Fourth Edition October 2013

City of Riverside

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REGIONAL INTELLIGENCE

REPORT™

Prepared by Beacon Economics, LLC.

Employment growth in the City of Riverside continues to outperform the rest of Inland Southern California. From August 2012 to August 2013, private employment is estimated to have expanded by 1.5% from 57,450 to 58,350 jobs (+900), according to Beacon Economics’ estimates. A portion of the job growth created by private establishments was offset by a shrinking Government sector, which shed 0.6% of its workforce, a loss of 150 jobs. Nevertheless, private establishments within numerous sectors have demonstrated impressive gains – a result that appears to reflect consumer demand for local goods and services.

Employment

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Source: California Employment Development Department

City of Riverside, Jan-08 to August-13Total Employment

Despite these gains in the City, Inland Southern California’s overall labor markets continue to struggle with high rates of unemployment and tepid growth. Throughout the Riverside-San Bernardino metropolitan statistical area, the unemployment rate was estimated at 10.0% in August 2013, on a seasonally adjusted basis, and total private employment had grown by only 0.9%, or 8,700 jobs, from one year ago.

In the City of Riverside, Leisure and Hospitality was perhaps the most impressive sector in terms of job growth over the year. From August 2012 to August 2013, the sector grew by 3.7% or 250 jobs. Hotel occupancy rates, which are an economic

Employment by SectorCity of Riverside August 2012 to August 2013 (SA)

Aug-13 Annual Chg. (%)Leisure and Hospitality 7,300 3.7Education/Health 15,250 2.9Trade,Transport,Util. 14,050 2.0Other Services 4,150 1.5Non-Durable Goods 750 0.9Financial Activities 2,800 0.1Professional/Business 8,050 -0.7Construction 3,850 -1.5Information 900 -2.1Durable Goods 1,250 -2.6Private Sector 58,350 1.5Government 25,400 -0.6Total All Industries 83,750 0.7Source: California EDD, estimates by Beacon Economics

indicator of the local tourism industry, have improved recently in the Riverside/Corona region. From January 2013 to July 2013, 67.7% of hotel rooms were occupied daily, up from 65.5% during the same period a year before.1 The sector’s employment growth has also been driven by spending at local food and drinking establishments, which experienced strong improvement in sales compared to last year.

Other growing sectors over the year include Education and Health Services (2.9%), Other Services (1.5%), and Non-Durable Goods Manufacturing (0.9%). On the other hand, jobs at Durable Goods Manufacturing establishments declined (2.6%), as did jobs in Information (2.1%), Construction (1.5%), and Professional and Business Services (0.7%).

There has been wide criticism about the growing number of part-time jobs nationwide and how they inflate the appearance of the labor market. These jobs are primarily in sectors like Retail Trade and Leisure and Hospitality, where wages tend to be lower and benefits are less-frequently offered to employees.

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1Source: PKF Consulting

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2Source: Wells Fargo/Gallup Small Business index

Taxable Sales

Yet, bear in mind that 70% of part-time workers are classified as part-time for ‘non-economic’ reasons –these are workers who are not pursuing full-time employment (e.g. students, parents who only want part-time work, etc.). At the national level, all of the gains in part-time employment over the last year were due to an uptick in the number of people employed part-time for non-economic reasons. In fact, the number of workers who were employed part-time for economic reasons actually saw declines over the year. In the City of Riverside, jobs in sectors that offer high levels of part-time employment provide opportunities for students enrolled at the area’s two major college campuses - the University of California in Riverside (UCR) and Riverside Community College (RCC).

For the City’s employment base to return to its 2008 levels, local establishments would need to increase payrolls by roughly 4.8%. In other words, assuming the 0.7% growth in nonfarm payrolls from one year ago, the City would take more than six years to fully recover. Beacon Economics projects that the City will recover much sooner, but further job cuts in the Government sector continue to pose a risk. Nevertheless, improvements in consumer spending and the real estate market (residential and nonresidential) could provide the extra push needed to increase the pace of recovery.

