January 1, 2008

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Real Estate Outlook

Experts Bullish on 2008 Market

Marie Mischel

January 1, 2008

All sectors of the real estate market in the Beehive State raged through the record books during the past two years, but the skyrocketing appreciation, climbing lease rates and near-zero vacancy will ease in 2008, according to Utah’s leading real estate experts. Nevertheless, they predict a healthy market for this year, citing low interest rates and the state’s strong economy as primary reasons for their optimism. Even the tighter lending standards, which have severely affected some areas of the country, have only slightly deflated their enthusiasm. “We have everything we can possibly have going for us,” says Max Thompson, president and COO of Coldwell Banker. “When you look at interest rates, they’re at a 45-year low. We have infrastructure and economic growth along the Wasatch Front like we have never had before. We have growth in wages, we have growth in jobs, we no longer export our young [workforce]…There isn’t any facet you can look at that isn’t good and positive and healthy.” The national hubbub over the sub-prime lending practices that have led to numerous foreclosures in certain markets caused local buyers to be skittish, Thompson says, but “in Utah we experienced very little impact with sub-prime. I estimate somewhere between 2 [percent] to no more than 4 percent of the marketplace was involved in sub-prime in Utah. And that’s not the case across the country.” Utah’s real estate problem, says Kelly Matthews, executive vice president and economist for Wells Fargo & Co., is affordability, specifically housing prices, because the cost of homes has outstripped an individual’s income. The average sales price of homes increased by 20 percent, yet hourly wage rates rose only 5.5 percent, he says. The market is already adjusting to this discrepancy, he says. The number of new housing permits from September 2006 to September 2007 dropped 52 percent. “The sharply reduced volume of new single-family permits [indicates] a significant reduction in sales” in Salt Lake, Davis and Utah counties, Matthews says. Despite the reduction in supply, existing homes continue to appreciate in value, 20 percent along the Wasatch Front and 30 percent in the St. George area, he says. Overall, “we still look pretty good compared to five years ago,” he says. “To some degree, we simply need to unwind the excess demand created, and the unsustainable prices of the last three to four years.” Matthews foresees the 2008 market remaining sluggish, with the number of home sales dropping about 35 percent and even the price of homes decreasing by 7 percent. That scenario, he says, likely will be short-term. “I hope by the end of [2008] we will see housing increase in volume and the average sale prices stay flat or start to increase.” Residential Gary Cannon, the 2007 president of the Salt Lake Board of Realtors, says that the changing lending practices have had an impact on Utah’s housing market. “With the downsizing of sub-prime loans and them being almost being non-existent now, we’ve had to restructure and recreate how to do a lot of business,” he says. “Not necessarily in all the price ranges, but at least in the $500,000 to $1 million price range. Our greatest amount of inventory is in that price range. The problem is, we don’t have as many good qualified buyers in that price range. I don’t know if we ever had a lot of good qualified buyers in that price range or just had creative loan programs out there that enabled people to get into product that they probably shouldn’t have been getting into.” In the third quarter of 2007, 1,628 homes valued at $500,000 or more were newly listed in Salt Lake County, with an additional 269 in Davis County, according to Utah Association of Realtors statistics. Other than the high-end segment, Cannon believes Utah’s housing market will have a good showing in 2008. “I don’t think the $400,000 and less price range is going to be affected as badly. If you look at the numbers of actual sold houses in certain price ranges, the differential from a year ago in some areas is only 10 [percent] to 15 percent. The biggest difference is the amount of houses on the market now, which may have increased 40, 50, 60 percent.” Like the Salt Lake area, southern Utah has seen a significant increase in residential inventory, reflecting a cooling market compared to the past two years, which showed record growth and appreciation. Utah’s Dixie now has more than 30 months of residential housing inventory, compared to about six months worth in 2005, says Vardell Curtis, CEO, Washington County Board of Realtors, and home prices are moderating. “Homes are still a good investment, but it truly is a buyer’s market,” Curtis says. “Before, I had one property with eight people in a bidding war, and now I have eight properties with one interested buyer.” Despite the softening market, he remains optimistic about 2008. “The interesting thing about real estate is that it’s a cyclical industry that seems to follow pretty closely a 10-year cycle. In the mid-’90s, we had similar growth with ramping up and cooling off. We are back in a more traditional market now.” He also points to significant industrial development in the community, such as the replacement of the Washington County airport and the Intermountain Healthcare hospital that was recently completed, as signs that the market will remain healthy. “I think the numbers back up my optimism,” Curtis says. Industrial Record-breaking lows in vacancy rates across all categories of industrial real estate in Utah occurred in 2007 even as 1.9 million square feet of big-box distribution space was absorbed into the market. In 2008, growth will continue, but at a slower pace, says Greg Hunter, SIOR, an industrial specialist with Commerce CRG. “We’re at the end of the dog’s tail. It’s not a negative. Instead of rapid growth, it will level off to stable growth.” One limiting factor, Hunter says, is that “in the Salt Lake Valley, industrial ground, especially in Salt Lake County, is drying up.” Alterations to the master plan of several hundred acres west of the Salt Lake airport, changing from industrial to residential, contributes to the shortage, he says. In the face of the low supply, the cost per square foot for industrial space will increase. Hunter foresees lease rates rising from 37 cents to 43 cents per square foot in the next year. On the bright side, 2.3 million square feet of product has gone through the permitting process and is ready to build, he says. “It won’t drive down