2011 looks like rehab year

Uncertainty. Challenges. Slow recovery for those who are already lean and mean.

That’s what’s in store for the Northern Colorado economy in 2011, which should be a better year than 2010 – and way better than 2009.

To discuss the shape of the coming year, as well as what we’ve been through in the past 12 months, the Northern Colorado Business Report assembled a group of industry experts to sit down on Dec. 6 in the conference room at First Western Trust Bank in Fort Collins.

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Larry Wood, chief lending officer at First National Bank, represented the banking industry; Marcia Coulson, CEO of Eldon James Co., a manufacturer of plastic fittings and tubing, with facilities in Loveland and Fort Collins; Josh Guernsey, principal and partner with Brinkman Partners, a commercial brokerage and development firm that also includes Brinkman Construction, a general contractor, in Fort Collins; Jessica Hergenreter, director of Employer Solutions Group – ESG – which provides HR services for businesses throughout Northern Colorado; and Eric Thompson, president of The Group Inc. Real Estate. Andy Grant of Grant Farms was scheduled to attend but could not join the discussion.

Questions were asked by Kate Hawthorne, editor of NCBR; Steve Porter, staff writer who covers health care, agribusiness and natural resources; Joshua Zaffos, who covers technology and green business; and Jeff Nuttall, publisher.

KATE HAWTHORNE: First of all, how did 2010 compare to 2009? Let’s start with banking.

LARRY WOOD: In 2009, everybody started to recognize that there’s a problem out there. In 2010, it’s been more, ‘Okay, now we’ve accepted it. We have to move some toxic assets off the balance sheet. We have to improve our capital.’ And so we understand that, and then you have the regulators jumping in and putting restrictions on the banks on their capital and on their reserves, which causes a major problem. So 2010 was kind of that acceptance and realizing what the regulators were wanting and trying to figure out how to get it done. Most banks have gotten it done. And then 2011 is really going to be similar to 2010, although I don’t think you’re going to see more banks getting in trouble, because everybody is in trouble already. It’s not going to be a real banner year, because you need to make loans and make money off of your deposits, and we really don’t have that in 2011 yet. I don’t think the confidence is there for people to borrow money.

MARCIA COULSON: Manufacturers pretty much got lean and mean in 2009. They decreased inventory. They laid off extra personnel. And then we experienced about 18 percent growth in 2009, even though it was a concerning year. This year, we had about 33 percent growth, and we found that customers were once again stocking products, building more products, and this year was a delightful year. Every once in a while you get a year that makes you appreciate the good things, and 2009 was that year for us. Then 2011 looks like a lot of seeds have been planted and it could be a banner year for us and other manufacturers that we work with. We get a pretty good feel for the industry, because we do sell components to a lot of different industries. So across the board, we’re experiencing growth, even in the automotive market that’s been hit pretty hard.

JOSH GUERNSEY: 2009 was a year everyone was running scared, trying to figure out what’s happening. 2010 was more of a year of being conservative. We’re seeing transaction volumes come back, both on the leasing and the sales side, so that’s been the positive indicator. So I’d say we’re in some form of recovery into 2010, and looking forward to 2011. I think it’s going to be better than 2010. You’re seeing an overall stabilization of the market. Lease rates have stabilized, vacancy rates are stabilizing, and you’re starting to see positive absorption, especially in office space, which is a great indicator. Because as that space gets absorbed, the next step will be moving forward, and it’s going to create development opportunity. Everybody got lean in 2009. And I think it’s going to make for a healthier market going into 2011.

JESSICA HERGENRETER: From a regulatory perspective, in 2009, we started to see federal enforcement that was up, both on the Department of Labor side and on the OSHA side. And with that enforcement comes increased regulation, and unfortunately, that happened at the exact same time that employers were having to operate leaner and get back in their business, and the last thing that they had time to really think about or deal with was increased regulations. So 2009 was a reactionary year for the way regulations were dealt with at the federal level. In 2010, as you know, the health-care reform was enacted, and I think it’s a symbol that a lot of employers are scared of it, and don’t really know where to get resources to understand how it’s going to affect their business.