Consumer and business spending continued to post solid gains in the second quarter of 2013. Taxable sales in the City of Riverside grew by 7.8% from the second quarter of 2012 to the second quarter of 2013. On a quarter-to-quarter basis, growth was more tepid from the first quarter to the second quarter of 2013, with taxable sales ticking up by a modest 0.4% after a substantial 6.3% increase from the fourth quarter of 2012 to the first quarter of 2013. This volatility in growth is caused by payment anomalies connected to the state’s allocation of funds, whereas consumer and business spending has been increasing steadily since the second half of 2009. Indeed consumer and business spending has now bounced back 32.6% since bottoming out in the second quarter of 2009. On the other hand, even with this resurgence in spending, taxable sales remain 11.2% below their pre-recession peak. However, much of the growth during the build-up to this peak was fueled by an overheated housing market and excessive borrowing on the part of households. Recent growth in spending is steadier and more in line with income.

Year-over-year taxable sales growth in the City outpaced Inland Southern California, which climbed by 6.4% from the second quarter of 2012 to the second quarter of 2013, compared to 8.7% growth throughout the state. The City of Corona (10.1%)

was another large city in Inland Southern California that experienced strong year-over-year growth, while Fontana (6.0%) and Moreno Valley (4.6%) grew at a slower pace, and Rancho Cucamonga (-5.2%) lost ground. Although we do not have a detailed breakdown of spending categories for the City of Riverside, we can look at spending patterns in Riverside County to get a sense of local trends. Spending in the Business and Industry category increased 18.4% between the second quarter of 2012 and the second quarter of 2013, contributing the most (29.0%) of any category to gains in taxable receipts in Riverside County. Growth in Business and Industry spending is a likely sign that local businesses are becoming more optimistic about the future and are more comfortable investing in expansions and upgrades. This is in line with the nation overall, where consumer sentiment among small businesses is at its highest levels since before the Recession.2

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Q2-08 Q2-09 Q2-10 Q2-11 Q2-12Source: California State Board of Equalization

City of Riverside, Q2-08 to Q2-13Taxable Sales

On the consumer side, tax receipts for Autos and Transportation are up 14.4% over the year, contributing the most (28.7%) of any consumer category to gains in taxable receipts. Not far behind are Building and Construction receipts, which, despite a downtick in Construction employment, are up 18.1% year-over-year and are responsible for 21.2% of the gains in taxable receipts over the year. Both of these consumer categories generally represent higher cost goods and services, and often require a long-term commitment. Continued gains in both of these consumer categories are great signs for the local economy as spending on these types of goods and services traditionally means that consumers have grown more confident about the future strength of their finances.

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The rebounding real estate market continues to be an engine for growth in the City of Riverside. The median price of an existing single-family home in the City increased 25.4% to $246,600 on a seasonally adjusted basis from the second quarter of 2012 to the second quarter of 2013. This marks the sixth straight quarter that the median price of an existing single family home has increased in the City of Riverside. Since the recessionary trough (during the third quarter of 2009) median prices have surged a substantial 42.6%. Perhaps more importantly, the City of Riverside still remains remarkably affordable compared to nearby Orange and Los Angeles County, where median prices reached $586,900 and $421,700, respectively, in the second quarter of 2013. Workers can garner substantial cost savings by opting to live in the City of Riverside and commuting to neighboring counties; these savings are amplified when workers are able to find employment locally and avoid the costs associated with a long commute. And while median prices for existing single-family homes remain 40.9% below their pre-recession peak, much of the price appreciation that occurred during the build-up was fueled by an overheated housing market.

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Source: DataQuick

City of Riverside, Q1-05 to Q2-13Existing Home Prices and Sales

Lack of available inventory continues to be an important factor affecting median prices in the City. In Riverside County, inventories stood at just 3.2 months of supply in August 2013, unchanged from a year ago. This means that at today’s volume of sales current inventories would last just over three months. Low inventory has also contributed to sluggish home sales; existing home sales fell to 1,075 units in the second quarter of 2013, down 2.3% from one year ago. A lack of available inventory poses a danger to long-term affordability in the region, as buyers are priced out the market because of supply constraints.