prices, but it will ease the burden on the low vacancy rate.” Among the development taking place are three large projects of flex space currently under construction, he says. “We’ve been starving in that market. There’s a 0.85 percent vacancy, and it’s very expensive.” Demand is also high and supply tight for manufacturing space, a situation Hunter believes will continue. The situation in southern Utah is slightly different than that along the Wasatch Front, he says, because more industrial land is available. “Large manufacturers will continue to go there. The only thing that will stifle growth is [shortage of] employees.” Office The market for office space in Utah combines the good news in the housing and industrial sectors: plenty of available product and high demand. “We have approximately one million square feet that will be complete during the fourth quarter [of 2007],” says Paul Skene, first vice president, office properties for CB Richard Ellis. “More than 70 percent of that is located in South Valley suburban areas.” About 35 percent of the space was pre-leased, Skene adds. Because of increased construction and land prices, the new product will command lease prices higher than those in 2007, but because so much space will be available, landlords are likely to offer additional incentives to attract tenants, Skene says. Utah’s strong economy implies the local real estate market will remain strong, but negative changes in the national economy could have an adverse impact here, Skene says. Barring that, “I think things will continue the way they have for 18 to 24 months [before] we see a slightly slower suburban office space market.” The picture changes when focused on downtown Salt Lake City, where “the vacancy rate for Class A office space is the lowest it’s ever been,” Skene says. Until portions of the City Creek development open, which aren’t scheduled to come on line until 2010, “I don’t think we’ll see a lot of clients clamor to be downtown…[but] in two to three years it will be a dynamic place to be for office tenants.” The 222 S. Main project, scheduled to open the first quarter of 2009, will relieve some pressure on the Class A office space market downtown, he says, while Class B and Class C office space will continue to perform well because of demand. Overall, the vacancy rates for Class A space could easily reach 13 percent in 2008 because of the new product coming onto the market, Skene says, leading to a more competitive leasing environment. “The impact of what the [LDS] church is doing is so significant,” says Wells Fargo’s Matthews. “I can’t imagine any weakness appearing in commercial real estate unless gas prices go up and people stop buying. There’s no evidence that the job market will slow. Commercial real estate is in terrific condition and will continue to be.” Investment Investors in Utah’s real estate closed their wallets last August but started to reach for them again toward the end of the year, says Jaren L. Davis, vice president of business development for Coldwell Banker. “The market experienced nearly a shutdown where those investors that were to buy put their inventory back into the hands of the seller – whether it was a single-family home or new construction to be built, new construction [already] built, whatever it was – because they didn’t have the vehicle to borrow,” he says. Because demand dropped nearly in half and the inventory increased dramatically, “we went from a very stable seller’s market that was experiencing decent appreciation…to a market that then had some inventory to deal with.” Toward November, Utah’s strong economy allowed most of the real estate sectors to recover, he says. “What we’ve been dealing with since that time is a robust economy that is firing on all cylinders, and if you took housing out of our conversation, you’d think everything was fine. Housing, because it’s national news, has been hard to maintain positive stories or feelings or momentum because of that.” The sub-prime lending issue did cause the local market to pause, agrees Bryce Blanchard, a principal and investment specialist with NAI Utah, “but the commercial market has weathered the storm,” and lenders continue to make loans to this industry segment. The high demand and limited amount of industrial product available has made it an easy sell, Blanchard says. National investors “have identified this as a market that continues to blossom in industrial real estate,” he says. “The challenge has been finding willing sellers. If I can find a seller, I have a list of buyers.” However, those who own industrial property tend to be reluctant to relinquish it, Blanchard says, because “the market is in their favor. The current market is good, and the [outlook] for the near future is much better.” Likewise, “the investment market [for office space] has been very strong in Salt Lake. It’s difficult to find product and there’s no shortage of buyers,” Skene says, but cautions that the credit market could have a slight negative impact on investments in 2008. The local housing market is prime for investors willing to take the plunge, Davis believes. “If you’re coming here and you read national news, your inclination might be to wait to buy. Whereas in reality, it’s a great time to buy and the reason is that interest rates are so low and you are able to negotiate on properties because it’s not the strong seller’s market that it was in July.” In addition, “the rental market is actually strong, vacancies are low, and that bodes well for somebody who is buying on real estate principles.” The ongoing trend of national retailers that are locating in Utah is yet another indication that the real estate market will be strong in 2008, Davis says. “When they elect to come into a market they do an intense feasibility study. We’ve had national companies come here, and some of them are pretty extraordinary, because they have as many people attending their store as our national parks. Cabela’s is an example.” The Economic Development Corporation of Utah continues to report visits from corporations looking to locate here – the past year has seen companies such as IKEA, The Cheesecake Factory and Procter & Gamble announce a presence in the Beehive State. “We’re positioning ourselves for record-setting growth,” Davis says. “We have the momentum that’s created from the interest and the placement of Utah on the map – on an international map, quite frankly – that is positioning us for continued growth. Record-setting growth. Job creation. In-migration. And so, with that, how can you predict anything but positive momentum?”
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