INTELLIGENCE REPORT REGIONAL. Zero To Hero. UNITED STATES Page 1

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1 REGIONAL INTELLIGENCE REPORT Prepared by Beacon Economics, LLC Seventh Edition November 2014 Zero To Hero In 2008 the U.S. economy sunk into the deepest downturn since the Great Depression. By the end of that year most of the globe had followed the United States into recession and in 2009 global output shrank by over 2%, the first time that has happened since World War II ended. The United States was not the only country with a large housing bubble, nor were U.S. banks the only to indulge in over-leveraging even as they invested in highly risky assets. Nevertheless, it was clear that the United States was at the heart of the problem. Today, the global economy is weak again. Europe has yet to fully pull out of the recession, led by sovereign debt crisis, that it experienced last year. The BRICS (an acronym for an association of five major emerging national economies: Brazil, Russia, India, China, and South Africa) are also showing signs of trouble. China, while still growing, has slowed and its real estate markets are showing signs of distress. Brazil has slipped into a mild recession due to sagging commodity prices. Sanctions on Russia are clearly having an impact on that nation and India has also slowed sharply. The World Bank and the IMF have both had to scale back their growth outlook numerous times in the last few months. $ Billions 2,000 1,900 1,800 1,700 1,600 Non-Education Consumer Credit Q1-07 to Q2-14 Q1-07 Q1-08 Q1-09 Q1-10 Q1-11 Q1-12 Q1-13 Q1-14 Total Source: Federal Reserve Y-o-Y Growth Year-Over-Year Growth (%) But this time the United States is no longer at the core of the problem; quite the opposite, the U.S. economy will be an important source of strength globally as these nations work to reverse course and get back onto a growth trajectory. Nearly every part of the U.S. economy is showing real signs of slow but steady improvement, from housing to public spending to credit. The only portion of the economy that is acting as a drain on the nation is the export sector for all the aforementioned global reasons. That said, the U.S. economy will keep growing this year, but at slightly below 3%, a bit slower than last year. Next year, expect the U.S. economy to grow at a pace modestly over 3%, with the following year improving even more the growing momentum will be driven by improving fundamentals. Workers (000s) 20,000 15,000 10,000 5,000 0 Distressed Workers and Real Disposable Income Growth United States, Jan-04 to Sep-14 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 year LT Unemployed Marginal Disposable Income Growth Source: Bureau of Labor Statistics PT Economic Discouraged As for major risks, they remain largely external although there is nothing on the international front that could seriously derail the nation s economy. The global economy remains the swing item. If there is a better recovery than expected, then next year will be better than Beacon Economics current forecast. If it is significantly worse, then growth will likely dip into the low 2% range. Regardless, the U.S. economy will continue to expand for the foreseeable future Y-o-Y Growth (%) UNITED STATES Page 1

2 California Economy As the Great Recession fades from California s rear-view mirror, it is becoming increasingly imperative to focus on the structural challenges that the state faces over the long run. Fortunately, as the economy has healed and cities and counties are no longer plagued by the existential challenges of precipitous declines in key revenue sources, the state finally has the opportunity to address these challenges. Beacon Economics is currently forecasting that the California economy will continue to lead the national economic recovery, with growth picking up in 2015 and 2016 before settling into more normal rates of growth thereafter. As such, California should have more breathing room to tackle the major challenges it faces to improve growth prospects and solidify the economic base for decades to come, including improving educational attainment, finding sustainable solutions to the state s pension obligations, funding the infrastructure investments that are needed to maintain and expand the state s various assets, reforming California s Environmental Quality Act (CEQA) to reduce the cost of housing and make the state more friendly to manufacturing, and reforming our tax system and widening the tax base to mitigate the effects of future economic downturns. Despite the persistence of these longer-term challenges, California continues to show signs of economic improvement. As of September 2014, nonfarm employment in the Golden State jumped ahead of its pre-recession peak by more than 80,000 positions. While some sectors have performed better than others, every major industry in the state s economy has shown progress since hitting bottom in The unemployment rate has dipped to 7.3% from its peak of 12.4% even as more Californians have re-entered the labor force. Additionally, jobs are