Investing in Summit County
By Penelope L. Banks, CPA
Tax Partner, Gordon, Hughes & Banks, LLP, Frisco Office

The real estate investment brokerage company of Marcus and Millichap, in a new report, identifies three major factors that should support real estate pricing in 2004,with particular relevance for mountain towns in Summit County and surrounding ski resorts:

• Strong capital flows. An improving stock market would normally shift capital away from real estate and into common stocks. However, real estate has been a favorite for investors throughout the past economic cycle and should continue to attract both domestic and foreign capital despite lower returns over the short term.


• Orderly transition. Interest rates are likely to rise gradually as the economy improves and while this will result in an increasing cost of capital to real estate firms, it should be accompanied by improving rents and occupancies, so allowing fundamentals to catch up with prices.


• Expansion cycle. The U.S. appears to be entering a new expansion cycle with favorable projections for demographics and gradual job growth. This year, employment should expand by 1 to1.5 percent, below its historical average of 1.6 percent over the last decade.

The past three years saw falling demand and excess supply in the condo and apartment sector as the stock market declined and a jobless recovery prompted the Fed to drive interest rates to 40-year lows. As a result, single-family home ownership came within the reach of many former renters while simultaneously lowering the cost of developing new multi-family properties. The result was an increase in vacancy of up to 300 basis points from the cyclical low in 2000.

This year will see some relief for apartment operators but the market recovery will be a muted one. Rental demand will rise due to two factors: (1) falling single-family home affordability especially in ski resort towns; and (2) demand for apartments from the many renters who doubled-up or moved back with parents during the past few years.

However, strong demographic and immigrations trends, including a jump in the population sectors most attracted by apartments and an end to increasing single-family home affordability, means that tenant demand will grow steadily over the next several years. While prices have been driven upwards by the relatively predictable returns offered by apartment investments, strong investor interest since the 2000 bear market in stocks has meant that many investors have been unable to buy properties. As a result, any price weakness is likely to be brief.

The report notes that too many units remain in the development pipeline. With low cost financing available in most markets and investors ready to buy properties as soon as stabilized occupancy is reached, developers have incentives to keep building. The generally high cost of land and construction materials is forcing builders to construct luxury units despite the strong demand for affordable housing.

Commercial real estate investors may face higher borrowing costs in 2004, but the increase will not significantly alter the financial dynamics of most deals. Below-trend employment growth and a lack of inflationary pressures will give the Fed plenty of latitude to hold rates at or near the lows established in 2003 for much of 2004. With investors desperate for yield in a world of one-percent money market returns, and real estate's stellar performance throughout the recent bear market, financing with commercial loans offer a compelling investment alternative.

Lenders will keep spreads at or below their year-end 2003 levels for much of 2004. In the apartment and retail markets, this means spreads of 120 to 160 basis points over the 10-year Treasury for good-quality deals with loan-to-value ratios of up to 75 percent. Spreads on office deals will average 30 to 40 basis points higher. Seasoned borrowers will be able to book very low-leverage loans (LTVs of less than 50 percent) on top-quality properties with spreads at or below 110 basis points over Treasuries. As real estate market fundamentals improve, lenders are likely to ease underwriting standards, which will reduce costs for borrowers seeking higher leverage.

How does the report’s findings impact what realtors and developers have been experiencing in mountain towns? The prediction for mountain towns is continued brisk sales for 2004, in spite of the past two years’ of declining values caused by Colorado’s slow economy and an over-supply of inventory. Investors moving out of the stock market and into real estate, as low interest rates made property more attractive, was one reason for the uptrend in sales.

Joyce Nenninger, broker/owner of Summit Real Estate, believes that the recovery in Summit County will be largely due to the wave of ‘baby boomers’ who are now beginning to move into retirement, or at least think of retirement options. Many boomers are in their peak earning years, may have received some inheritance money, and may be cutting down on work schedules. Many of these boomers, already current second-home owners, are finding that they want to sell their smaller part-time condos and move up to a property that feels more like a permanent residence.

Inventory is currently limited in some segments of the market, interest rates are still low and buyers are eager to purchase before the next wave of increasing values. Summer 2003 saw the beginning of a literal explosion in real estate sales. For example, overloaded inventory was significantly depleted by investors snapping up condos in Keystone that were selling for roughly 15% less than the original price paid 3-5 years earlier. Properties in the Keystone area are now appreciating again, but at a more reasonable rate. After two years of very limited speculative building, contractors are back at work. Frisco, for example, is undergoing some of the most significant and concentrated building seen in the past 20 years.

The increasing popularity of condominiums is expected to continue throughout 2004, driving construction starts of for-sale multi-family units to highs not seen for the past 10 years. David Seiders, chief economist of the National Association of Home Builders says that condos represented slightly more than a quarter of all multifamily development started in 2003- a share that approaches that of the 1987 and 1993 booms in condo construction; and that rate is likely to continue to rise in 2004. According to Joyce Nenninger, it is the ‘baby boomers’ who are investing in mountain property as good investments and a place for family reunions with children and grandchildren. Even if the percentage of ‘boomers’ who buy vacation homes just matches the roughly 7% of their parents’ generation who have done so, estimates call for a 40% rise in vacation home owners in the next decade.