Investing in real estate is one way to for people to diversify their financial portfolios. Yet, problems plaguing the mortgage lending industry, coupled with the housing market slowdown, have put big question marks on the prospect. “People are more reluctant to invest because they’re nervous about what’s going on with real estate values,” said David Goldwater, founder and president of Goldwater Capital LLC, a Las Vegas-based private money lender.
In reality, solid opportunities to invest in Nevada real estate exist, experts said. The state is predicted to be fastest-growing over the next 25 years in terms of population, according to a U.S. Census Bureau report entitled “Projected 2030, State Population and Change: 2000 to 2030.” Population growth means more jobs, better demographics and greater income levels, Goldwater added. “What’s really important is to be as knowledgeable as you can about the market and understand that every investment is about risk, return and liquidity, and that those things have to be balanced,” said Jeremy Aguero, principal analyst with Las Vegas-based Applied Analysis, an economic, fiscal and market research firm.
Southern Nevada’s Commercial Market
Southern Nevada’s commercial real estate market is strong overall, according to industry experts. “If you’re looking at activity and absorption, you have to be impressed by about every segment of the market,” Aguero said. “More office, retail and industrial is planned or under construction than at any time in our history.”
“More people are borrowing money for commercial projects – retail and industrial in particular – because that is where the demand is,” Goldwater said. “So people want to build to satisfy it.” Also, more money is available for those types of projects, and funding is easier to obtain at the larger lending institutions, he added. Goldwater believes retail is also in high demand. Two emerging high-demand areas, he suggests, are North Las Vegas and the southwest Las Vegas Valley. “You remember last year how everyone wanted to turn retail into single-family housing? Now they want to go the other way around,” Goldwater said.
Experts recommend investing in income-producing industrial developments and multi-tenant projects that have tenants with good credit. “Regarding industrial, if you can find the land, you need to build it,” Aguero said.
The apartment development market will be a solid investment in the near future because so much of the apartment inventory was replaced with condominium conversions, said Mark Daigle, chief executive officer of the Nevada region for Colonial Bank, which provides all types of lending. In addition, the proposed 40,000 hotel rooms for Las Vegas will boost the need for apartments. “We’re looking at continued declines in vacancy rates and significant increases in rental rates,” Aguero said.
Investing in office products is not recommended at this time, as vacancies were up (33.9 percent), and construction and employment in the office sector were down at the second quarter’s end, according to Colliers. Office condos, a for-sale product, had flooded the market.
Southern Nevada’s commercial market isn’t expected to change drastically in the next few years, but could experience a lull as residential inventory gets absorbed. “There is lots of space coming online, and it will be pretty tough to be able to absorb it,” Aguero said. “The vacancy rate will escalate through the end of 2007. That will make things a little softer.”
Northern Nevada’s Commercial Market
The Northern Nevada commercial real estate market is evenly balanced, with all segments doing well. Industrial is steady, with good demand. The vacancy rate was 7.6 percent at June’s end, according to Colliers International’s Reno market research.
“We’re seeing some good growth,” said Harvey Fennell, commercial department head for Dickson Realty – a residential and commercial real estate brokerage in Northern Nevada. A lot of retail has been built in the past year but not in excess, and customers exist for those new centers. The vacancy rate at the end of 2006 was 8.23 percent, Colliers’ statistics showed.
In terms of office products, some pockets of oversupply exist, such as in the South Meadows area, south of Reno, whereas some areas, such as Spanish Springs, north of Sparks, are short, Fennell said. Vacancies as of June’s end were 12.9 percent, according to Colliers. “It’s not severely overbuilt,” he said. “Vacancies can jump up and go back down again as things absorb.”
Multi-family housing is solid and likely will remain into 2008 and 2009. People who might have moved into single-family units and now can’t afford them will be in the apartment market, Fennell said. In addition, the single-family houses that have been up for rent will disappear as people sell them. “Consequently, we’ll see vacancies in apartments start to decline,” Fennell said. “That will be a very strong segment. We’ll probably see some upward pressures on rents as apartment vacancies fall.” The large number of condominiums coming on the market, however, could affect the apartment rental market, depending on condo prices. If people can afford to use their rent monies to buy a condo, apartment vacancies could increase.
Over the next few years, commercial real estate will remain a viable, steady market, Fennell predicted.