being created across the spectrum of wage categories, which is contrary to the media narrative that suggests the recovery has included primarily part-time or bad jobs. Indeed, California has enjoyed solid job growth in low-wage categories like Leisure and Hospitality, Administrative Support, and Retail Trade. However, the state s labor market has also created a sizeable number of new Healthcare, Professional, and Information jobs which tend toward the higher end of the wage spectrum. However, it isn t just the labor markets that have turned toward the good. Many leading indicators for future job growth remain in positive territory, as well. Business and consumer spending, as measured by taxable sales, are up by more than 4.5% through the first half of And, like employment, every major category of spending has increased on an ongoing basis, with the exception of fuel stations, which have seen the price per gallon of gas decline substantially this year. In addition, business investment continues to move forward in California. Indeed, with more than $5.4 billion in new venture capital deployed so far this year, the state has almost doubled the $2.9 billion in VC funding put into action at the same point last year. Much of this new venture capital funding has flowed to California s high-tech sectors of IT Services, Computers and Peripherals, Software, Industrial Energy, Telecommunications, Biotechnology, and Semiconductors all suggesting that more high-wage jobs are on the horizon. Nonfarm Emp. (Millions, SA) California Labor Markets, Jan-90 to Sep-14 Nonfarm Employment Reaches Record High Jan-90 Jan-95 Jan-00 Jan-05 Jan-10 Jan-15 Nonfarm Employment Unemployment Rate Finally, the real estate market has showed signs of ongoing progress. After precipitating the housing collapse, California s residential and (to a lesser extent) commercial real estate markets have become a source of economic growth once again. Through September, California has averaged a 14.9% annual growth rate in home prices. While home sales have been relatively lackluster, that is due almost entirely to the continued, precipitous declines in both defaults and foreclosures. While these declines in defaults and foreclosures have hampered the headline sales figure, they are ultimately a source of strength for the state as problem mortgages have largely worked themselves through the system. Commercial markets have been slower out of the gate, but both rents and vacancy rates are both edging along in the right direction. Fortunately, these improvements have driven ongoing gains in both residential and nonresidential building permit issuances. Through September, residential permits were up more than 1% over a solid 2013 and nonresidential permit values were 17.7% above where they were at the same point last year. The Great Recession is increasingly fading from view. Every major critical indicator in the state has shown consistent progress over the past two years. As such, Beacon Economics remains optimistic that the improved economy will enable policy makers in Washington, D.C., Sacramento, and across California to begin to shift their focus from a triage/survival mode to the long-term efforts that are needed to ensure that California retains its role as a leader of nationwide economic growth in the decades to come Unemployment Rate (%, SA) CALIFORNIA Page 2

3 Labor Markets The labor market in the East Bay maintained its upward trajectory over the last year. According to the California Employment Development Department (EDD), total nonfarm employment grew by 2.1% from September 2013 to September In fact, East Bay payroll employment is now just 2,000 jobs short of the pre-recession peak. On a regional basis, job growth did lag behind labor markets elsewhere in the Bay Area during this time period. Nonfarm employment in the San Jose and San Francisco metropolitan areas grew by 3.2% and 3.5% respectively. However, payroll employment in the East Bay did grow faster than the state and nation overall, each increasing 1.9% year-over-year. Employees (000s, SA) 1,060 1,040 1,020 1, East Bay Payroll Employment Sep-04 to Sep-14 Sep-04 Sep-06 Sep-08 Sep-10 Sep-12 Sep-14 The employment gains over the last year have been broadbased, but a large share of the job growth has been in the Professional, Scientific, and Technical Services industry one of the higher wage sectors in the region. From September 2013 to September 2014, this sector added 5,100 jobs: a 5.7% increase, which represented 24% of the net increase to payroll employment. A few other sectors made solid contributions to job growth as well. The Education and Health Services industry added 4,600 jobs (a 2.7% increase from September 2013 to September 2014). Construction (2,800/4.9%), Leisure and Hospitality (2,403/ 2.4%), and Wholesale Trade (1,900/ 4.2%) rounded out the top five contributors to the year-over-year increase in East Bay employment. Even the public sector has managed to turn the corner and is now contributing to employment growth in the region. From September 2013 to September 2014, Government