Another factor contributing to the uptick in median prices has been the decline in the volume of distressed properties in the local market. This is important because the mix of properties being sold can have a substantial impact on the median price being reported. Indeed the metric can be skewed because only more expensive homes are being sold, causing the reported median price to increase even if there is no increase in the price of the average home. In Riverside County, 23% of total home sales in July 2013 were distressed, representing a substantial 32 percentage point decline from July 2012. In the City of Riverside the number of defaults has fallen by 47.3% from a year ago, to 426 on a seasonally adjusted basis in the second quarter of 2013. Foreclosures in the City declined even more, falling by 56.7% from a year ago. Moreover, at 128, foreclosures are now at their lowest levels since 2006. The shrinking inventory of distressed units paves the way for continued price appreciation, although this price appreciation should be more tepid than the rapid escalation witnessed during the boom years.

The apartment market in the City of Riverside is also improving and continues to post solid gains. Vacancy rates at apartments in Inland Southern California have fallen 0.8 percentage points since the second quarter of 2012, reaching 3.6% in the second quarter of 2013. In addition, the City of Riverside submarket is outperforming the broader region with vacancy rates at 3.2%. Asking rents in Inland Southern California and the City of Riverside are up as well, with rents in Inland Southern California up $18, to $1,087, and rents in the City of Riverside up $12 to $1,195 in the second quarter.

Improving market conditions are helping spur construction in the City of Riverside. There have been 199 single-family permits issued over the last twelve months (through July 2013), nearly three times the number in the prior twelve month period. Multi-family permits totaled 219 (# of units) over the last twelve months, representing a relatively small uptick of 1.4% from the prior twelve month period. Residential permits were also up in Riverside County, with single-family permitting trailing the City (12.4%) and multi-family permitting outpacing the City (47.1%) over the same period.

Single-family homes in the City of Riverside and across Inland Southern California remain affordable relative to renting; however, the market is starting to tighten. Truila’s Rent vs. Buy Report for Summer 2013 shows that buying a home in Inland Southern California is 38% cheaper than renting (down from 44% in the Winter 2013 Report), while it is 28% cheaper in Los Angeles County and 24% in cheaper in Orange County.3 These declines in affordability are a function of interest rates rising from near historic lows and sizeable increases in home prices in the region.

3http://trends.truliablog.com/vis/rentvsbuy-summer-2013/

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Along side the residential market, the commercial market in Inland Southern California and the City of Riverside continues to steadily improve in key areas. Since the second quarter of 2012, vacancy rates at retail properties in Inland Southern California have fallen by 0.5 percentage points, hitting 9.9% in the second quarter. The local Corona/Riverside/Moreno Valley submarket is faring better than the region overall, posting lower vacancy rates (6.8%) and steeper declines from one year ago (0.9 percentage points). Additionally, asking rents in Inland Southern California increased $0.05 per square foot from a year ago, to hit $20.58 per square foot in the second quarter of 2013, and in the local submarket asking rents increased $0.10 per square foot, to hit $20.36 per square foot in the second quarter. With an improving retail landscape and rising taxable sales, vacancy rates at retail properties should see additional declines in the coming months as retailers expand and new retailers are established.

The office market in Inland Southern California is also strengthening. Office vacancy rates in Inland Southern California have fallen 1.3 percentage points since the second quarter of 2012, reaching 23.6% in the second quarter of 2013. However, these rates remain elevated relative to pre-recession levels. Additionally, asking rents at office properties in Inland Southern California dropped by $0.05 per square foot from a year ago, falling to $21.29 per square foot in the second quarter. Moreover, office properties in the local submarket are slightly trailing the broader region; the Corona/Riverside/Moreno Valley submarket posted higher vacancy rates (23.9%) and higher asking rents ($22.25) at office properties.

The industrial market in the region is improving as well. Vacancy rates at warehousing and distribution centers have fallen 1.2 percentage points from a year ago, reaching 10.6% in the second quarter of 2013. Additionally, asking rents have ticked up by $0.09 per square foot to hit $4.27 per square foot in the second quarter. Conversely, vacancy rates at Flex/R&D properties have ticked up 1.2 percentage points since the second quarter of 2012, hitting 15.5% in the second quarter of 2013. However, much of this increase can be attributed to new Flex/R&D units coming on the market, with 648,000 square feet of additional space becoming available over the last year. Indeed, the amount of occupied stock at Flex/R&D properties is up from a year ago.

