Wednesday, February 22, 2017

Commercial Real Estate Forum's Buried Lede: The Invisible Hand is Broken

The big "Commercial Real Estate Economic Forum" was held last week, and overall it seems like there are fewer things to say than last year (see part 1, part 2). Much of what was true then remains true this year.

And yet the cheery optimism in the newspaper's report might be a little problematic. Who benefits from the "lift"? The benefits from "continued growth" do not seem to be distributed quite the right way!

In fact, the real story might be rather different. The real story might be that in the face of strong demand, tight supply, and rising rents and sales numbers across multiple sectors, developers are not responding very quickly with new supply.

The story is not so much "economy offers a lift," but instead is "supply and demand are stuck in an imbalance and are not adjusting to find the new equilibrium."

The invisible hand may not just be invisible, it's totally absent or broken!

A sign of this might be in the "Industrial" section. There are two paragraphs that from here read like they are in contradiction on supply, the first written from a standpoint of surplus, the second from a standpoint of deficit:
  • Portland currently has over two million square feet under construction, or in the development pipeline, largely fueled by institutional developers like ProLogis or Trammel Crow. The valley needs any new construction to absorb immediately to get these developers to consider anything of scale in our market.
  • The Market Quick Facts show a sub-market that is out of balance from a supply and demand standpoint. Without new industrial inventory the supply will not exist for local businesses to expand and companies from outside the area have no options to locate within the valley. That also puts upward pressure on the value of existing buildings both for sale and for lease. Asking prices and asking rents will continue to climb until supply and demand are back in balance.
Which is it?

This underscores the suspicion that developers and government business development folks sometimes may be gaming the system!

Maybe it's nothing, but it seems incoherent. It could just be sloppiness, but maybe it's also a dodge, an evasion of the fact we are facing a market failure, and that developers and owners might be "rent-seeking" in an artificially constrained market instead of seeking new rents by building more.


Overall, as commenters have pointed out over the past year, the City's decision to focus on ADUs ("granny flats") in zoning reform means they chose to focus on something too small and feeble to make an aggregate difference in the total supply of housing and the average cost of housing. The solution they chose doesn't scale. It's not useless, but it's dwarfed by the problem.

It is interesting, then - nothing new, but something always to point out - that abstracting real estate as a "product" and an "investment" means that renters are always seen as something from which to extract value, and not as people who have dignity and who deserve basic things like housing and food.

From the booklet:
To help offset the imbalance of supply and demand, developers continue to bring new projects to the market. 1,372 multi-family units are in various stages of planning and construction. This includes the recently completed South Block Phase II, seven multi-family projects currently under construction totaling 652 units, and six multi-family projects totaling 657 units in the planning phase with construction anticipated for 2017 (82 units in 2018).

Salem/Keizer continues to be in catch-up mode. Rent appreciation averaged 19% over the past year, with 2BR/1BTH units capturing the highest increase of 27%. 3BR units followed suit at 23%.

The disparity between median family income and rent appreciation is increasing and will likely prove to be unsustainable over the long term. With rents increasing year over year, renters are beginning to pursue other living arrangements such as moving back home or doubling up...

Despite the affordability gap, opportunity for rent growth remains due to increased population, continued lack of supply, and shortage of readily developable land available for new projects. This is reiterated by the recent redevelopment of previously improved sites and several new and planned projects pending conditional use approvals and/or zone changes prior to development.

Once the developing and planned projects come online, rent appreciation is expected to slow, and vacancy may increase slightly; albeit, not in excess of one to two hundred basis points. This is anticipated to begin in mid-2017 due to the upcoming deliveries such as Keizer Station Apartments (Keizer), Hyacinth Street Apartments (NE Salem), and River Valley Terrace (West Salem).

If interest rates continue to climb, capitalization rates will follow suit, which may lead to a decrease in transactional activity and sales volume in 2017. However, the multi-family property sector is anticipated to remain the darling of commercial real estate investments in the near term.
Whatever else this is, it is also strong evidence for a market failure.

If demand is high, but conditions are such that it is difficult to increase the supply, then the market is failing to reach a new equilibrium, and it is appropriate for government to intervene.

Office Space and Tax Abatements
Related, the City sent out a breathless press release the other day:
Advanced Manufacturing and Technology Industry Expands in Salem: Companies Recognize Advantage to Locating in Salem [woo-hoo!!!]
Here's a bit from the Forum:
Rents continue to surge forward with the lack of new product hitting the market and little construction on the horizon...With the improving market, concessions have been virtually eliminated in all but the hardest to lease locations in the market.
If things are so great, and if private owners do not have to give out concessions, why does the City keep handing out "Enterprise Zone" property tax abatements like a drunken sailor?

The whole thing just doesn't add up. Whatever it is that we are doing for incentives don't seem to be working - they may be unnecessary or they may be targeted at the wrong things.

Other Bits

In the "retail" section, there's a note about a "three-tenant development" between Wilco (the old Safeway) and Roth's, anchored by a Starbucks. There was a demolition permit issued for the old sign shop next to Rock-n-Rodgers, so those pieces look like they fit. The Starbucks probably be another drive-through coffee shack. I wonder if they'll close the one by Fred Meyer, just north of Madrona.

A Final Bit on "Car Housing" vs. Human Housing

Why are we so ready to accept extracting disproportionate wealth from people for human housing, but we are totally unwilling to accept charging tiny fees for car housing?
With rents increasing year over year, renters are beginning to pursue other living arrangements such as moving back home or doubling up.
No problem! Nothing to see here.

Basically, we guarantee free car housing
But want to charge a buck an hour for a car stall? Huge, huge problem. Petitions, epic outrage!

We have mandatory inclusive zoning for cars, and we insist on free curbside parking in the public right-of-way, but we condemn people to homelessness regularly.