added back 1,410 jobs, a 0.9% year-over-year increase. After relatively flat growth in 2013, public sector employment is poised to finally return to positive growth in 2014 as local budgets continue to heal. East Bay Payroll Employment Growth by Industry September 2014 (SA) Sep-14 1-Year 2-Year (000s) Change Change Total Nonfarm 1, Total Private Prof Sci and Tech Construction Transport,Warehouse,Util Wholesale Trade Educational Services Health Care Leisure and Hospitality Manufacturing Retail Trade Other Services Government Information Financial Activities Management Admin Support NR/Mining Very few sectors posted job losses during the year-over-year period. The largest decline was in the Administrative Support industry, which fell by 1.2%, or 680 jobs. However, many of these jobs were likely employees in temporary positions that transitioned to full time employment, which is ultimately a positive for the region. The Management of companies (-200/-0.7%) and Financial Activities (-175/-0.4%) industries also saw employment levels decline over the last year, but these losses were more than offset by gains in the region s remaining industries. It is important to keep in mind that payroll employment statistics do not capture self-employed residents or those working in neighboring counties. In comparison, household employment in the East Bay, which tracks employment of East Bay residents regardless of where they work, has increased 2.1% from September 2013 to September This is a healthy trend for the East Bay labor market as employment is growing among both businesses and residents. However, the gap between household employment and payroll employment, which tracks employment among business establishments, has increased over the last year, from 189,400 in September 2013 to 194,800 in September So even though overall employment in the region is growing, the number of East Bay residents finding employment Page 3

4 outside of the East Bay is growing at a faster rate. Meanwhile, the unemployment rate, also derived from the household survey, stood at 5.8% in September and has declined by 1.4 percentage points over the last year and is lower than the state (7.3%) and nation overall (5.9%). Employment (000s, SA) 1,260 1,240 1,220 1,200 1,180 1,160 1,140 Household Employment and Unemployment Rate East Bay, Oct-04 to Oct-14 Oct-04 Oct-06 Oct-08 Oct-10 Oct-12 Oct-14 Household Employment Unemployment Rate Consumer and Business Spending Consumer and business spending has continued to grow in the East Bay. Seasonally adjusted taxable sales in the region increased by 5.3% from the second quarter of 2013 to the second quarter of By comparison, seasonally adjusted taxable sales increased by 4.1% in Santa Clara County and by a substantial 8.4% in San Francisco County. Taxable sales growth in the East Bay slowed down somewhat over the course of the summer, as year-over-year taxable sales growth stood at 8.1% in the fourth quarter of 2013, outpacing San Francisco by nearly one percentage point. However, taxable sales in the East Bay are higher than they have been at any point in the past, thus a slowdown in growth is perhaps expected as taxable sales begin to grow in line with disposable incomes and inflation moving forward. Taxable Sales (Indexed, SA) Taxable Sales Bay Area Comparison, Q to Q Q2-09 Q2-10 Q2-11 Q2-12 Q2-13 Q2-14 East Bay South Bay Source: CA Board of Equalization San Francisco Unemployment Rate (%, SA) East Bay taxable receipts data show that spending increased in every sector of the regional economy from the second quarter of 2013 to the second quarter of The Autos and Transportation sector led the way with 11% growth in taxable receipts during this time. Employment and income growth is strong, and pent-up demand for large-purchase items is finally emerging. Moreover, Business and Industry spending grew precipitously in that time, at 10.3%. As described in the East Bay Economic Outlook in Spring 2014, high consumer spending increases business revenues, which then opens up opportunities for firms to spend on business services. Businesses also have more money to spend on travel, which, combined with growth in tourism, leads to an increase in leisure and hospitality spending. Thus, we can understand why taxable receipts from restaurants and hotels increased by 6.8% from the second quarter of 2013 to the second quarter of Sales Tax Receipts by Category East Bay, Select Quarters (SA) Q Q Year ($000s) ($000s) Change (%) Autos and Transportation 15,523 17, Building and Construction 8,427 8, Business and Industry 17,045 18, Food and Drugs 5,740 5, Fuel and Service Stations 10,829 11, General Consumer Goods 21,155 21, Restaurants and Hotels 10,390 11, Total 102, , Source: HdL Companies Taxable receipts from Building and Construction, meanwhile, edged up slightly at 1.5% year-over-year. Despite strong home price appreciation, construction activity has yet to grow at a comparable rate within the East Bay. This slow response, driven by a lack of developable land in the urban cores and high permitting costs, has shifted