Declining vacancy rates at commercial properties have helped spur an increase in the construction of new commercial properties in the City of Riverside. Commercial construction activity has picked up considerably over the last twelve months (through July 2013) coming in at a value $38.6 million, a

Commercial Real Estate

4http://www.pe.com/business/business-headlines/20130827-riverside-top-shade-manufacturer-rolling-into-town.ece5http://www.marketwatch.com/story/nordstrom-rack-to-open-at-riverside-plaza-2013-09-05

considerable increase from the $12.8 million during the prior twelve month period. Permitting at retail and office properties are helping to drive commercial construction activity, with permit valuations hitting $10.0 million for office properties and $15.1 million for retail properties over the last twelve months. Industrial permitting is also surging, with permit valuations hitting $2.4 million over the last twelve months, compared to just $0.56 million over the prior twelve month period.

Additionally, new businesses are continuing to open, and existing ones are expanding in the City of Riverside. For example, Roll-A-Shade, a manufacturer and installer of commercial roller shades, is relocating their operations into a 25,000 square foot building in the City of Riverside. Roll-A-Shade is one of the largest makers of sun control window treatments west of the Mississippi River. The firm had revenues of $5.6 million and 30 employees in 2012.4 In another example, Nordstrom’s recently announced plans for a new Nordstrom Rack at Riverside Plaza, which is currently undergoing a facelift.5 The ongoing desire of firms to locate in the City of Riverside is a strong indicator that recent gains in the commercial real estate market should continue in the coming years.

Poverty & IncomeImproving economic conditions in the City of Riverside have helped lower poverty rates in the City over the past year. According to the U.S. Census Bureau’s American Community Survey, poverty rates in the City of Riverside stood at 19.5% in 2012, down a full percentage point from 2011. In contrast, in Inland Southern California, poverty rates rose by a full percentage point over the same period, coming in at 19.0% for 2012. In addition, the City of Riverside saw health insurance coverage rates tick up a full percentage point from 2011 to 2012, with 79.2% of the population covered in 2012. Health insurance coverage rates in Inland Southern California pulled back slightly (0.1 percentage points), hitting 79.5% in 2012.

Perhaps more importantly, incomes in the City of Riverside have risen from one year ago. Between 2011 and 2012, median household income in the City of Riverside inched up by $257 to hit $52,697 in 2012. In contrast, median household income in Inland Southern California pulled back by $1,506 falling to $51,695 in 2012. Stabilizing household incomes and declining poverty rates in the City of Riverside signal that economic conditions are continuing to improve as the City’s recovery becomes more expansive. As more people find work in the region, Beacon Economics expects household incomes to post gains again this year, helping to further drive down poverty rates in the City of Riverside.

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California: Still On The Mend Despite Federal HeadwindsCalifornia’s economy continues to improve, though the pace of growth was slowed by Federal policy changes during the first half of 2013. Rising taxes due to the “fiscal cliff”, reductions to federal spending reductions known as the sequester, and most recently the government shutdown have meant that aggregate demand, although increasing, has not done so at the pace that would have otherwise been achieved without these drags.

Beacon Economics agrees that the U.S. deficit and debt, as well as various entitlement programs like Medicare, Medicaid, and Social Security require solutions to ensure solvency and liquidity over the long-run. However, these structural issues in our economy do not represent imminent threats to our economy that would necessitate decisive fiscal changes over the short-run—particularly in light of the already-lackluster recovery. Given the presence of the defense industry in the State as well as California’s reliance on consumer spending and tourism, these changes at the national level have translated into growth that has yet to reach its full stride as a whole.

Still, the state continues to get stronger each month. We’ve already added back over 825,000 of the 1.368 million jobs lost during the downturn, and the current forecast calls for continued improvement in 2013 and beyond. Beacon Economics is projecting that job growth during the latter half of 2013 will remain relatively tepid, posting a 1.6% increase during the year. However, as the broader macroeconomy adjusts to new tax rates and the current fiscal situation,

expect job growth to accelerate into the 2-2.5% range during 2014. As we regain our pre-recession peak employment levels, Beacon Economics expects job growth to level off in the 3% range in 2015 and beyond. The unemployment rate, which has already dipped into the single digits, will continue to fall—dipping below 7% by late 2015.

