Published January 2005

2005 market depends
on jobs, interest rates

Forecasting real estate is a bit easier than forecasting other investment markets simply because the supply side is fairly stable and easy to track. One need only watch the pipeline of building permits and projects in development to know where supply will land in the near future. It just isn’t that volatile.

The demand side of income properties — both residential and commercial — is tied very directly to jobs. For residential rentals, mortgage interest rates are a major influence as well. The variance between a residential rent payment and a residential mortgage payment is a variable that very directly impacts demand. But if home values and rates move up at the same time, which is likely in 2005, the variance is even wider.

Mixing all of these factors together results in a forecast for real estate investors for 2005 that could probably be summed up in one word: improving. The consensus seems to be that we’re out of the bottom of the down cycle and at least making momentum in the right direction.

But it is relative. For example, move-in specials for a 12-month residential lease in most of Snohomish County were between one month and two months of free rent in 2004. A reduction in these to half of one month’s rent in 2005 would bring 4 percent more revenue into investors’ pockets on the average apartment building. An equilibrium market presumes no concessions at all, however. So 2005 — while likely to be an improvement over 2004 — will still probably deserve only a courteous smile rather than a hearty round of applause.

To some degree, investors’ performance in 2005 depends on what segment of the real estate market we’re talking about. To a great extent, job growth locally and whether interest rates move up more than 500 basis points during the year could be the “X factor” in determining improvement.

With so little sizable single-family housing tracts in the pipeline, it’s no stretch to assume home values might, in fact, stay on the same rise in 2005 before values stabilize. Such a doubling up of value and interest-rate increases could widen the gap from renting to homeownership and help support the rental market.

On the supply side, the pipeline is virtually dry with residential rental product. As a percentage of its total size, in fact, the 2004 Puget Sound rental market produced one of the lowest levels of new supply in over 20 years.

Because Boeing was hit so hard by the terrorists’ use of airplanes as their weapon of choice on Sept. 11, 2001, Snohomish County development was perhaps the driest in the region as developers decided to avoid building anything that depended on the airline industry until they could see an obvious recovery. Only now are we hearing some chatter to build again.

But since it takes months and sometimes years to convert land into rental property, it is safe to forecast at best a trickle of supply in the pipeline in 2005. Developers will want to wait for another reason anyway. They’ll want to see the market absorb more of the current 6 percent to 9 percent residential vacancy rates before they jump back in.

The commercial office and retail forecasts are really two different stories. Excluding the recent Alderwood mall addition, there isn’t a great deal to talk about on the supply side in either of these product types.

But the recession of the past few years clearly hit the office market harder than retail. Consumers kept consuming retail products through the recession, so retail has survived and is forecast in 2005 to continue a relatively positive trend in Snohomish County. Retail, of course, is very location specific. So there are always winners and losers in retail in any market condition.

Office product has pockets where demand actually exceeds supply in certain types of space. Commercial real estate agents report that downtown Everett, for example, is undersupplied in the Class A or B+ uses. A tenant looking for 5,000 to 10,000 square feet of quality office space will have to pounce on the vacancies created when the county exits some of its roughly 30,000 square feet of leased space to move back onto its expanded campus, or that window will close quickly. There’s not enough demand to justify another 100,000-square-foot building in downtown Everett the size of the KeyBank Tower (formerly EverTrust Tower), but tenants in this product type have fewer choices than their counterparts in Bellevue and Seattle still enjoy.

South Snohomish County is seeing some pick-up in demand and forecasting an improvement in the office market as well. But that end of the county has plenty to absorb, having perhaps been more impacted by the dot-com boom and bust than other parts of the county. A few major acquisitions late in 2004, though, are shoring that market up quickly.

Back to demand. Snohomish County’s most powerful demand force for residential and office space is still King County. When King County experiences business expansion, its prices rise, and Snohomish and Pierce counties begin to look attractive again on a cost comparison basis. But King County rents contracted in the post-9/11 period, narrowing the difference in rental rates in nearly every category over the past three years. If King County recovers in 2005 and that rent difference widens again, Snohomish County will see a second injection of demand that most local forecasts do not contemplate.

Regardless, 2005 will surely look busy. Road improvements to I-5 between the Boeing freeway and Highway 2 are bidding out now. Contractors competing for the work already are scrambling to identify office, parking and residential space to rent if the work starts as planned. Those real estate pockets will get a mini-lift from this transportation project, benefiting office and residential properties alike. Such pocket boosts tend to push demand around to other areas, thereby helping the market overall, most likely in mid- to late 2005.

Tom Hoban is CEO of Everett-based Coast Real Estate Services, a property management and real estate advisory company specializing in multi-family and commercial investment properties. He can be contacted by phone at 425-339-3638 or send e-mail to tomhoban@coastmgt.com.

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