THE REAL ESTATE BUBBLE - LESSONS LEARNED FROM THE 2008 CRASH

Transcription

1 THE REAL ESTATE BUBBLE - LESSONS LEARNED FROM THE 2008 CRASH Michael J. Kelly, MAI Real Estate Analysis Corporation Chicago, IL mkelly@reac.com David Kaplan Geary, Porter & Donovan Dallas, TX dkaplan@gpd.com Robert S. Goldman Partner Madsen Goldman & Holcomb, LLP Tallahassee, FL rgoldman@mgh-law.com 2016 IPT Annual Conference ~ Traverse City, Michigan

2 The Real Estate Bubble Lessons Learned from the 2008 Crash Michael J. Kelly, MAI Real Estate Analysis Corporation Chicago, IL 2016 IPT Annual Conference ~ Traverse City, Michigan 1

3 Big Picture of Commercial Markets Source: Moody s/real Commercial Property Price Indices; REAC Chart * Graph based on resales of same property Moody s Investor Service * September 2008 was Lehman Brothers Bankruptcy (start of the Crash ) 2016 IPT Annual Conference ~ Traverse City, Michigan 2

4 State of Current Commercial Market, Since the 2008 Crash Described best as Stratified or quality bifurcation Pre-Crash, most properties increased at similar rates one size fits all Post-Crash every property class needs to be analyzed separately quality bifurcation For Example: Fully Recovered Values Modern Rental Apartments Modern High Ceiling Warehouses on Interstates CBD Office Buildings (not suburban) Newer Medical Office Buildings (any location) CBD Hotels vs. Still Depressed Most Residential Condos Older, Low Ceiling Manufacturing Suburban Office (some still declining) Suburban Hotels Power Centers In Urban Locations and Adjoining Edge Cities Class A Malls Farmland Strip Centers in Outlying Areas Anchor Stores in Malls Large outlying residential Tracts of Land 2016 IPT Annual Conference ~ Traverse City, Michigan 3

5 Characteristics of Current Commercial Market Significant amounts of equity and debt looking for assets Cap Rates being compressed, again Yields are at historic lows, becoming less attractive Buyers starting to look beyond core assets (class A) for higher-yielding purchases-running out of good product More purchases of niche properties (MOB, self-storage, student housing) Demographic changes from emerging Millennials are affecting values 2016 IPT Annual Conference ~ Traverse City, Michigan 4

6 Macro Demographic Changes Will Shape Future Real Estate Market Emergence of Millennials as Dominant Group Group Age % of U.S. Population 2015* % of Workforce Millennials % 34.7% Generation X % 31.4% Baby Boomers % 31.4% Silent Generation % 2.5% *Source: Pew Research U.S. Census 100% 100% 2016 IPT Annual Conference ~ Traverse City, Michigan 5

7 Characteristics of Millennials First generation exposed to Internet in their formative years More connected to technology Most diverse & educated (61% attended college vs. 46% for boomers ) Many entered workforce during 2007 crash which affected early career decisions More connected to social relationships Important to live close to friends, family and place of work Stay with early-career employers longer 2016 IPT Annual Conference ~ Traverse City, Michigan 6

8 What Type of Real Estate Will Be Most Affected by Millennials? Primarily: Office and Apartments Historically, baby boomers shaped office design and location since the 1950s to the suburbs Now, millennials will shape the future locations and designs 2016 IPT Annual Conference ~ Traverse City, Michigan 7

9 Characteristics of the More Successful Office Markets Millennials are attracted to the area Creation of the 18-Hour City 18 Hour market versus traditional 9 to 5 Combined environments of work, live, and play Office, dining, retail, living space combined, or nearby Commutes are by train, walking, or within biking distance (minimal auto) Availability of nearby desirable rental housing 2016 IPT Annual Conference ~ Traverse City, Michigan 8

10 If House Prices are Down, Why Are Renters Not Buying? Home prices crashed in 2008 Interest rates are historically low Theoretically, affordability is higher However, Prices are recovering Down payment proportions are up (from the 2007 market of little or $0 down) Student debt payments hurt ability to pay house debt service 2016 IPT Annual Conference ~ Traverse City, Michigan 9

11 Zillow says renters pay 30% of their income to landlords; versus 15% for mortgage holders Young people holding pre-2008 house purchases are underwater and can t move-up to next house Housing mismatch where young workers live versus where they can afford to buy 2016 IPT Annual Conference ~ Traverse City, Michigan 10