the construction of new housing to areas outside of the region. Residential Real Estate Even though home price appreciation has cooled considerably in the East Bay thus far in 2014, the housing market in the region remains relatively heated. The median price of existing single-family homes grew 17.7%, to $611,400, from the second quarter of 2013 to the second quarter of 2014 in Alameda County, while prices increased by 12.4%, to $451,000, in Contra Costa County. In comparison, prices rose by 13.6% in San Francisco and by 10.5% in the South Bay. Declines in distressed sales in the East Bay have contributed to the cool down, as the number of distressed properties sold at a discount has taken up a smaller share of the overall housing mix in the region. At the same time, demand for housing, which has been boosted by the continued relaxation of lending standards, historically low interest rates, and a gradually healing economy explains why the housing market has remained heated in Page 4

5 Median Prices ($ 000s, SA) Home and condominium sales in the East Bay continued their slide through the second quarter of Sales are down 8.9% year-over-year in Alameda County and 11.0% in Contra Costa County. Sales are down in the East Bay primarily because of the tight supply of housing in the region. Another critical factor is the decline in the number of distressed properties on the market. As such, sales will continue to lag in the East Bay until greater efforts are made to alleviate the ongoing shortage of housing supply in the region. Sales (SA, Indexed Q = 100) Existing Single-Family Home Prices Q1-04 to Q2-14 Q1-04 Q3-06 Q1-09 Q3-11 Q1-14 Source: DataQuick Alameda County California Contra Costa County Single-Family Home and Condominium Sales Q1-04 to Q2-14 Q1-04 Q3-06 Q1-09 Q3-11 Q1-14 Source: DataQuick Alameda County California Contra Costa County Much like the housing market, demand for apartments in the East Bay has continued to grow in The region s apartment vacancy rate declined by 10 basis points from the second quarter of 2013 to the fourth quarter of 2014, to 2.7%, and has been relatively stable during this time. Meanwhile, rental prices increased by 4.6% over the year, to an average rent of $1,517 per unit. The cost of rent in the East Bay accounts for an average of 39.1% of the median household income for renters in the area, compared with 43.3% in San Francisco and 35.1% in the South Bay. However, rental prices in San Francisco (6.8%) and the South Bay (6.2%) grew at a faster rate than they did in the East Bay during this time, widening the affordability gap between the East Bay and the rest of the Bay Area, thus making the East Bay more attractive to renters. Commercial Real Estate The demand for office space in the East Bay has gradually improved over the last four quarters. The office vacancy rate in the East Bay declined by 20 basis points from the second quarter of 2013 to the second quarter of 2014, although it remains elevated at 18.0%. Office space is equally available in the South Bay (18.1% vacancy), while the San Francisco office market appears much healthier at 12.6% vacancy. Meanwhile, rent prices for office space have grown only mildly in the East Bay. The average rent price per square foot per year only increased 1.9% to $26.72 in the second quarter of In contrast, rent prices for office space grew by 5.2% in San Francisco to $45.38 per square foot, and by 6.4% in the South Bay to $33.45 per square foot. The relative affordability of office space in the East Bay may help bring more tenants into the region. At the same time, the overall vacancy rate among retail properties only dipped by 10 basis points from the second quarter of 2013 to the second quarter of 2014, falling to 6.2% vacancy. The relatively slow decline in the vacancy rate is due to new units, totaling 181,000 square feet of retail space, coming online over the year. Additionally, the retail vacancy rate is relatively low, which limits how quickly it can fall. By comparison, the vacancy rate in the South Bay declined by 140 basis points during the same time period. Rent prices at East Bay retail stores continued to increase over the past year. This is partly a result of new and/or higher-end units being constructed, which tends to put upward pressure on prices. Rent prices in the East Bay grew by 1.4% from the second quarter of 2013 to the second quarter of 2014, reaching $28.38 per square foot per year and marking three consecutive quarters of rising rents. Demand for industrial properties continued to improve in the East Bay over the last year, both among warehouse and distribution centers and among flex and research and development (R&D) properties. At warehouse and distribution centers, the vacancy rate declined by 40 basis points to 10.8% from the second quarter of 2013 to the second quarter of Importantly, the East Bay has a much larger market of available warehouse and distribution centers: There was 13.2 million square feet of vacant warehouse and distribution center space in the East Bay in the second quarter of 2014, compared to 2.7 million square feet in San Francisco and 5.0 million square feet in the South Bay. Page 5

