Building Nevada - July 2010

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Commercial Real Estate Vacancies and Projects

by Jennifer Baumer

    Good news is hard to find in the world of commercial real estate. Mostly there’s lesser bad news, and even that has to be ferreted out. The silver lining to Nevada’s economic tumble is a bit tarnished.

    According to Lance Bradford, president, Stable Development, “The market is slowly getting better. It would be going more quickly, but the biggest weakness we have right now is the banks are being very conservative in their lending. There isn’t much lending at all on commercial products.”

    Another factor affecting commercial real estate relies is employment. According to Jake Joyce, senior project manager, Applied Analysis, commercial real estate users are generally employers who directly employ workers in those markets, which continue to be down. “That’s being witnessed in our 14.2 percent unemployment rate that’s being affected by the fact that across all sectors, in every market we have a double digit drop in pricing over the last months and we’re likely to see pricing continue to drop going forward, probably for at least 12 months.”

    Which means, essentially, that every sector of commercial real estate has reigned in from the glory days a few years ago when lease prices were up and vacancy rates down, and landlords are now doing whatever it takes to fill space (though a few are adopting a wait-and-see attitude).

    We need to know what the equilibrium is. “Are we entering recovery or have we entered recovery? We’ve probably all heard the national economy has entered recovery. The question is how hard and at what speed is that going to reverberate to us in Southern Nevada, particularly in the commercial market?” asked Joyce. “Probably that’s going to be one of the most lagging sectors of our economy. Spending has to come back from consumers, and once that comes back, then hiring has to come back then, after three to four years of excess inventory pretty much across all sectors you have to backfill.”

    We continue to see ultra high vacancy rates in all sectors, construction halted and only a few more projects coming online statewide. There’s nothing much in the planning pipeline or expected to materialize in the next 12 months.

    So where are we with that tarnished silver lining? A year or two ago vacancy rates were climbing about 2 percent every quarter; now they’re still going up but at a much more subtle 1 percent.

    Still waiting for some good news? According to Joyce, some commercial sectors are doing well. It’s been said Nevada will continue lagging behind the national economy. Now that the national economy is entering recovery, with the manufacturing index up 10 months in a row and at a six year high in April and we have some very good signs across the broader economy, the ultimate answer we all want is: When will that turnaround happen locally?

Office

    The office market took a hard hit as businesses failed or downsized, and continues sluggish with close to 20 percent vacancy statewide.

    According to Bradford, businesses are active even if they’re downsizing, and there’s been evidence of a few new businesses popping up for the first time in a couple years. Although, that doesn’t necessarily mean there’s anything more selling than there has been, “We’re starting to see some refurbishing or completion of projects that were distressed a couple years ago, which led to a great discount for new owners who are finishing them up,” said Bradford.

    Bradford thinks the market is on the upswing, but a gradual upswing compared to the steep increase and precipitous drop of recent years.

    Chuck Witters, SIOR, senior vice president, Lee & Associates Commercial Real Estate Services, said the office market in Southern Nevada is still seeing serious problems. “At the end of the first quarter we still had about 11.5 million vacant square feet in the Las Vegas valley. To my knowledge, that’s a record. That’s about 23.5 percent vacancy.”

    Those numbers don’t include the sublease market, which no one tracks but which adds in some 300,000 to 600,000 square feet above the 11.5 million. With 11.5 million square feet vacant and negative net absorption for the last two years, Witters predicts at least six years before the office market gets back to where it was three years ago.

    Bring together 23.5 percent vacancy, a six year inventory of vacant space, dropping lease rates and over 13 percent unemployment and everyone gets hurt – developers, architects, landlords, lenders, commercial real estate brokers.

    In Northern Nevada, Frank Gallagher, SIOR, senior partner, Gallagher Commercial Properties, LLC, said in both office and industrial sectors there is movement, primarily owner-users companies moving out of leased spaces and into spaces they can own, generally at the same price.

    Companies with existing relationships with existing banks can finance these deals and banks seem willing to lend on the owner-user side, some assisted by SBA (Small Business Administration) financing, and others with cash. Companies that are doing all right can take advantage of the market, but there’s no additional absorption, since such moves concern businesses upgrading space without significant expansion or hiring. Investment remains flat, and most banks remain uninterested in funding it.

    “I do think we’re going to see a little more product selling and do think we’re seeing an increased level of confidence with business, but people are still very cautious and haven’t reached a level of confidence where they’re prepared to hire,” said Gallagher. Bottom line? Until companies start hiring more workers, there simply won’t be enough bodies to fill this commercial space.

    The only sector Gallagher sees movement in is existing projects being taken over by new owners and finished, and that’s mostly in residential subdivisions, which typically consist of improved lots and unfinished homes where a new owner can go in and complete homes on a limited, reservation-only basis.

Industrial

    The boom in all things construction in 2007 and 2008 overloaded Northern Nevada’s industrial market. We’re still trying to fill those spaces and vacancy rates are at 15.5 percent, the highest ever. The good news is there are now more deals with tenants going into buildings than going out of buildings, so we may be getting into positive absorption, according to Dave Simonsen, CCIM, SIOR, senior vice president, NAI Alliance in Reno.