12 Office Market- CBD So, What Has Happened to CBD Office Cap Rates Since the 2007 Crash? Overall Rates CBD - National* 1 st Quarter National CBD Office 6.68% 8.35% 5.58% *Source: PWC Investor Survey Cap rates have dropped 300 basis points in the CBDs Since the Crash (Not in the Suburban Office Market) 2016 IPT Annual Conference ~ Traverse City, Michigan 11

13 CBD Office Sale Prices Back Up How Come? 2016 IPT Annual Conference ~ Traverse City, Michigan 12

14 Did Rents Go Up? Historical Gross Asking Rent - Chicago CBD Office Market $34.00 $33.00 $32.00 $31.00 $30.00 $29.00 $28.00 $27.00 $26.00 $ Q'10 1Q'11 1Q'12 1Q'13 1Q'14 1Q'15 Overall Asking Rate $28.55 $28.30 $28.88 $29.43 $30.21 $30.34 Source: CoStar Chicago Office Market Reports, REAC Chart Only Slightly 2016 IPT Annual Conference ~ Traverse City, Michigan 13

15 So What Happened? Why are Sale Prices Back Up? 2016 IPT Annual Conference ~ Traverse City, Michigan 14

16 Are Cap Rates Back Down to Pre-Crash Levels? Historical 1st Quarter Overall Cap Rates Office CBD 9.00% 8.50% 8.00% 7.50% 7.00% 6.50% 6.00% 5.50% 5.00% 4.50% Chicago CBD 7.14% 7.97% 7.60% 7.30% 7.11% 6.91% 5.68% 5.58% Source: PWC Korpacz Real Estate Investor Survey, REAC Chart Yes, but only in the CBDs, Not the Suburbs 2016 IPT Annual Conference ~ Traverse City, Michigan 15

17 Question: If rents & Occupancy are Stagnant, Why are Cap Rates Low Again? Answer: Projected Future Rent Increases, Abundance of Equity & Debt, Scarcity of Alternative Investments Korpacz 1 st Qtr National CBD Office Market Discount Rate Overall Rate CBD Market s Assumed 1 st Year Rent Change 6.88% 5.58% +2.92% Anytime OAR is lower than discount Rate, buyer is typically projecting future rent increases IPT Annual Conference ~ Traverse City, Michigan 16

18 Office Market-Suburban While the CBD Market Has Rebounded, Suburban Office Market Has Stalled, or Collapsed Difference in Cap Rates Tells the Story City CBD Sub. Difference in OARs Atlanta 7.05% 7.60%.55% Boston 5.35% 6.94% 1.59% Charlotte 6.80% 7.48%.68% Chicago 6.07% 8.61% 2.54% San Francisco 4.90% 6.50% 1.60% Philadelphia 6.90% 8.15% 1.25% Large Suburban Single Tenant Office Buildings Took the Biggest Decline and No Recovery Why? Emergence of millennials as Dominant group in workforce 2016 IPT Annual Conference ~ Traverse City, Michigan 17

19 Problems With Suburban Locations Long Commutes No mass transit systems Suburban Campuses obsolete model for workplace says Urban Land Institute Advantages to the Workforce Being in the CBD Housing nearby Commute shorter, by walking or biking Urban areas are magnets for young people Recruiting for skilled positions more desirable for urban locations Sense of community being around other young workers building critical cultural mass 2016 IPT Annual Conference ~ Traverse City, Michigan 18

20 Apartment Market Overall Capitalization Rates* st Quarter % 5.35% Apartment Market has fully recovered since crash Emerging demand comes from: Millennials Suffering middle and lower income middle class Domestic and international migrants Safest investment considered to be B buildings in A markets. *Source: PWC Investment Survey 2016 IPT Annual Conference ~ Traverse City, Michigan 19

21 Industrial Market Activity is focused on modern Warehouses, not factories Factories tend to be older, low ceilings They can compete, if they have high ceilings and are near interstates Cap rates are down since the crash: Average OAR (Modern Bldgs. ) 8.80% 5.52% Buyers migrate to high ceilings (30 feet) located on interstates As internet sales grow, warehouse demand increases cannibalizing retail space Internet vendors free returns and same-day delivery increase need for warehouse space 2016 IPT Annual Conference ~ Traverse City, Michigan 20

22 Retail Market Top North American Retailers Rank Company 2015 Revenue (billions) 1 Wal-Mart $485B 2 Costco $112B 3 Kroger $108B 4 Walgreens $103B 5 Amazon $89B 6 Home Depot $83B 7 Target $72B Emergence of amazon is most notable 2016 IPT Annual Conference ~ Traverse City, Michigan 21