6 Vacancy Rate (%) Warehouse Vacancy Rates Q to Q Q1-10 Q1-11 Q1-12 Q1-13 Q1-14 Source: REIS Warehouse and distribution center rents increased by 2.2% in the East Bay from the second quarter of 2013 to the second quarter of 2014, reaching $5.16 per square foot per year. That year-over-year growth represents the steepest increase in rent prices since prior to the recession indicating that industrial property managers are seeing competition from potential tenants and upgrading their facilities to better meet tenant demands. Forecasts Beacon Economics is currently forecasting positive employment growth in the East Bay over the next five years. Nonfarm employment is forecast to grow in the 2% range over the next five years as the local economy continues to move forward. We expect the unemployment rate to fall below 5% by the middle of Employees (000s, SA) 1,150 1,100 1,050 1, East Bay South Bay Payroll Employment Forecast East Bay, Q4-94 to Q4-19 San Francisco Q1-95 Q1-00 Q1-05 Q1-10 Q1-15 Q1-20 Actuals Forecasts by Beacon Economics Forecast The Professional, Scientific and Technical Services industry is expected to remain a major driver of employment growth in the years to come. We are currently forecasting this industry to grow by 3.7% in 2015, and then average 3.5% annual growth thereafter. This rate of growth is faster than our projections for overall payroll growth, and as a result the Professional, Scientific and Technical industry s share of nonfarm job growth will continue to rise over the next five years. Based on the region s relative affordability advantage we are also projecting household employment to continue to outpace payroll employment growth over the next five years. As the East Bay continues to attract more residents willing to commute to jobs outside the area, we expect household employment to grow in the 1.5% to 2.5% range over the next five years and for the gap between household and payroll employment to grow to 220,000 by the end of With a forecast of strong job and income growth, Beacon Economics projects steady growth of taxable sales. Taxable sales are projected to grow 3.5% year-over-year by the end of 2015, ramping up to roughly 5% by the end of Growth in the residential and commercial real estate markets, as described in the Real Estate section of this report, should bolster consumer spending over time as more and more homes come into the market home price appreciation should continue to encourage more homeowners to sell. And population growth should provide a supplement to consumer spending in the region. Finally, we expect taxable sales growth to stay between roughly 4.5-5% until the end of Despite the persistence of supply constraints in the East Bay, price appreciation should slow down in the East Bay heading into We project that price growth will reach the singledigits in the fourth quarter of 2014, and prices will grow at an annual rate of around 5% over the next year. With prices starting to cool down, housing sales should start to turn around. Sales of existing single-family homes are projected to grow by 11.8% in the second half of 2014 compared with the first half of the year. This momentum should carry into next year, as we predict that total sales in 2015 will top the number of sales in 2014 by 11.8%. With market fundamentals as they stand, the biggest uncertainty regarding our forecast is the supply of available housing. Demand for housing in the East Bay has grown significantly over the past two quarters and should only get stronger in the year ahead due to the region s relative affordability and the continued relaxation of lending standards. Without a commensurate boost in construction activity in the region, prices will continue to appreciate rapidly, further chipping away at the region s strong affordability and extending the ongoing decline in sales. Page 6

7 About Beacon Economics Beacon Economics, LLC is a leading provider of economic research, forecasting, industry analysis, and data services. By delivering independent, rigorous analysis we give our clients the knowledge they need to make the right strategic decisions about investment, growth, revenue, and policy. Services Economic, revenue and occupational forecasting Economic impact analysis Regional economic analysis Economic policy analysis Real estate market analysis Industry and market analysis EB-5 Economic analysis Public Speaking Expert Testimony For more information, please visit About The East Bay Economic Development Alliance (Alliance) was created nearly 25 years ago with the mission of establishing the East Bay as a world-recognized region to grow businesses, attract capital and create quality jobs. Representing a broad network of cross sector members and resources on the eastern side of the San Francisco Bay, the Alliance serves Alameda and Contra Costa Counties and contributes to one of the world s most dynamic regional economies. Analysis. Answers Beacon Economics, LLC. All rights reserved.