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Will Fort Bend Real Estate be favored in recovery?

So the economy has bottomed. It may be premature to toast a new commercial real estate market sans recessionary woes, but it is certainly not to soon to prepare to play the upside in Fort Bend County real estate.

In my September 2009 article I referenced the possibilities of a “U-”, “V-” or “W-” shaped recession/recovery. Today, it seems even the most optimistic predict that a “U” will define this recession, with a multi-staged and gradual recovery. Some economists still predict a “W”, with a second dip to bottom out before beginning a sustainable recovery. Either way, we find ourselves at the bottom of the “Great Recession”—thankfully not in the midst of another Great Depression. We recognize there are challenges yet, but we see light at the end of the tunnel. So where does commercial real estate fit into the recovery? We know that the bottoms of economic cycles present opportunities, but how do we identify them?

Commercial real estate lags the economy. Some economists claim property values have bottomed, while others predict they have further to fall. No one seems to disagree, however, that the path to recovery will be a slow one. Unemployment remains high and credit remains tight. Yet the worst of times presents the greatest opportunities for someone looking to participate in the upswing in property values. The gradual recovery through 2010 and 2011 presents what Emerging Trends calls “the ‘opportunity of a lifetime,’ a limited window to cash in on one of the best acquisition environments ever.”

Vacancies may still increase, and rents may have further to fall if the commercial real estate market has not yet hit bottom. However, as employment growth emerges and more space is needed for added employees and equipment, the market will stabilize. Depressed prices due to weak demand and a tightly wound credit market create opportunities for investors with cash. Prices are well-below replacement costs, and if investors are patient and selective they can buy wisely. If they follow through with conservative management of operations and leasing, these investors can score big in the long run.

The credit markets are far from normalized. Banks have been focusing on accumulating reserves, taking advantage of low interest rates and federal assistance. Many have been content to invest in CD’s for interest rate spread rather than make loans. At some point banks will begin selling assets, tapping these reserves and recognizing losses. The market is eager for banks to resume activity; however, it tepidly awaits the distressed assets that will be hitting the market —just how many will there be? We hope there will be just enough to help the market bottom and present investment opportunities. The FDIC expects hundreds more banks to fail, yet as the surviving banks resolve their balance sheet problems, they will eventually “act like banks” again and finance economic growth and real estate activity.

The possibility of skyrocketing inflation is frightening to many. With the flood of government spending and hoards of investor cash and bank reserves that are going to eventually hit the market, it is a valid concern. Inflation would create obstacles for real estate, such as higher interest rates, which put downward pressure on prices and restrict business expansion and consumer spending.

However, real estate offers protection because values increase for real assets during inflationary times. Further, investors able to obtain financing will have the benefit of paying off debt using cheaper dollars whose values would be depreciated by inflation.

Our local economy was late in experiencing the recession. Being favored heading into the collapse, will Fort Bend be favored in the recovery? There are many strong arguments that it will, including:

Employment. Relatively strong employment and income growth are the reasons Fort Bend was named by Forbes (Feb. 2010) as number one of the “Best Places to Get Ahead” and by CNN/Money Magazine (Aug. 2009) as 6th in the nation for job growth. And while the Houston MSA did experience accelerated job losses—and actually surpassed the national rate—in 2009, initial numbers indicate that the area has actually experienced job growth in the past several months.

Housing. Home prices did not rapidly rise in the boom years; thus, there was less correction in the market. Foreclosures and delinquencies have increased, but levels remain much lower than the national averages. The supply level of 6 months is healthy. The Houston MSA has shown remarkable strength in the mist of a national housing bust, and Fort Bend County has proven to be particularly strong. According to the MLS, average and median sales prices in Fort Bend actually increased in 2009. Local household finances are in better shape; consumer spending should thus bounce back quickly when job growth resumes.

As cited in my previous articles, our diversified industry base with strength in health care, energy and trade provided a buffer to the national recession; it will also facilitate our recovery. While off their peak, energy prices justify oil and gas exploration again, and production has a huge multiplier effect on our economy. Health care was one of the few sectors that has been experiencing job growth, and an aging population will sustain demand. Trade and distribution will be early to pick up as exports revive in a global recovery.

As far as commercial real estate is concerned, our area has maintained a relatively good balance of supply and demand. Prices, vacancies and cap rates have remained relatively stable compared to other areas. The CCIM (Certified Commercial Investment Member) Institute named the Houston metro area as one of “2010’s Top 10.” The Institute used variables such as local GDP, unemployment, housing data, per capita income, and commercial real estate fundamentals to compile the list of 10 markets that are expected to perform well in 2010. These characteristics of our local market indicate that we will recover at least as fast—perhaps faster—than the rest of the nation.

With the knowledge that market bottoms present opportunities to ride the wave up, and the Houston area, especially Fort Bend County, is posed to recover with (if not before) the rest of the nation, how should real estate investors respond?

No one will sound a bell when the real estate market hits bottom. However, investors looking to capitalize on the upswing in commercial real estate can look for an improving job market and other indicators of economic stability. When comfortable with timing, they can make wise buys by focusing on quality and using traditional, conservative underwriting standards. For income-producing properties, they should once again use real operating numbers. For land, they should anticipate long-term holds. For all property types, underwriting should be based on a pure cash (unleveraged) model rather than a leverage-driven one. With depressed prices and low transaction volume, investors once again have time to be selective and find deals that have real, unleveraged yield that meets their requirements.

Investors with cash are clearly at an advantage in today’s environment. However, financing can still be an option. Banks favor owner-users. Investors can also pool with other investors. Not only does this make it easier to meet hefty equity requirements for loans, it also gives investors the ability to diversify. Even investors able to meet equity requirements on their own might consider teaming with other investors in order to invest in different properties—as well as different property types—to further diversify. Furthermore, passive investments in real estate, without the headaches of management, might make the investments more appealing. It might not be as simple as it once was, but users and investors still have the ability to take advantage of low interest rates. Lerleen Hawkins, Senior Vice President of Frost Bank, says, “We believe the worst is behind us and that it’s time for businesses to get ready for the future. We have the money to lend to good borrowers and are working with our customers to make sure they’re ready for the turnaround.”

Many factors are yet unknown. More distressed real estate (both residential and commercial) than anticipated could hit the market. Much depends on inflation and job growth, which may make the economic and real estate recoveries painfully slow. It may be several years before the economy and real estate markets are running over with strength, but there is much to be grateful for in Fort Bend County. There are a number of factors pointing to a recovery that outpaces the rest of the nation. One need not be an eternal optimist to view the glass that is Fort Bend County as half full.

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