For our client base, we’re not stabilizing. We thought we had seen the worst of layoffs in February and March. We had a little bit of recovery in April and May. We did not see the summer recovery like we usually do in payrolls. Payrolls are down in our businesses about 27 percent, and we’re continuing to do layoffs throughout this month. But health-care reform, is, I think, a challenge for 2011.

ERIC THOMPSON: In residential real estate, 2010 was a pretty interesting year, a year with virtually the same number of transactions compared to 2009 and with essentially flat prices. But I think three things come to mind when we look back on this year. Number one, 2010 was really the tale of two halves of the year because of the tax credit. It had to be under contract by the end of April and closed by the end of June. So that created a big surge of activity in the first half of the year. So things did fall off through the summer in the last year, but we’ve seen a rebound of things returning back to normal, more like the end of 2009.

The second thing is how our markets compare to other markets across the nation, and I’m continually reminded how good our real estate market is, comparatively speaking. The Fort Collins/Loveland market over the last year, the prices are up about half a percent, that puts us in the top quarter of metropolitan areas nationally.

And the third thing that comes to mind for 2010 is we saw the emergence of what we call a dual market. Below certain price points, you could be a seller in a seller’s market, and if you were moving up, you could be a buyer in a buyer’s market. If you have less than six months of inventory in a price range, it’s a seller’s market. More than six months, it’s a buyer’s market. So, for instance, in Fort Collins, if you were selling a home below $300,000, you’re selling in a seller’s market; and if you’re moving up to a home that’s $450,000, you were buying in a buyer’s market. So we saw these distinct breaks in all of our markets in Northern Colorado – that was a pretty neat dynamic.

THOMPSON: We just had Dr. Lawrence Yun here. He’s the economist for the National Association of Realtors, recognized as one of the top 10 economists in the country. He was making the point that the 2009 and 2008 vintage of mortgages are some of the strongest ever, if not the strongest ever. So initially, you think, what a great thing. His point was it’s not great news, because what that’s telling him is that mortgages are too strict right now, for good reason. Banks are really having to be extra-conservative on who they lend money to, but it’s telling him that things are too cautious, too conservative, and we need to loosen our grip.

HAWTHORNE: On the commercial side, are you still having challenges with financing?

GUERNSEY: Absolutely. You have to fit in a pretty small box to get a commercial project financed right now, and that small box is usually owner-occupied real estate. Some investment deals, it’s going to be a really strong deal with a really strong borrower for those to get financed. I think that’s going to be our biggest challenge, going into 2011. And the other thing we’re faced with on the commercial side, a lot of these loans were made in 2006, 2007, 2008, and had five-year maturities on them. So now 2011, 2012, 2013, those loans mature, and the values are down. Banks are going to need new ratios. So I see that being a huge, huge challenge going into at least the next year or two.

HAWTHORNE: And what are the challenges on the bank’s side?

WOOD: There are a lot of challenges. If you’re on some sort of regulatory watch, the guidelines that you have to live within are onerous. They are very hard to maintain. It’s basically no exception. So your debt-coverage ratios, your loan-to-values, have to be within that box you’re talking about. And so hitting that box in today’s market is very hard because the loan-to-values, generally, are out of line. People don’t have the cash to pay it down.

On the mortgage side, it’s the same thing. You have guidelines that have to be hit, and you have to have cash in, so people want to wait to get back to normal. It’s a new normal right now, and we’re living it.

We are trying to lend money. All the banks are very liquid. If you look at their financial statements, they have a tremendous amount of cash. Normally, you put it out in Fed funds overnight to make money. Fed funds right now is paying zero. On those deposits, we’re paying FDIC insurance at the highest level we’ve ever paid, and at the same time, we have all of this cash sitting there losing money.

And people aren’t wanting to borrow. People want to get out of debt. Getting lean and mean is getting rid of those monthly interest payments. And so it’s just kind of augers in, then, as you try to loan money, you have all of these things working against you and you can’t get it done. We’re going to need confidence to come back, people to take a chance. And people don’t have that confidence to take a chance.