23 E Commerce Since the Crash E-Commerce has significantly impacted bricks & mortar retail. E-Commerce sales are 7.5% of all retail sales in 4 th quarter IPT Annual Conference ~ Traverse City, Michigan 22

24 Current State of Retail by Sub- Type Regional Malls Class A with steady retail sales ($500 sq. ft. +) are still very desirable and economically healthy Those in urban locations with barriers to entry are even better Anchor Stores in Malls Most have declining retail sales per sq. ft. even in A malls Future is questionable in many B and C malls Free Standing Discount Stores Most vulnerable to competition, particularly in suburban areas which may be over-retailed 2016 IPT Annual Conference ~ Traverse City, Michigan 23

25 Power Centers Tend to be less risky because of 2-4 tenant design and risk diversification Strip Centers Tend to have biggest health problems in outlying suburban areas Too much supply of local non-national tenants Easiest to replicate No barriers to entry 2016 IPT Annual Conference ~ Traverse City, Michigan 24

26 Recent Signs of Bubble Bursting in 2016 Note Decrease in trend line Feb IPT Annual Conference ~ Traverse City, Michigan 25

27 Wall Street Journal Headline Turning Point? U.S. Commercial Property Sales plunge in February Total Sales Transactions of Commercial Property $46.2B February 2015 $25.1B February % Decrease in Sales Transaction Volume Commercial Mortgage Bonds (CMBS) $100B 2015 Issued $60-75B 2016 Projected Commercial Lending Year Loan to Value Ratio Interest Rate % % % 5.0% Reduction in Foreign Investment In 2015, $70B invested,or 11% of total U.S. Investment of $600B For 2016, it is projected to decrease significantly due to: China s poor economy, low oil prices, etc IPT Annual Conference ~ Traverse City, Michigan 26

28 Symptoms of a Bubble Market Sale Price hikes without increase in underlying fundamentals (i.e. rent increases). Example Of Rent Forecasts before 2008 Crash Changes in Market Rent of 3.4% annually were projected right up to the 2008 crash 2016 IPT Annual Conference ~ Traverse City, Michigan 27

29 Are we back to the same 2007 lack of Fundamentals? Yes Example - Chicago CBD Office Rent Levels Compared to OAR Changes Year Overall Asking Rate Overall Cap Rate- Average $28.55 $29.43 $ % 6.92% 5.68% Rents are Stagnant, while OARs decrease 2016 IPT Annual Conference ~ Traverse City, Michigan 28

30 Rents are projected to decline after the crash occurs Year CBD National Office Projected Market Rent Change* % % Crash Occurs % % % % % *Source: PWC initial rate of change 2016 IPT Annual Conference ~ Traverse City, Michigan 29

31 What have Assessors done since 2008 crash? Assessments have generally been raised However, increases tend to reflect average increase of the market Class A properties end up increased, but are under-assessed Class C tend to be Over-assessed One size fits all approach 2016 IPT Annual Conference ~ Traverse City, Michigan 30

32 Conclusions Market Since the Crash Broad Picture of Commercial Market Certain classes recovered since crash of 2008 Primarily, due to compression of cap rates Recovered as a much more stratified market CBD Office and Apartments are strongest sectors Important Demographic Change in U.S. Emergence of Millennials will change location and designs of office properties Move is back to the CBDs creating 18 Hour Cities CBD Apartments are in strong demand Millennials will primarily be renters by choice for the foreseeable future Renters will not be buying due to student debt, down payment requirements and higher prices, can t afford to buy where they work 2016 IPT Annual Conference ~ Traverse City, Michigan 31

33 Why are Office CBD Prices up? Primarily due to cap rate compression Rents are not significantly higher and concessions are still in place Significant capital chasing too few Class A & B assets Why are Single Tenant Suburban Headquarters Down? Affect of millennials on location choice Out of favor with employees Move to suburbs is over 2016 IPT Annual Conference ~ Traverse City, Michigan 32

34 Retail Market Most complicated to analyze Bricks and mortar suffering Affected rapidly by changing consumer tastes and technology 7.5% of retail sales taken by E-Commerce Industrial Market Has recovered for modern high ceiling properties located near interstates More demand for modern warehouses due to e-commerce and just-intime inventory Older low ceiling manufacturing still depressed 2016 IPT Annual Conference ~ Traverse City, Michigan 33

