Market Report – October 2007

Dear Clients and Friends,

Thurston County’s economy continues to be strong, so I hope we don’t get dragged down because of the bad news we hear every day from the press. Unemployment is down again to 4.2%, we’re still adding new members at all the Chambers of Commerce, tenants are upsizing, “building-to-suit” has not abated, people would still rather own than lease, and those are healthy signs. The Gateway project in Hawks Prairie and Great Wolf in the Grand Mound area should contribute jobs and prosperity to Thurston and adjoining counties.

In Washington, non-residential construction spending year over year was up nearly 15% (SSBJ). Slower housing starts will be a drag, but so far the impact is negligible. In Thurston County, the value of real estate property totaled $27.5 billion, up by $5.3 billion, an increase of almost 19%.

Property tax revenues in Wa increased 7.1 percent to $7.73 billion in 2007, with taxes on new construction accounting for nearly 20 percent of the $514.5 million gain during 2006, according to the state Department of Revenue. Taxes on existing properties, statewide, excluding new construction, increased 5.7 percent in the same period. For the 2008 tax year, Thurston County valuations on existing commercial properties were up 11%. Waterfront residence valuations increased an average of almost 20%. One can only hope that the millage rate is reduced, and that if values go down, appraisals will also.

Capital Gains. Some good news, some bad, both from the Kiplinger Tax Letter. First, the good: there may be a possibility that the time limits for tax deferred exchanges may become somewhat more flexible. Since several ‘facilitators’ absconded with a bunch of money and then declared bankruptcy, sellers weren’t able to complete their transactions. The IRS seems to have let up a little, which may provide a little wedge for some easings. The 45 day identification limit and the 180 closing requirements are extremely difficult to meet, prompting use of ‘reverse (1031) Starkers’ which the IRS abhors. Also increased is the use of TIC’s (Tenants in Common), instruments which pool money to buy properties. It is a quick way to buy real estate, but it means fewer individuals owning their own real estate, and in my opinion, that’s not good. Absentee ownership is less desirable for a community.

Bad news: new rules take effect next year. If taxable income, including long terms gains, hits the 25% bracket , the lower capital gains rate applies only to the portion of the gain that fits into the lower brackets. In 2008, taxable income (income minus deductions and personal exemptions) hits the 25% bracket at $65,000 (marrieds). Capital gains preferential tax treatment gets more and more eroded, which is contrary to common sense. Long holding periods should count towards reduction of rates. Now there is no distinction other that the one-year cut-off. I would prefer if they extended the cut-off to five years and then drastically reduce or eliminate the tax.

Many forget that capital gains also are a tax preference item for AMT purposes. It is no longer difficult to trigger this extra tax. If people would take the time to study their tax returns, they would be dismayed. With AMT, exemptions phase out as gains are taken. The phase-out starts at AMT incomes over $150,000, and exemptions disappear at $400,200.00 as do several other deductions. To the extent that gains cost exemptions, they are effectively taxed at up to 22%. Once exemptions go away completely, the AMT rate on any extra gain returns to 15%.

Speaking of income and taxes, the top 1% of filers (AGI of $364,000.00+) paid 39.4% of the income tax load, even though they had only 21% of total adjusted gross income. The bottom 50% of filers paid only 3.1% of total income tax. Although the FICA tax hits them the hardest, they also get relief from the earned income credit. I don’t mind progressive taxation, but I get really tired of hearing that the affluent do not pay their fair share of taxes…

Multi-family vacancies are at low levels again. A couple of reasons for the low vacancies are (a) a good economy, (b) condo conversions have reduced the supply of apt. units, and (c) it is harder to get a mortgage than it used to be. I wonder, though, what will happen when some of those condos turn into rental units…

Rental rates are climbing across the board: average rents for all units in Olympia: $749.00; in Tumwater: $795.00 and in Lacey $799.00. We are still quite a bit lower here than the regional average of $930. (Dupre and Scott)

Office rental rates have not declined, but there is an oversupply of space. When the big boys build huge buildings for the State, it vacates space in smaller private buildings. That is the main reason for the current oversupply. Tenants aren’t balking at rental rates so much as they are negotiating on tenant improvements, which is a big up-front number added to their start-up costs.

Retail is holding its own, but exploding in Hawks Prairie. Other places are softer, but could be worse. Again, there is a huge supply of new retail space coming on line, especially in Hawks Prairie, and at high prices $30.00 to $45.00. Folks are getting used to $30. and even $35. but probably will balk at $45. At least for a while. When the traffic picks up at Cabela’s, demand will accelerate.

Lacey is feverishly working on traffic issues in that area. An I-5 exit at Carpenter would help, but that is probably years away.

I read in the WSJ the other day that this year marks the 50th anniversary of Ayn Rand’s great work Atlas Shrugged. I read her books as a freshman in college. I knew, from living in Peron’s Argentina, that redistribution of land/wealth is the surest way to impoverish a nation. Those books of Rand’s galvanized my unformed and cloudy notions, and transformed me into the free-market capitalist that I am today. Profit is not a dirty word, and the fact that humans will act according to their economic self interest is a good thing! Every one of us has the right to produce and trade with anyone we choose. No one is coerced to buy or sell anything from anybody (except for GOVERNMENT, of course). Everyone can and should take pride in the wealth they create for themselves and others, and can use that wealth however they see fit, including spreading it around. If there is no profit, there is no wealth, and if there is no wealth, the quality of life is greatly diminished. And the surest way to build wealth is to work hard and save as much as possible. I also despise, as she did, those profiteers and crooks that give free enterprise a bad name. Those folks are not entrepreneurs, they are leeches, sucking the life out of the businesses unfortunate enough to be subjected to them.

Debt Coverage Ratios (DCR) vs Loan to Value (LTV) During the last several boom years, lenders didn’t really use DCRs as much as they used to, because rental inflation and property appreciation took care of the bank. Now we’re seeing a return of this requirement when negotiating a loan. Basically, what DCRs do is ensure sufficient cash flow to service the debt and then some. With this, even a higher vacancy than normal doesn’t throw the property into a precarious situation. DCRs reflect the relationship between Net Operating Income (NOI) and the debt service constant. The higher the DCR the more secure the loan, because a greater cushion of income is available to absorb negative developments that might affect the property. Example: if a lender requires a DCR of 1.30, that means that each $1.00 of loan is secured by $1.30 of NOI. When the NOI is divided by the DCR, the resulting figure is the amount of annual debt service (principal and interest) the property can easily tolerate. The lender plugs this in, along with the term of the loan, to determine the amount of the loan he/she will make on the property.

I’d like to welcome Lara White (receptionist/bookkeeper) to our shop, as well as Liz Myers as our newest agent. Liz has lived here forever. She and her husband Jim, a long standing dentist in our community, own a little winery in Nisqually called Medicine Creek. No, that’s not why I asked her to join us, but it does add to the plusses…

                                                                        Priscilla S. Terry, CCIM, ed.

Please visit our website www.primelocations.com to see a complete listing of our properties for sale and for lease, as well as a comprehensive listing of our apartment communities for rent.