HAWTHORNE: And how long do you think it might be before the brakes get put on the auger-in?

WOOD: I think it’s going to be a little slower for the rest of the United States, but I have a real positive on Northern Colorado. I think by the end of 2011, we’re going to see a lot more jobs come online, particularly in Weld County. You have Leprino, which is going to be hiring 300 to 500 people. You’re going to have to come up with 95,000 more dairy cows in Weld County to provide that milk. That’s a lot of construction, a lot of new animals in the market. The ag industry is going to continue to grow over there.

Vestas, they’re still coming out of the ground down in Brighton. That’s going to be a large number of people that they’re hiring. You’ve seen JBS Swift, the largest meat provider in the world, their headquarters are in Weld County, and they’re looking at doubling the size of their corporate headquarters.

So you have a lot of jobs coming on, but it’s going to require some construction and some time, and that’s not going to happen until toward the end of ’11, so ’12 looks like it could start up, and we’re really looking at ’12 to start up and ’13 to be back into making new loans and doing a lot. 2011 will be fairly flat.

HAWTHORNE: There are lots of people, obviously, who need jobs. And there are companies that are hiring. So what’s the disconnect?

COULSON: We are offering jobs $12 and $14 an hour and finding that people would rather stay home and collect unemployment. So the government is de-incentivizing people to go to work. I’m starting to ask in interviews, ‘What have you been doing since your last job?’ And I’m starting to discriminate against those who have been sitting at home for two years, collecting money from the government. So I have a real problem with that, because I think they could have been working but have been incentivized to stay at home and collect unemployment. So we have a real problem, and then you’ve got people who have been sitting at home for two and a half years. They’ve fallen behind on work skills, work ethic, organization at work, perhaps, and they may not be employable even at that $12 to $14 anymore because they’ve lost track of their computer skills and working with other people skills and working with other people.

HERGENRETER: Just in the state of Colorado, we had benefit payments in 2005 of $305 million, and in 2009, we paid $1.06 billion in unemployment benefits. And then what I’m really worried about is that in June 2009, the insurance fund in Colorado had a balance of $340 million. Persistent weakening of the economy because of layoffs and people paying taxes in, we’re now at a $20 million shortfall. We’re borrowing $22 million a week from the Federal government, and this unemployment rate is something that we’re not talking to our employers about. We’re seeing a 30 percent increase on our client companies on unemployment.

COULSON: Who pays into the unemployment fund?

HERGENRETER: Just employers.

COULSON: So now we’re borrowing from the Federal government. Who’s going to pay that fund back? Just employers. And employees act like its their money. But it’s the employers who fund it. I think if we run it like any other business, you go broke, and that’s the end of it. The economics of the whole thing don’t make sense.

HERGENRETER: In addition, in Colorado, we pay to the first $10,000 of employee per year. One of the lowest in the country. Our surrounding states are $25,000, $30,000. So they extend unemployment benefits again. I don’t know how they’re going to fund it.

HAWTHORNE: So if we were suddenly in charge of fixing this unemployment problem, what would we do?

HERGENRETER: First of all, and I know that it can’t be that black and white, but I think there needs to be rules of engagement. I think the state has to help us understand better how unemployment tax rates are calculated and how over time, we can be effective at managing that expense. Workers’ Compensation does it perfectly fine. Your history stays with you three years. You understand it’s because of experience, and that model would work for unemployment. They kind of do that, but then they add on all these little charges that nobody understands. That’s the problem.

COULSON: You never know what you’re capable of doing until your back is against the wall. So I think, if unemployment is broke, it should go away. There’s a fund that can be replenished.

STEVE PORTER: How do you reduce unemployment and pay those benefits? One of the best ways of doing that is job creation, good jobs that people want to go out and get. And so what I’m hearing from everybody here is that things are looking better for 2011 – manufacturing, hiring, commercial and residential real estate – and that has happened under some very tight lending restrictions. I’m wondering if people think that now is the time to relax those federal lending rules a little bit, or if we should just keep squeezing the economy on to a better day?