35 General Outlook Broad Picture of Current Commercial Market Too much capital chasing insufficient number of qualified properties Overall rates are at all-time lows Are we going back to where we were in the overheated markets of 2006 and 2007? Yes 2016 IPT Annual Conference ~ Traverse City, Michigan 34

36 2008 crash caused by easy financing and lack of value fundamentals Since the crash, financing has gotten more stringent Replaced by equity investors due to lack of higher yielding alternatives In 2016, lack of fundamentals is back Stagnant rents but decreasing cap rates Next crash will not be as severe, more of a correction 2016 IPT Annual Conference ~ Traverse City, Michigan 35

37 THE REAL ESTATE BUBBLE - LESSONS LEARNED FROM THE 2008 CRASH Robert S. Goldman Partner Madsen Goldman & Holcomb, LLP Tallahassee, FL rgoldman@mgh-law.com 2016 IPT Annual Conference ~ Traverse City, Michigan 36

38 The Florida Experience Downturn earlier than some recognized Coastal property value boom in particular Pre-2005 speculative pressure major hurricanes, the bubble busters Insurance cost skyrocketed Existing owners taxed out of market Long term sea level rise effect TBD 2016 IPT Annual Conference ~ Traverse City, Michigan 37

39 Statewide Taxes Levied ($Millions) Source: Florida Department of Revenue Fiscal Year Total Taxes Levied Percent Change , , ,970 (1.2) ,251 (5.0) ,536 (8.2) ,819 (5.3) ,361 (5.4) , , , , , IPT Annual Conference ~ Traverse City, Michigan 38

40 Total Taxable Value (Billions) Source: Florida Department of Revenue Tax Date Jan. 1 Market Value Percent Change % New Constr , , , ,811 (1.5) ,838 (4.5) ,924 (12.4) ,198 (14.3) ,564 (3.4) , , , , IPT Annual Conference ~ Traverse City, Michigan 39

41 Recession as Cause of External Obsolescence Legal context: depends on facts, circumstances Subspecies of economic obsolescence Examples of arguments: Normal business cycle or fundamental market change for foreseeable future? National, regional, local trends General economic trends vs. impact on particular business or industry Impact of tight credit 2016 IPT Annual Conference ~ Traverse City, Michigan 40

42 Recessions Affect Some Locales More Than Others Menard Inc. v. County of Clay, 2015 WL (MN Tax Ct. 2015) Big-box home improvement store 2011 through 2014 assessments Owner s appraiser cited Great Recession, national overbuilt status of big-box retail Court: more credible evidence of local situation refuted claim of economic obs Growing population Increasing wages 2016 IPT Annual Conference ~ Traverse City, Michigan 41

43 National and Local Factors at Play Marina Dist. Dev. Co. v. City of Atlantic City, 27 N.J. Tax 469 (N.J. Tax Ct., 2013) Large hotel-casino property in Atlantic City Tax years 2009, 2010 Economic downturn Unemployment Less consumer confidence bad for gaming New normal prolonged low growth, high unemployment. Also, newer casino competition in PA Court: most weight to income approach; cost approach not reliable Downturn reflected in income approach 2016 IPT Annual Conference ~ Traverse City, Michigan 42

44 Lack of Financing Affects Value Inn at the Wickliffe v. Bd. Of Education, 2105 WL (OH App. 2015) Hotel; owner paid $4.8 million in May assessed value $4.8 million based on sale Great Recession Fall 2008 Financing unavailable for improvements Could not retain franchise Lower market rents with different branding Held: Value reduced to $2.5 million 2016 IPT Annual Conference ~ Traverse City, Michigan 43

45 Misplaced Burdens Phoenix Cement Co. v. Yavapai County, 2015 WL (AZ App. 2016) Issue: Cement plant value during downturn Taxpayer had burden to meet three-part test for economic obs Consistent w/ nature of obs as depr? Strong expert testimony for taxpayer on obs Dismissed as fluctuations in business cycle Unhelpful TP testimony: would not sell for claimed value 2016 IPT Annual Conference ~ Traverse City, Michigan 44

46 Two Challenges for Taxpayers General reluctance of assessors, courts to recognize obsolescence, related to Misallocation of burden of proof Misunderstanding nature of obs Mass appraisal systems Protection of tax base Lag in recognizing it where undeniable Bureaucratic inertia Hope it will go away 2016 IPT Annual Conference ~ Traverse City, Michigan 45

