situation Index, which reflects households' current perceptions about the economy, improved from 26 during the fourth quarter of 2009 to 55 in the first quarter of 2010.


The Expectations Index, which reflects where households think the local economy is headed in six months time, also improved, rising from 145 during the fourth quarter of 2009 to its current value of 167.

Local businesses, both large and small, also are expressing a degree of optimism about both current and future conditions.

The CEO Index has continued to improve since the second quarter of 2009. The fourth quarter of 2009 was the first time since the survey's inception that there were more positive responses to the questions than negative ones, represented with an index value of 53. The first quarter of this year resulted in a further increase in the value to 56.

When asked about six months into the future, 59 percent of the CEOs felt that things would be the "same" for the local economy, while 41 percent felt that conditions would be "moderately better." None felt the situation would get worse.

The Small Business Index shows a slight percentage of small business owners believe that conditions overall, and for their particular industries, are "substantially better." The largest response rate for all questions was "moderately better." From the Business Examiner, June 8, 2010.

SBA recovery lending extended through May

Two of the U.S. Small Business Administration's key small business loan programs have received $80 million in additional funding from Congress.

The enhancements, first made available under the American Recovery and Reinvestment Act, include a higher guarantee on some SBA-backed loans and small business fee relief.

The SBA estimates the money will support about $2.8 billion in small business lending under the 7(a) and 504 programs.

Under the extension, SBA may continue to reduce loan fees and provide higher guarantee levels on 7(a) loans through May 2010, or until the funds provided under the bill are exhausted.

This extension has no effect on the continued availability of financing under other Recovery Act programs, including SBA's America's Recovery Capital (ARC) loan program and the agency's Microloan program. Recovery Act funding still remains available for both of those programs.

Retailers Looking to Olympia's Westside

Commercial markets continue to correct locally and nationally. Retail has been one of the harder hit segments. However here are a couple of bright spots on the local retail front.

http://www.theolympian.com/2010/02/19/1143591/discount-clothier-to-open-shop.html

http://www.theolympian.com/2010/02/18/1142121/mall-finds-long-term-tenant.html

Market Shaping News in 2010

There are a number of projects to keep an eye on in 2010. This year, downtown Olympia will see real progress at the port property. Last year, work began in earnest on platting the acreage on East Bay. Infrastructure is being put in place to support a mixed use development on 13.3 acres.

Anchored by a new Hands On Children’s Museum, which will start construction mid-year, the plans for the port property include a hotel, shops, office space and residential condos. Other communities that have sited at Children’s Museum in downtown have watched a huge positive transformation take place.

Also, LOTT will be completing its new administration building on the adjacent property. This LEED certified building will also feature a cogeneration plant that will convert methane gas to power to heat and cool the building and the neighboring Hands On Museum. LOTT is also planning a fantastic interpretive center to showcase the process of making Class A reclaimed water. The combination of that facility and the Children’s Museum will be a huge draw for tourism, which will in turn be a huge shot in the arm for downtown Olympia.

At the south end of the County, keep an eye on Grand Mound. The tremendous success of the Great Wolf Lodge will propel the need for additional services in that area. The Planning Commission is already working on zoning changes to ensure smart land use decisions and growth in that region.

Opportunities for Owner-Occupied Buyers

It is no surprise to anyone that demand in all segments has been hampered in this economy. There is significantly less capacity in the credit markets, so the growing supply of properties on the market cannot be easily absorbed.

At the same time, this supply-demand picture presented some great opportunity for buyers to find properties at levels of affordability not seen in a long time. So with banks strapped for lending capacity, how was the typical buyer able to capitalize on this market?

The answer for many clients in 2009 came through a combination of the structure of the property for sale, and government guarantee loans.

One successful sales strategy for sellers of larger multi-tenant buildings has been to convert the building to commercial condos. Restructuring the building as condos has done a couple of things for these sellers. First, it provides an incremental exit strategy for those owners who don’t want or need to sell the entire building.

Second, it greatly expands the market of potential buyers. This area’s economy is centered on a lot of small businesses. Many of these business owners would like to own their own space but find a limited supply of buildings small enough to fit their needs.

At the same time many lenders in the region are challenged with too much real estate in their lending portfolios. As they look to reduce exposure in this area, they become selective in the types of real estate loans being made.

As a general proposition, lending on properties held for investment is less available than loans for owner-occupants. Lenders have more capacity to loan on owner-occupied space than property held for speculative investment because it is seen as less risky. So a building that has condos for sale will be able to pull in interest from these types of borrowers.

Owner-occupied lending can also be coupled with a government loan guarantee, which is the second factor helping move this area of the market.

We saw a great many loans processed for owner-occupied buyers using guarantees from the Small Business Administration (SBA) and Department of Agriculture (USDA). Area lenders work with these government agencies to help reduce the bank’s exposure while providing the source of money to allow commerce to keep churning.

We reported throughout last year that these programs have some nice features for small business owners, such as lower down payments and the ability to wrap in costs for renovations, machinery and equipment. In a time where businesses want to preserve cash reserves, those were huge selling points to our many clients who put the loan program to work.

If you or someone you know wants to explore wealth creation by owning a building, give us a call. We’d be happy to put you with some great lenders who can show you how attainable that goal might be.

Commercial Market News

As we start 2010, we reflect on the challenges and opportunities that exist in our marketplace. Under any type of market condition it is necessary to adapt to the current and impending challenges to find creative solutions. In so doing, buyers and sellers, landlords and tenants can find opportunity. During the past year, and throughout this year, we take great pride in helping our clients do just that.

The economic conditions at the beginning of last year were certainly reflected in the local commercial real estate market. After an abnormally high run-up in prices during the seller’s market from 2003-2006 market balance continued shifting back in 2009. Vacancy rates in most property types were up, while lease rates were down. This brought prices and yields back in line with historical levels of price gains.

During the seller’s market, the biggest driver of value – location - flattened in importance. During this market, location has become a big factor again. While no property was immune from the downturn, properties with the best locations faired far better than those in less desirable locations.

2009 continued to see tenants looking to shave occupancy costs. Rates in vacant spaces around the county offered tenants a chance to get into space at a rate manageable in this economy. And proactive property owners, looking to lock-in tenants to fill negative-cash-flow, empty space, were offering attractive rates. However, we advised owners to stay shorter on lease term, so as not be locked on below market rates when the market swings up again.

Even as the economy is starting to improve, after two quarters of positive GDP growth and stronger corporate earnings, we are still seeing the need to stay competitive on pricing. Until more of the inventory is absorbed, there remains a supply-demand imbalance that will keep a lid on appreciation for much of the year. However, we are starting to see renewed interest among tenants and buyers for well-priced properties as they recognize the opportunities that exist in today’s market.