Pros and Cons of the Commercial Market
When purchasing a commercial property, Fennell recommends making it a long term investment. The advantages can include a reasonable rate of return in the short-term, appreciation over the long-term, along with a tax benefit. “This doesn’t necessarily happen with residential investments,” Fennell said. “However, most commercial property investors do really well if they hold [their investment] long enough – about five to 20 years.”
Unlike with residential real estate transactions, less emotionalism is involved in business-to-business commercial deals. It isn’t hard to get into the commercial real estate market, nor does it require mass quantities of capital. “The market makes a wide selection of reasonably priced, smaller, investment properties available for purchase,” Fennell said.
To avoid these hazards, view the purchase of any commercial property as a long-term investment, rather than something you’re going to flip out of in a hurry, Aguero advised. “It’s a long-term play right now,” he said. “It’s hitting singles and doubles in anticipation of a home run, not swinging for the fences on a big deal.” Avoid areas that have poor infrastructure and where significant cash flow is required to make them work, Aguero recommended.
The Land Market
“It’s [Southern Nevada] a little bit risky at the moment,” Aguero said. “The price of land has escalated from $200,000 an acre to $700,000 an acre in the last two years.”
It’s a difficult time to evaluate projects such as raw land development, Daigle said. If your projected timing is short and you’re carrying debt, the unanticipated money you’re paying quickly eats into your expected project return.
Currently, land demand is low. Homebuilders are continuing to selloff acreage they bought over the last two years. “It’s a situation where they’re being forced to sell undeveloped land off their balance sheets,” said Bill Oakley, First National Bank of Nevada’s Southern Nevada regional market president.
Similarly, demand for raw land in Northern Nevada is minimal as a result of the downturn in residential homebuilding, builders halted all land purchases. In addition, many of the projects that were underway have either been sold or put on hold.
“Certainly there is a long-term shortage of developable property, particularly in the Las Vegas Valley, so at least for the immediate future, there is probably an oversupply,” said Fennell.
Southern Nevada’s Residential Market
Residential housing in Southern Nevada is overbuilt, with lots of inventory that needs to be consumed and very little is currently under construction. Permits are down substantially for new homes, Oakley said. The region is experiencing an all-time high in existing homes. Nearly 27,000 units were up for sale as of mid-August.
“We have too many houses that were bought by investors,” Oakley added. “If you drive through the neighborhoods, you’ll see houses that have been owned for two to three years and never lived in, with for sale and for rent signs. When the market got hot, it became overheated.”
It’s a buyer’s market. People looking to purchase a home to live in, not to flip, should move forward. “If you are a qualified buyer, can obtain conventional financing and don’t have to over-leverage yourself to get into a property, there’s nothing wrong with buying at this time,” Daigle said.
Experts suggest opting for a more generic home, something in the middle of the block and not the most expensive. Purchase a home that’s within your means and ensure you can make payments on it without relying on lease income. Factor in the additional costs, such as utilities, repairs, maintenance, insurance and property taxes, Daigle advised.
Foreclosures on brand new homes in good locations present good opportunities. Nevada had the highest foreclosure rate (1 in every 175 households) in the country as of June 2007, according to RealtyTrac, publisher of the “Monthly U.S. Foreclosure Market Report.” The preponderance of those foreclosures was in Southern Nevada. It is important to understand what’s going on in the market and neighborhoods around you, in terms of foreclosure activity which can have an impact on the value of your property the near term.
It likely will be 18 to 24 months before the residential inventory drops back down to a reasonable, four- to six-month level, Oakley predicted. The proposed Strip projects – Echelon Place Resorts, CityCenter and more – should bring more workers to the area and help absorb the residential inventory.
“They’ll be buying and renting houses, and possibly pushing markets a little further away, like Pahrump and Mesquite. Plus a number of new markets, not yet on the drawing board, will likely be established somewhere in between the Las Vegas Valley and the outlying communities,” he said.
Northern Nevada’s Residential Market
In terms of residential real estate, Northern Nevada, too, is experiencing a buyer’s market, with a large quantity of existing inventory currently available. Paradoxically, as recent as 2004, the region sustained a seller’s market so extreme, fewer than 500 properties were available.