47 Being Proactive To address reluctance Legislation on burden of proof and/or obs Emphasis in evidence, briefing that obs is depreciation that must be reflected Prepare witnesses (avoid Phoenix Cement) To address lag All the above, plus Early meeting with assessor Involve others affected, e.g., Chamber, industry group 2016 IPT Annual Conference ~ Traverse City, Michigan 46

48 Conclusion Signs of another downturn approaching Burden on taxpayer can be heavy Proactive approach is best solution 2016 IPT Annual Conference ~ Traverse City, Michigan 47

49 The Real Estate Bubble Lessons Learned from the 2008 Crash 2016 IPT Annual Conference ~ Traverse City, Michigan 48

50 TEXAS HAS ESCAPED SO FAR! Statewide property values have increased every year since 2008 From property taxes levied against property statewide increased from $38.979B to $45.266B Tax Year Total Levy 2008 $38,979,969, $40,034,355, $40,273,271, $40,480,597, $42,750,397, $45,266,935, IPT Annual Conference ~ Traverse City, Michigan 49

51 VALUES HAVE ALSO INCREASED Source: Texas Comptroller of Public Accounts 2016 IPT Annual Conference ~ Traverse City, Michigan 50

52 Two Things Taxpayers Do Not Unpredictability Like -- Changes in property values are beyond the control of the taxpayer and are somewhat subjective -- Different types of property change value at different rates Paying More Taxes Tax rates increased during declining markets are rarely decreased in rising ones 2016 IPT Annual Conference ~ Traverse City, Michigan 51

53 Sales Not Typical of the Market May be Useful Generally Accepted Appraisal Techniques frown on the use of foreclosure or distress sales because they are thought to be not at arms-length. Sometimes these sales are a large portion of the market Texas Legislature amended Tax Code Section (c) in determining the market value of a residence homestead, the chief appraiser may not exclude from consideration the value of other residential property that is in the same neighborhood as the residence homestead being appraised and would otherwise be considered in appraising the residence homestead because the other residential property: (1) was sold at a foreclosure sale conducted in any of the three years preceding the tax year in which the residence homestead is being appraised and was comparable at the time of sale based on relevant characteristics with other residence homesteads in the same neighborhood; or (2) has a market value that has declined because of a declining economy IPT Annual Conference ~ Traverse City, Michigan 52

54 Properties in Distress Often Change Owners During the Appeal Process This can present a problem if ownership changes: -- after the lien date but before the protest deadline -- after the protest deadline but before the protest hearing -- during the pendency of the judicial appeal Who can file or manage the appeal? Who gets any refunds? 2016 IPT Annual Conference ~ Traverse City, Michigan 53

55 Who is the Owner Property tax statutes in most jurisdictions are drafted with a snapshot in time approach to ownership and tax liability Judicial interpretations of ownership can vary Legislative changes can clarify the authority of a succeeding property owner to pursue an appeal Texas Property Tax Code Sec Person Acquiring Property After January 1. (a) A person who acquires property after January 1 and before the deadline for filing notice of the protest may pursue a protest under this subchapter in the same manner as a property owner who owned the property on January 1. (b) If during the pendency of a protest under this subchapter the ownership of the property subject to the protest changes, the new owner of the property on application to the appraisal review board may proceed with the protest in the same manner as the property owner who initiated the protest IPT Annual Conference ~ Traverse City, Michigan 54

56 Similar Provisions during a Pending Judicial Appeal Filing an appeal in the name of a party later determined not to be the owner can deprive the Court of jurisdiction to hear the appeal Texas Property Tax Code Sec Intervention in Appeal by Certain Persons A person is entitled to intervene in an appeal brought under this chapter and the person has standing and the court has jurisdiction in the appeal if the property that is the subject of the appeal was also the subject of a protest hearing and the person: (1) owned the property at any time during the tax year at issue; (2) leased the property at any time during the tax year at issue and the person filed the protest that resulted in the issuance of the order under appeal; or (3) is shown on the appraisal roll as the owner of the property or as a lessee authorized to file a protest and the person filed the protest that resulted in the issuance of the order under appeal IPT Annual Conference ~ Traverse City, Michigan 55

57 Keeping Track of Notices Distressed properties often change ownership without the involvement of closing agents or title companies Appraisal and assessment officials may not record changes in ownership names and mailing addresses in a timely manner but this will usually NOT extend any relevant protest or tax payment deadlines 2016 IPT Annual Conference ~ Traverse City, Michigan 56