    In Southern Nevada, industrial real estate is currently at about 15 percent vacancy through the first quarter of 2010.  According to Kevin Higgins, senior vice president, Voit Commercial Bankers, the activity recap for 2009 was almost a negative 4 million square feet and while it’s better in the first quarter of 2010, it’s still not great. The silver lining is only that while there’s still negative absorption, it’s less negative absorption.

    That said, there’s very little industrial real estate selling, either land or buildings. Only the strong of heart are buying land, Higgins said, at times for $.20 on the dollar.

    Land prices are down 80 percent from the peak in 2007, according to Joyce, with many deals being done through trustee sales as owners default on land. The price drop actually normalizes the land market for when building starts again, especially if developers and home builders can pick up the land at current prices and hold it during recovery.

    Meanwhile, nothing new is coming onto the market. “Everything stopped,” said Higgins. “A few projects finished up in the latter part of 2008, maybe spilled into 2009 or one or two going on here or there like a small user building, but construction in industrial markets has really stopped.”    

    We’ve got a market with negative absorption and a lot of product coming on, but Higgins doesn’t think we’re at the bottom of the cycle. He expects readjustments to valuation of properties, and that the shaky global economy will keep commercial real estate shaky. People are waiting to feel confident, and they just don’t yet.    

Retail

    The Southern Nevada retail market has seen a slight increase in vacant properties leasing, but the interest is small and often brought by existing tenants looking for better deals. Like the industrial and office markets, retail landlords are apt to make deals in order to fill space, including lower lease rates, though many would prefer not to commit to long-term deals, according to Penny Mendlovic, senior associate, CB Richard Ellis. Average rents have gone down for five consecutive quarters, according to NAI Las Vegas.

    Retail box properties in the 20,000 to 50,000-square-foot range are seeing some positive movement as some new tenants enter the market. But it’s likely that the retail market, in terms of leasing and vacancies, has a ways to go before stabilizing and is probably looking at another three to five years to absorb the current inventory of retail box spaces. According to NAI Las Vegas, there’s some 516,300-square-feet of space that came online in the last year, and 809,800 more finishing up construction this year.

    In Northern Nevada, the first quarter of 2010 saw positive net absorption; vacancy rates fell from 16.85 percent to 16.32. Spending continues to be down, so retail continues to be down, and there are 19 vacant big box anchor shopping spaces over 20,000-square-feet that are vacant in the Northern Nevada market, according to NAI Alliance.    

So What Happens to These Properties?

    “You have the gamut of thought processes on this,” said Higgins. Some people want to sell and be done. Others believe they’ve held on this long and aren’t motivated to sell till they get their price. Higgins expects the attitude to settle in the middle – we’ll sell, but not just yet – as banks and institutions end up with more and more product they don’t know what to do with.

    Witters says he and his colleagues haven’t seen much improvement. “The one thing on the horizon that we haven’t seen much of yet is a very tiny trickle of firms that are fed up with the state of California and the taxes there and how difficult California makes it to do business, and those firms have started sniffing around the area.” Another area besides legal and medical that’s started to expand is GSA – government service agencies.

    Some companies that had just headed west to create branches of Midwest and eastern companies and which went home again about 18 months ago are starting to look at Nevada again, said Michael Hoeck, SIOR, senior vice president, industrial division, NAI Alliance. Companies that had high inventories when the recession hit are now looking to start manufacturing again and possibly expanding into larger spaces. But everyone’s moving cautiously.

    “Essentially the market has leveled off and where we were falling for 18 to 24 months, now we’ve leveled off and taken a turn for the positive absorption, which will lower vacancy rates,” said Simonsen. “So my sense is that things are getting better. There’s more positive stories than negative stories out there, and that’s a change in the market.”

    With no new construction coming online, existing product should start to fill. “Everything stopped in 2007,” Simonsen said. “That was our highest speculative year ever and that’s right when the market started to fall off.”

    In Southern Nevada older office buildings are doing marginally better than brand new shells that have no tenant improvements in place. Shells cost more to build out, said Witters. At $50 a square foot, no one is going to lend to build out because lease rates aren’t high enough to cover the shell, the improvements, the pay back and the property management costs.

    In order to amortize a shell built out space, deals used to be five year leases. Now skittish businesses that don’t want to be locked into five years want two to three year leases and banks don’t want to cover $50/square foot loans with a lease too short to amortize the loan.

    In Northern Nevada the trend is slightly different as older, functionally obsolete properties continue to struggle while the newer, modern buildings are filled for lower prices.

    For retail, in-line shops continue to struggle with rising vacancy rates, and landlords continue making concessions to keep anchor tenants in anchored centers.

Toward a New Normal

    “It’s going to be a slow change and most of us just want to get to the new normal and a stable environment,” said Higgins. “I don’t know that we’ll ever get back to 4 million square feet a year of positive absorption, but something of positive absorption where you can see we’re chipping away at the 14 to 15 percent vacancy and coming down to something that makes you feel good – that might be several years away.”

    “On the whole what we hear is Reno is probably taking a little harder hit than certain other areas but we’re better off, for instance, than our closest competing market, Sacramento, a little behind Salt Lake, far head of the Phoenix market,” said Simonsen. “I think we’ve held our own, compared to our competitors.”