“In some parts of the market, we saw upwards of a 32 percent appreciation,” said Nancy Fennell, president and co-owner of Dickson Realty.
However, with conditions now firmly in favor of the buyer, new homes led the market in terms of granting concessions and incentives to buy. Purchase incentives offered by homebuilders were diverse and creative, and included instances where the seller prepaid up to two years with of the new home’s association dues, or two years worth of mortgage insurance premiums. In some cases, sellers absorbed the lot premiums, while others offered free upgrades worth up to $70,000.
The market will adjust over about the next 18 months, and inventory will come down, Fennell predicted. “I think people are confused about the gloom and doom of the housing slump,” she said. “It is a short-term problem. We’re going to go into a rebalancing act. For many years, we had a 3 percent to 5 percent annual appreciation. We’ll return to that.” And lenders are currently leading the way toward establishing a fair market value as they divest themselves of foreclosed-upon properties.
Pros and Cons of the Residential Market
One advantage to investing in residential real estate is that one can always sell a house. You might not get the amount you want, but you can always lower the price and sell should you want to get out, Oakley said.
Buying a home ensures that you’ll have more control over what you’ll pay and an incredible range of options from which to select from which to select. “In the 20 years I’ve been in this business [in Northern Nevada], I’ve never seen the kind of variety, diversity or amount of inventory available for a buyer to choose from,” Fennell said. Interest rates remain low – anywhere from 6 percent to 7 percent on a jumbo loan, and lenders still have money to lend.
This is not the time, however, to purchase and flip a home. “We’re going back to where residential real estate represents a component of your overall portfolio as a minimum three- to five-year investment,” Fennell said. “If you’re looking for a short-term investment, I think you should look elsewhere. You need to be a little more careful and make sure the basics that create value are in place – location, condition, construction and architectural style,” she said.
Financing Issues
While two years ago, buyers could choose from an amazing array of exotic loan products that were available through a huge selection of mortgage brokers that no longer is the case. Today, there is less liquidity and available credit, making loans more difficult to get. This has greatly narrowed the margin for error among borrowers. “What’s different relative to a year ago was if you were off or if you left a little margin for error, that was okay because there was always an alternative form of financing or a way to buy a little bit of time,” Goldwater said.
The issue of financing will remain a problem over the next couple of years, Harvey Fennell predicted. “It probably will be the summer of 2008 before things calm down,” he added. “And it could get worse. The markets are really unsettled.”
Consequently, borrowers likely will have to put more money down and, undoubtedly, have to be much more cautious. “You have to be a prudent borrower with an exit strategy, have realistic assumptions based on time and know the market conditions when you approach a loan,” Goldwater added. Don’t get optimistic about potential rent increases, and be careful with variable-rate loans, advised Harvey Fennell.
Other Investments
Another way to invest in the real estate market is to invest in others’ real estate debt – that of developers, for example. “If you’re nervous about the real estate market, real estate debt at this time is something that can take your risk profile down while giving you some exposure to real estate,” Goldwater said. “To ignore real estate debt [as a potential investment] I think is a mistake.”
Real estate debt is available through deeds of trust and other instruments, such as private funds and mortgage-backed securities. Deeds of trust are deal-by-deal investments. You know what specific piece of land it is you’ve invested in. You can secure your investment on the actual real estate, an advantage in today’s market, Goldwater added. You can charge more interest, 13 percent to 14 percent on first trustee. “The worst case scenario is you get a very cheap piece of land back,” he said. “The best case scenario: You end up earning 13 percent on the whole transaction.”
REITs (Real Estate Investment Trusts) work differently than first-trustee investments, but are another way to invest in commercial and residential real estate business. A REIT is a company that owns, and most often operates, income-producing real estate such as apartments, shopping centers, offices, hotels and warehouses. Some REITs also engage in financing real estate. The shares of many REITs are freely traded. Hundreds of different types of REITs exist, so do your homework before selecting one in which to invest.
REITs are classified in one of three categories including equity, mortgage or hybrid. Equity REITs are primarily real estate operating companies that engage in a range of real estate activities – they own and operate income-producing real estate. Mortgage REITs extend credit directly through the acquisition of loans or mortgage-backed securities. Hybrid REITs owns properties and extends loans to real estate owners and operators. Including REITs in an investment program helps build a diversified portfolio.