That doesn't add up either, and is another instance of a broke market that supplies wildly suboptimal outcomes.


Susann Kaltwasser said...

Last week I had to have some electrical work done. The electrician and I chatted about the current construction climate. He said that he has been working in Salem for the last 15 years and has never seen business so brisk as it is now. He was recently working on the South Block II and said that jobs were stacked up for weeks. I was lucky to get getting such quick service.

The thing he said is causing delays is that Salem and surrounding areas do not have enough qualified trades people. It is good that Salem has a technical high school and skills are taught at Chemeketa Community College, but it takes time to educate these people and get them on the job. Portland may be pulling some of the people out of the area as well.

I read where 50,000 skilled jobs go unfilled each year, because there are not enough people to fill those positions.

It is good to hear that more apartments are being built, but I fear that the rents will not go down. Even older apartments are raising their rates.

People are indeed doubling and tripling up in houses. This is putting pressure on neighborhoods with more points for conflict and changing their character.

Don't look to the ADU (Accessory Dwelling Unit) code to help much either. In the proposed language are rules to allow for someone to buy a house and then build an ADU in the back yard. The ADU can be up to 75% the size of the main house. So, it could easily be a 2-bedroom (750 sq ft) ADU on a lot with a 3-bedroom 1000 sq ft house. Or it could be a 1000 sq ft 3-bedroom house on a lot with a 1500 sq ft house. The set back from the next property line can be a little as 3 feet.

There is a proposal that the person who owns the houses does not need to actually live in either house. Therefore, it is not impossible for someone to buy a 3-bedroom house as an investment, rent it out to 3 to 5 unrelated people) ( a couple could live in one bedroom, and then rent out the 2 or more rooms in the ADU to separate people. This lot might thus have a de facto 6 rental units on a single family lot with up to 10 people living there. Off street parking might not be required either.

If you are looking for cheaper shelter, this all may sound like a good idea. To an investor it might sound like a great idea. Right now many rooms for rent are going for $500 a month, so a lot could easily generate $2500 a month.

I worry that people will see this as an opportunity to make some fast money, but not so good for the community as a whole.

The ADU code has not been completed yet. I hope that people will take a close look at the proposal because once it is accepted by the City Council these developments will be permitted and no one will be able to stop their neighbor from changing the character of their street.

I don't think people have thought too long or hard about the impact of someone building a two-story house in their backyard and renting it out to someone who can not only look directly into their yard, but be unsupervised by a landlord living in the main house. They like to sell the idea as 'granny flats' for you elderly parent, but in reality there is nothing that keeps them from being rental with loud tenants that will make your life miserable and destroy your property values.

And don't get me started on garage conversions, which is also coming in the ADU codes.

Salem Breakfast on Bikes said...

Shoot. In all seriousness, the preference for stasis in "no one will be able to stop their neighbor from changing the character of their street" is very much part of the problem!

The idea that there is some "neighborhood character" that should remain frozen in amber is a significant problem and not at all the way cities work.

At Strong Towns, Chuck Marohn has written "I’ve suggested that all neighborhoods – those areas around our transit stops as well as the broad swatch of single family homes – should be allowed, by right, the next level of intensity in their development pattern." He says by right! It should be automatically permitted.

If we cannot allow gentle increases in density like the missing middle, we will only get high density apartment blocks and single family neighborhoods. This feast-famine dynamic is not a healthy mix and we need to have a broader mix - more options! - of housing types and residential densities.

The problem may instead be that our current system of exclusionary zoning is set up so that people can think too much about "someone building a two-story house in their backyard and renting it out to someone who can not only look directly into their yard, but be unsupervised by a landlord living in the main house."

It is not possible to agree with you on some of this!

Here are three Strong Town pieces to consider (you might find more!):

"Golly, I wish I had a smaller house"

"More Landlords on the street"

"The challenges of building rental housing"

"How Urban Geometry Creates Neighborhood Identity"

Susann Kaltwasser said...

I think that codes can be written to accommodate ADUs in certain locations. The proposal at this point is too 'flexible' for most neighbors. We have a right to protect our property values. In my neighborhood there is a HOA that a prevents this, but in my old neighborhood where we used to live, there are numerous problems with people renting out rooms, and allowing RVs to park in unauthorized locations. The blight is evident. We could not sell our house when we moved because of the low market at the time, but now that a prices have come up, we can't sell because the neighbors impact the quality of the neighborhood. This is real, but we have no recourse.

If the code would require that at least one of the houses needs to be occupied by the owner then we might have true 'granny flats' or ADUs that are used by extended family members.

If it happened to you, you would care I am sure if you quality of life were impacted by your neighbor

I am not opposed to ADUs in general, but I am opposed to taking away someone else's property rights in the process. I think if the code were written as it is currently being discussed, this would end up in LUBA as a takings.

Best to write good code than to write something that is going to just hinder the process.

In any event the whole idea is something of such low value to solving the real problem of affordable housing in Salem, that it is exacerbating the problem. The City should have moved directly to identifying more multifamily property that could be re-zoned in an orderly fashion to address the issue.

Now there are bits and pieces happening all over Salem on small lots (1 to 1.5 acres) and it is not always logical to issues relating to transportation. I have two in ELNA right now. I expect more as the market pressure increases.

I am not a NYMBY. I have done land use for over 25 years in Salem, helped write some of the codes for RM and other issues and I know that even with the best of intentions, you do not always get what you want with some codes. Reversing bad code is not very easy. Best to be cautious.

Salem used to have the land Use Network where such things could be vetted. But now we have committees that are dominated by developers and only a few uneducated citizens. It is a recipe for trouble unless Neighborhood Associations are more aggressively involved. Right now they are not watching out very well.