The real estate market, which is already hot, is expected to continue to perform well over the next several quarters. Specifically, Beacon Economics forecasts that home price appreciation will remain in the double-digits into mid-2014, when it will moderate back down toward historical norms of 5-7% in 2015 and 2016. In part, this will be driven by tight housing inventories as well as a gradually healing labor market and rising incomes. Interest rates will begin to rise for mortgages, but from a historical standpoint, affordability remains high, which should help to support housing demand in the state. New home construction, both on the single- and multi-family sides are expected to remain robust over the next several years as well: not only are home prices rising, but California remains chronically under-supplied on housing.

California’s population will continue to expand, though the rate will remain below 1% per year as shifting demographics lead to lower levels of natural increase. Still, as the cyclical effects of the Great Recession fade, net migration should provide an upward influence to the state’s population base. This should also help to grow the state’s spending base—important both for businesses supplying and selling consumer goods, but also for local governments who rely on sales tax revenues to finance significant portions of their operations.

It is still not the time to pop champagne corks and toast to California’s full recovery. But, the Golden State has made significant progress over the past three years in repairing the damage done by the Great Recession. Employment is growing, housing is improving, business activity and tourism are expanding, and incomes are rising again. Some sectors, like manufacturing and exports faced continued difficulty in the face of a tumultuous global economy, but even there we see glimmers of hope. There is still a long way to go before California can celebrate, but it is also clearly time to start feeling optimistic again.

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‘We have met the enemy and he is us’ –Pogo.

On one level, it may be comforting that a half-century-old cartoon character’s remark can so accurately describe the current path of the U.S. economy. But at another level it’s frustrating to realize that massive advances in our understanding of the inner workings of the economy remain so far removed from the political debates in Washington DC.

The U.S. economy is trying to get out of its own way, but our elected leaders seem to have other plans. The fiscal cliff negotiations during the last weeks of 2012 led to sharp cuts in Federal spending and a big jump in taxes—completely unnecessary shocks to the nation’s fragile recovery. Yes—the deficit has to be closed, but closing it should be done over a number of years with the tax increases and spending cuts done logically and announced far ahead of time.

Yet the economy managed to bounce back for 2 plus percent GDP growth in the second and third quarter of 2013. This mini-recovery came under threat again because of the recent Federal government shut down and the potential hit from running into the debt ceiling. They did come up with another last minute compromise—but only until next February. In the meantime businesses are wondering if they should bother investing under this ongoing cloud of budget uncertainty. The economy can grow, but only if our elected leaders start doing the things they should—and stop doing the things they shouldn’t.

Consumer spending has bounced back since the fiscal cliff’s $200 billion personal tax increase at the start of the year—with auto sales close to their long-term normal 16 million-unit annual sales in the third quarter of 2013. Retail sales have also been moving forward, with faster growth in recent months than earlier in the year. While some have worried about slower growth—any growth at all is positive given the tax hikes.

The improving recovery in the labor markets is partly responsible for the bounce in consumer spending. The nation has added over 2 million jobs in the past year—with private sector employment up 2% from August 2012 to August 2013. The unemployment rate for those with a bachelor’s degree or higher is now below 4%, leading incomes to rise at a faster pace. Unemployment for the lowest skilled workers has also fallen sharply over the last two years, and while the number of long-term unemployed is still too high, it has finally started to fall from its 2011 peak.

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Economy Continues To Grow Despite DC Gridlock

Financially the nation is doing better. The banking sector has almost returned to normal from a distress perspective and businesses are making record profits. Corporate profits are now 25% higher than their pre-recession peak. It’s little wonder that the stock market has bounced back so nicely. Outside of residual issues from the housing collapse, consumer debt is seeing record low delinquency levels.