WOOD: I’m not sure that relaxing them is going to bring a lot of people to the table. We beat the streets looking for people that want to borrow money under any circumstances, and we’re getting zero. It’s just a minimal number of people that want to borrow. You talk to somebody about getting those interest-only for the first 10-year mortgage loans. People are afraid of those. They’ve heard all the negatives, so even if you had some of those products available, I don’t think people would take advantage of them. So I’m not real sure that loosening up is going to help an awful lot. I think the confidence has to build a little more.

PORTER: The money’s got to be there to create jobs, to expand the production lines and so on.

WOOD: But they have to know that they have something to sell. There are some real successes. Look at OtterBox. They’ve doing very, very well, but they’re an anomaly in the market right now. I think 2011 isn’t going to get any worse, but I don’t think it’s going to get a hell of a lot better. And I think that’s good. If we can stop the slide, that would be good.

But in talking to some of the employers, I had a couple of things. Aren’t we also experiencing a lot of people that lost a lot of money, they were 65 and lost it in the market, and that group is coming in and filling in some of those jobs also? So it’s not that when the unemployment runs out, those jobs are going to be available. They’ve been filled. So those people are going to be out there without a job waiting.

HERGENRETER: You’re right, the jobs are being filled, but I think from an employer perspective, we’re not always getting what we think is the candidate we want right away. At the same time, we have college graduates coming out, highly educated, who would be great for new thinking, innovation, new ways of doing things, but your 65-year-old, 70-year-old employee, they’re not leaving their jobs. And now what we’ve been seeing in the last year is a lot of these 23- to 27-year-olds are not even coming into the workforce. They’re actually just re-enrolling in college. So one thing that I think will be interesting is, we look to hire office managers who have master’s degrees. What does that mean to us for hiring, particularly in Fort Collins? We have a highly educated workforce anyway. So it has all these unintended consequences.

HAWTHORNE: So we might as well talk about benefits, and health care reform.

HERGENRETER: So the first thing that I think a lot of employers are really struggling with right now is whether to grandfather or not to grandfather. If you had a health plan in place before March 23, 2010, that became your plan; and if you didn’t want to make any changes to it and you wanted to keep it, then all of a sudden, you could call it a grandfathered plan. But to keep this grandfathered plan, you couldn’t make any significant changes to it.

So why would someone stay grandfathered? The biggest effect working right now is on small to midsized employers who have a benefit plan that gives greater benefit to highly compensated employees – we call them management carve-outs. For example, the top five executives, they want to pay a hundred percent of their premiums and their family’s premiums, but for the rest of the employees, they only pay 50 percent or maybe they don’t offer it at all. During grandfathering, you can’t make significant changes in your plan in terms of benefits, pensions. If you do, and you don’t offer it to all your employees, you’re going to pay a $100 tax per employee per day.

I don’t think it’s inhibiting people from hiring, but I think it’s freaking them out from offering health care. In conversations, it’s been so bad for the last couple of years anyway because of rate increases that they’re saying, ‘I don’t know where to go with this one.’

PORTER: Don’t you think there’s a lot of information on the Internet, particularly from the federal health-care reform site, to enlighten people?

HERGENRETER: It’s very directed for the consumer, to the employee. There’s some information for small businesses, but there’s not a comprehensive solution say, ‘OK, I’ve got 25 employees. This is what my plan is doing. What do I have to do this year? What do I have to do the next year?’ It’s hard to get somebody to bring you through the whole life cycle. Everybody has their fingers in it. Health and Human Services. IRS has a piece of regulation. And the Department of Labor. If you have a full-time person to do the regulations, who do you start talking to first? And we’re waiting for interim final regs.

Is there anything good in it? There’s a small business tax credit. If you have 24 or fewer full-time employees whose average compensation is less than $50,000, you can get a tax credit of 35 percent of the employer’s portion of the premium. But it’s a degrading tax credit. So for every employee over 10 and every wage over $25,000, the tax credit starts to go away.

