The North Dakota Office of State Tax Commissioner recently reported a $63 million shortfall in anticipated sales tax collections in December of 2015. Sales tax collections have declined by over 50 percent in some oil patch cities. Even with a massive state investment program and projects that were financed prior to the recent decline in oil prices, sales tax revenues still collapsed.
Plunging sales tax revenues may only be the tip of the iceberg of what may be an even larger systemic problem starting to develop in the formerly “white hot” North Dakota real estate market. If sales tax collections are any indication of what the future holds, there may be big trouble on the horizon for local real estate markets and local governments who rely on property taxes to finance budgets.
The recent real estate boom in the North Dakota was primarily based on the expectation of continued population growth and high wages. Developers and investors made assumptions that oil priced would never go below $60 per barrel and that an endless sea of workers would continue to flood into the area for high paying jobs. Many expected this to last for the next 15 to 20 years. As a result, massive speculation kicked off the largest real estate boom in North Dakota’s history. The boom peaked in 2014 when over 4,000 new rental units were brought online in the oil producing counties to support the anticipated demand.
As oil prices started to decline in the last half of 2014, investors, policy makers and industry executives anticipated a short-term correction and a quick recovery. Unfortunately by April 2015 it was clear that the oil markets were in a secular decline brought on by oversupply in the global energy markets fueled by a deep recession in China. As a result, companies started to lay off workers, and over the following months caused a massive exodus of people as jobs were eliminated. Nobody is exactly sure how many people have left the state, but some put estimates as high as 25,000.
Real Estate is a just now starting to feel the effects of the massive transition in the market. As leases that were signed as far back as 2013 start to expire, people are either re-negotiating lower rent rates or simply leaving the area. Companies are no longer paying for employee housing. The effect was not immediately understood because rent prices did not appear to be coming down much in 2015.
Recently, however, there has been a dramatic decline in rent prices. As rental inventory continues to come online from projects that were financed prior to the decline in oil, and as additional units are financed for “low income” people from the ND affordable housing tax credit fund, further price and inventory pressure continues to build in the marketplace. “At market” rent prices may now actually be lower than the affordable housing targets set by the state affordable housing program. This presents unique challenges to the use of taxpayer’s money to finance housing.
Bakken.com did an informal survey of the lowest current rentals available in the four largest cities in the oil patch. It would appear that rental prices have started to come down across all major North Dakota cities. The strongest real estate market continues to be Watford City with the weakest in Minot. However, even in Watford City the price of a three-bedroom rental home has come down from $2,500 in 2015 to a current price of $1,400. This represents a 44 percent decline of the rental price in the market. It would appear that the price of rentals is now comparable to cities like Bismarck, Grand Forks and Fargo. If rental prices continue to decline renters may have some of the lowest cost housing in the country, unlike the highest experienced just a few years ago. Housing affordability may become an attractive way to attract lower wage service workers who are still in high demand.
What is not clear from the data is what the true vacancy rates are in the Oil Patch. Property management companies are unwilling to share vacancy rates for fear of losing existing tenants who are paying higher lease rates or making people think they are desperate. Several property managers in the area confidentially shared their vacancy rates, but did not want to be quoted publicly in the media. By analyzing the number of listings in each market it would appear that vacancy rates in the area range significantly depending on the location and property type. Historically anything over 20 percent vacant is considered distressed.
Estimated vacancy rates between 15 and 40 percent.
Daily rental posting 150+
4 bed $1,350 lowest price in market
3 bed $1,300 lowest price in market
2 bed $800 lowest price in market
1 bed $650 lowest price in market
Estimated vacancy rates between 10 and 30 percent.
Daily housing posting 30+
4 bed $1,500 lowest price in market
3 bed $1,400 lowest price in market
2 bed $975 lowest price in market
1 bed $700 lowest price in market
Estimated vacancy rates between 15 and 50 percent.
Daily housing posting 50+
4 bed $1,000 lowest price in market
3 bed $700 lowest price in market
2 bed $500 lowest price in market
1 bed $400 lowest price in market
Estimated vacancy rates between 20 and 70 percent.
Daily housing posting 200+
4 bed $1,175 lowest price in market
3 bed $600 lowest price in market
2 bed $495 lowest price in market
1 bed $400 lowest price in market
As rents decline, so do property values. If rent prices have declined by 50 percent it would be safe to assume the value of the properties will be significantly lower when re-appraised. Most policy makers did not expect property tax collections to go down or to see the reality of significantly lower collections. Just as property taxes increase with higher values, they also go down with lower values. The sword cuts both ways. This will have a cascading impact on local governments who have supported spending commitments based on past values and growth projections.
If rents continue to collapse and vacancy rates increase significantly, property owners are at risk of defaulting on debt obligations. It is unclear how many of the rental units were financed with private equity, alternative lenders or banks. If there are defaults, the underlying lender will end up with the property and either be forced to take a loss on the loan or hold the property until the market recovers. The major risk for the community would be what happened in the 1980’s when buildings were forced to shut down. There is a point where the cost to keep a property open will be more than the revenue collected excluding the debt service. When apartment buildings reach over 30 percent vacancy it is generally at risk of defaulting on mortgage loans. As vacancies increase to over 60 percent, buildings no longer have the ability to cover operating expenses to keep the doors open and are at risk of being shut down.
As this revenue dries up as it did in the late 1980’s, these communities will face significant challenges in adjusting local budgets. As this happens we can expect the state to get pressure to bail out some of these communities as they face cutting essential services or defaulting on bonds used to finance the boom.
About the author: Mike Marcil is a visionary business developer with over 25 years of experience in building innovative business ventures. Mr. Marcil is currently the CEO of Energy Media Group. Mr. Marcil is also the majority owner of Bakken Financial Inc., the parent company of Energy Media Group. Under his leadership the company has expanded to include over $50MM of investments that includes Real Estate, Technology, Media, Retail, Restaurants and other Energy-related businesses. From 2002 to 2010 Mr. Marcil served as the CEO of The Marcil Group Inc. Under his leadership the company was involved in the development, financing and management of more than 40 different development partnerships that comprise over 1,100 residential rental apartment units and over 300,000 sq. ft. of commercial space in California, Louisiana, North Dakota, Minnesota, and South Dakota. The net assets of the portfolio exceeded $100MM in assets. Mr. Marcil was one of the first apartment developers to enter the Bakken in 2007.