GDP Component 2012 2013Avg I II III est

Gross domestic product 1.95 1.1 2.5 2.1Final Private Demand 2.66 1.03 2.1

Personal consumption 1.39 1.54 1.21 1.24 Durable goods 0.56 0.43 0.45 0.3 Nondurable goods 0.25 0.43 0.28 0.5 Services 0.58 0.69 0.48 0.44

Private domestic investment 0.49 0.71 1.48 1.21 Structures 0.24 -0.8 0.4 0.39 Equipment 0.25 0.09 0.16 0.15 Intellectual property prod. 0.11 0.14 -0.04 0.21 Residential 0.38 0.34 0.37 0.31 Change in private inventories -0.49 0.93 0.59 0.13

Net exports 0.3 -0.28 0.0 -0.39 Exports 0.32 -0.18 1.11 1.35 Imports -0.02 -0.1 -1.11 -1.73

Government consumption -0.22 -0.82 -0.18 0.05 Federal -0.18 -0.68 -0.12 0.01 State and local -0.04 -0.14 -0.06 0.04

2013

Source: U.S. Bureau of Economic Analysis

Real GDP Growth by Component

The housing market continues to recover despite the modest hike in interest rates over the past 6 months that slowed growth a bit—but only to a more sustainable level. In September, median prices at the national level continued to grow at a 11% year on year pace, and inventories—the best predictor of price gains for the next year—remained a very tight 5 months of supply. Foreclosures are way down, and the number of underwater owners has dropped sharply.

And the Federal Reserve seems to be managing the money supply fine. They need to deal with unwinding quantitative easing, but there is little chance of inflation since most of the cash injected into the system is sitting in banks in the form of excess reserves. And with bank lending activity still weak, that money will stay there for a while. They have plenty of time to unwind these programs—and it looks like they’ll use it. Because most of the declines in rates occurred prior to the recession, Beacon Economics does not expect rates to shoot back up when these programs end. With plenty of liquidity in the world markets and weak demand for capital, expect low interest rates for some time.

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Jan-07 to Aug-13U.S. Home Price & Sales

Europe, China, and Japan are all showing modestly positive signs, which bodes well for U.S. exports in 2014 given that the dollar is still 25% cheaper than it was a decade ago, making U.S. products extremely competitive in world markets. Overall, there are plenty of reasons to look for better times ahead.

Still, despite all the good news, consumers are still wary of borrowing and their confidence is waning, business investment is remains low despite growing profits, and housing construction is still close to rock bottom. The reason has to do with the ongoing gridlock in Washington DC which is creating repeated budget crises and leaving many important regulatory decisions up in the air, a worse circumstance than having a set of unfavorable but concrete rules.

The debates over the debt ceiling and deficit have dominated headlines over the past year. There was the fiscal cliff issue at the end of 2012, and of course the recent government shut down. Last minute negotiations over the fiscal cliff in December of last year resulted in a $200 billion tax increase and automatic spending cuts at the start of 2013. The midnight deal kept businesses and consumers in the dark until the last minute—uncertainty that curtails business investment and keeps investors wary. Growth then slowed to a crawl in the fourth quarter of 2012 and first quarter of 2013.

Still, the economy has pulled through with 2.5% growth in the second quarter of 2013— and the likelihood of 2% or more growth in the third quarter. The recent government shut down and debt ceiling extension will almost certainly hurt growth in the fourth quarter, largely because the solution is temporary and only extended the deadlines on both issues until early next year.

Moreover, there is an important fact to consider: Although the debates in Washington DC are centered on the Federal budget deficit, the deficit is not being driven by direct spending but by financial choices regarding taxes and increased transfers. Direct public spending in the United States—on defense, education, and infrastructure—continues to contract. Combined, direct spending at the Federal, state, and local level is 5% lower today than when President Obama took office. This reduction has posed a significant drag on the economy over the last two years. Unfortunately, it is this direct spending that is taking the brunt of the cuts while the indirect spending, particularly the nation’s major public social insurance programs, are being ignored despite the fact that the long term sustainability of these programs is in grave doubt. The major social insurance programs are fine for now, but will be heading into crisis territory in 10 to 25 years if nothing is done to curb that spending. This is where the true crisis lies—and many leaders aren’t even broaching the issue.

And while the nation’s leaders debate the deficit, new rules on mortgage lending, conforming loans, the use of derivatives, and the structure of investment banks, have been left unfinished. Dodd Frank—once the solution to preventing future financial crises such as the one experienced in the last decade—has done little but leave lenders uncertain as to what rules they should be following. There are no plans as to what to do with Fannie Mae and Freddie Mac, the giant financial institutions bailed out by U.S. taxpayers. As a result, bank lending has been completely stagnant and potential homebuyers are unable to secure loans. Additionally, the pace of home building remains severely depressed despite a resurgence in the resale housing market.

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