We have a nonprofit here in Northern Colorado. The average person makes $37,000 a year. They’re not high income earners, and they have 27 employees. By the time we did the math, which took us almost two hours, their tax credit was zero. The important part here is – by the time we did the math. We do all their HR and payroll, so we have really good data. How many employers really have that kind of data? They don’t.

So if you have 10 employees and everybody is making about $27,000 a year, yeah, those aren’t people who have health care. We’re trying to incent them to get the health-care plans, but even at 35 percent of the tax credit, it’s not helping.

Because everyone was talking about health-care reform, the HIRE act got passed unnoticed. But essentially, most people benefited from the HIRE act, because if you hire employees that haven’t been working for 60 days then you didn’t have to pay the employer FICA match this year. And if you retained them for 52 weeks, you got an additional tax credit. That is a tax benefit that employers could really use.

The other benefit that we have to talk through is the cafeteria plan. In a cafeteria plan, you have a plan in which you have 100 or fewer employees, you could say, I’m going to give you 400 bucks a month, and you guys go buy your benefits with it. That’s really a cool way to do it, and people really get engaged in that, and you see your participation go up. But it used to be, you’d have a whole lot of documentation and things like that, and they passed the cafeteria plan health-care reform. That’s a benefit.

You know, in 2012, we’ll have to report, on their W-2s, employees’ cost of health care. The government wants to know what that is. So again, for people who outsource this stuff, it’s easier, because hopefully, their provider is tracking these things. For the small employer who is writing payroll in QuickBooks, are they tracking that? I don’t know. I think it’s going to cost them time, money and energy, and I think the penalties are frustrating, because there’s not a lot of recourse in how you do it.

HAWTHORNE: And I know that a lot of the people who work for The Group are not employees, right? So is it even more complicated for you, Eric, or would it be an incentive to make everybody an independent contractor?

THOMPSON: We have close to 200 real estate agents as sales partners, and they’re all independent contractors, so in some ways, it makes it less complicated. But they’re out on their own, trying to find their own health insurance, and that gets incredibly expensive.

HAWTHORNE: Have you had anybody say, ‘In this market, I’m not making any money, I have all these expenses, I’m not selling real estate anymore’?

THOMPSON: Across the country and in the state of Colorado, we’ve seen the number of real estate agents drop. I think nationally the numbers are down 10 percent compared to last year. Just like we saw a run-up in health prices and transactions, we actually saw a run-up in the number of real estate agents, and frankly, people weren’t in business for the right reasons, people that shouldn’t be selling real estate anyway.

HAWTHORNE: Do you think as a result you have people there now who want to be there?

THOMPSON: Absolutely. What’s going on now in real estate is exciting, and what that is, for four years in a row, we had flat prices. That’s never happened in 30 years of recording price history. So the value of the real estate agent, what they need to bring to the game is how to help a seller price their property, because in the past, you could get away with overpricing a property, because even if you have one year that was down, the next year it was going to bounce back up. That was, in essence, a safety net of overpricing of property. The market would eventually catch you. Now that’s not happening.

Where a seller in Northern Colorado – again, one of the more healthier markets in the country – puts their property on the market, and they have only 50 percent odds that that property is going to sell. We’ve been tracking to see what happens, properties that are priced right on day one versus properties that are not, and it’s staggering, the difference. The properties that are priced right on day one will sell two to three times faster than properties that need reductions over time. Properties priced right on day one will get 98 percent of list price. Properties overpriced will get 95 percent of price. I’m not talking 95 percent of first list price. I’m talking 95 percent of the last list price. So, yes, we’re ending up with just a stronger, more distilled agent force out there helping sellers through one of the more challenging, complicated times that we’ve ever seen in real estate.

HAWTHORNE: And how is the inventory of foreclosures?

THOMPSON: Well, this is another area where we’re shining compared to the rest of the country. Our rate of foreclosures is about half compared to the rest of the country. So we’re not seeing the level of impact that other places are seeing. Depending on the market that we’re looking at, we’re between seven and nine months of inventory overall, and again, by definition, anything less than six months is a seller’s market. So, yes, it’s a buyer’s market overall, but I think our inventory levels are fairly healthy.

Short sales are a challenge right now for sellers. Short sales have become more complicated. It puts the seller in a hard position, because they cannot get an answer from the lender, and also puts a buyer in a hard position, because the buyer is waiting, waiting, waiting for the short sale to be approved. And meanwhile, they’ve taken themselves off the market. They’re seeking other opportunities to buy a home that may come up. We’re seeing that these transactions take weeks and weeks to get approved, and it’s very frustrating all the way around. That’s something that needs to be addressed, I think, on the national level.

WOOD: The problem is the bank has to decide they’re going to take a loss. And they’ve got to write that off, and generally on a short sales, no chance of getting it back, because what the seller is going to say? ‘Either take the short sale or I’m going to file bankruptcy.’ What do you want to do, fight through the bankruptcy, or do you want to sell the property? And when you’re dealing with a bank, it’s not a decision just on selling that house. One, you catch a lot of grief if you sell something cheap in the market and affect the comps for the neighbors and somebody else that you have a loan with down the street.

The other thing is you’re having to watch your equity capital in your organization. And the only way you can take that loss is if it comes out of equity, so you may not have enough equity to take that charge off. So the chief financial officer becomes the big decision maker on whether or not to take that short sale, not the logic of, does this make sense and shouldn’t we just move out of it? And then you don’t want to create comps that you’re going to have to live with.

GUERNSEY: Speaking of the comps, that’s a huge issue on the commercial side. Say you have an arm’s-length transaction on a piece of land. Buyer, seller, agree on a price so, you know, here’s the contract price. Appraiser goes out and does the appraisal. He’s got four good arm’s-length transactions. They all support that value. And then there’s two that the bank had to sell as a foreclosure-type deal, and these comps come in low. How do you reconcile that as an appraiser? Are those market value? Should they be included in the value on the appraisal? Looking forward to 2011, I think it’s going to be a huge issue. How do you reconcile and what is the market value of that property, given the distressed comps that come into play?

WOOD: You can’t hardly do an appraisal without using those comps. And appraisers have been under strict notice, several under indictment in the area. Some will probably do jail time. So the regulators, they really review those appraisals when they come in and have to make sure they’re correct.

I don’t think we really know what anything is worth right now. We’ve had multimillion dollar properties sell for six figures, and is that a comp? Is that really what it’s worth? Or is that what it’s worth today when I have to get rid of some toxic assets? And is that a value we want to go forward with? And a lot of those foreclosures are selling under the cost to build. We have a lot of unemployed subcontractors, so it’s real cheap to build a house now, you’d think. But it’s hard to find a subcontractor. Find a drywaller. They’ve gone and taken jobs elsewhere. So it’s not cheap to build new, and those foreclosed properties, they tend to be the cheaper thing to buy.

HAWTHORNE: Has that been an issue on the commercial side?

GUERNSEY: I think as painful as it’s been for all sectors, I think it’s been a healthy cleansing process. Better agents coming on the back end of it. A lot of the guys dabbling a little bit in commercial, they’ve kind of gone away. So I think there’s a more professional level on the real estate side. I think on the construction side, it’s created a great opportunity, because there’s been some whittling down of companies, and it’s created a huge talent pool out there. Our industry is one of the hardest ones hit, and yeah, you have to wade through all the resumes, and there’s a lot of people out there looking for work, but there’s some incredible talent. A young company like ours, looking to grow and looking to capitalize on opportunity, that has created a tremendous opportunity there is going to be less competition on the back side of this whole downturn.

HAWTHORNE: So has inventory affected you? Did we overbuild office just at the wrong time?

GUERNSEY: I don’t know if it was an overbuilding. I think we were building for the velocity at which the market was growing. So the amount of space on the market affected the health of commercial real estate. But that’s starting to get absorbed now. We saw about a 25 percent reduction in overall rental rates, so those have stabilized. And I think we’re seeing, as those stabilize, the health of the market coming bac