The office space market across Nevada remains mired in the lingering effects of over-building, scarce credit and a sour economy. But while things won’t get much better soon, insiders are confident they will, indeed, get better.
The office market has been “a little bland the better part of the last six months,” says Dominic Brunetti, Vice President of the Office Properties Group and partner in NAI Alliance, a full service commercial real estate company based in Reno, “but it seems to be dragging along the bottom and getting a little bit better. The outlook is optimistic, although there aren’t huge strides being made in companies from out of state relocating here. We’re still a little short on the influx of new companies absorbing existing vacancy.”
The market, according to John Restrepo, principle of Restrepo Consulting Group LLC in Las Vegas, “is down. As you would expect, of the three commercial markets the office market has been the hardest hit in this recession. It always has been the most over-built; office has a tendency to get a lot more over-built than industrial or anchored retail.” His firm, which tracks tenanted but not owner-occupied buildings, is projecting a vacancy rate in the mid-twenties. “We are probably going to run a 30% vacancy rate when you include sub-leased space.”
What is driving the market, Restrepo points out, is the over-building that occurred during the boom. “There was a lot of office product being built that was not necessarily based on the fundamentals of supply and demand but the ability to get financing. That’s the bad side of cheap and easy credit: people make bad decisions. The office market particularly was hurt.”
“We’ve got vacancy rates at the highest we’ve ever had,” notes Brad Peterson, SIOR, Senior Vice President of brokerage house CB Richard Ellis in Las Vegas. “The third-quarter numbers haven’t quite come out yet, but let’s call it 25%. That doesn’t include shadow vacancy, which is sub-leased space, so it’s higher than that in reality.” Beyond that, he adds, there is no new construction, “and there won’t be any new construction for quite a while – I think it will be in that three- to five-year time frame. That means we will see vacancy rates go down, and we will see some of the well-located good product being leased.” What that means is that Nevada is “turning the corner from negative net absorption to positive new absorption.”
“I think the reality of the marketplace right now is that we’ve got seven or eight years of product under traditional absorption rates – and we’re not at traditional absorption rates, we’re negative,” says Mike Hillis, managing partner Commerce Real Estate Solutions. As a result, the state may still have a year-and-a-half or two years of negative absorption ahead before it even starts to see a positive trend, “so seven or eight years turns into nine or 10 years. That is the reality of the marketplace that I think has had a very sobering effect on landlords particularly, and of course tenants.”
Tenants, Hillis suggests, “all feel that they can steal stuff now, so they are very aggressive.” Landlords have been holding on to their lease rates hoping that the market was going to turn. But with this scenario staring them in the face, many have finally accepted that they need to start making deals at today’s market rates.
That explains why CRES’ business is ahead of last year’s by a “fairly significant” amount even though the market has deteriorated. Lease rates from a year ago have dropped even further and vacancy has gone up, but at least people are finally making decisions, Hillis reasons. “Maybe the faint hope is gone that it is going to turn around in a year or two. They realize, ‘Hey, I better do what I can to retain the tenants that I’ve got and to make deals with the few tenants who are out there moving around.’”
For many, early optimism has had to give way to a less satisfying reality. “The big thing we were waiting for was the year’s end — ‘Okay, 2009 is over, what is 2010 going to look like?’” Brunetti recalls. The first quarter turned out to be “a little rough, but at that point it seemed to stabilize and it felt like we were dragging along the bottom a bit.”
That said, Brunetti continues, the activity level remains strong. “It’s just that it’s more or less people who are currently here looking for better deals and wanting to upgrade their image through occupying a better office building or space.” Some companies have been arriving from out of town, but they are almost uniformly small. “From a comparison of volume of years past – compared to three or four years ago – it’s not even 50% of what it used to be.”
When it comes to new tenants entering the market, Tim Ruffin, CCIM, SIOR, Senior Vice President of Office/Managing Partner for Colliers International in Reno says he has seen growth come from the geothermal industry. “We’ve had one company relocate here from Bend, OR, (Vulcan Power Corp., recently rebranded its business to Gradient Resources, to Reno) and some others that are expanding. That is kind of the ‘sweet spot’ of the economy, the alternate energy concept. We’re seeing some positive absorption on that.”
Expansion is also coming, Ruffin adds, from the education sector. “Education especially for the private schools, seems to be counter-cyclical: when the economy goes down they seem to go up.”
On the negative side, most of the local businesses that rented space prior to the recession starting in December 2007 had five-year leases, will begin to expire. “They are taking less space, so they are giving space back to the market. We have continued to see negative net absorption as space comes back onto the market.” Industry watchers have also seen some of the local government agencies leave their lease spaces to move into owned city or county buildings to ease pressure on budgets.
On the federal side, Ruffin notes, “we have seen a little bit of activity. The federal government is coming in with some agencies leasing either build-to-suits or existing buildings and expanding.” Overall, however, the market is still relatively soft.
“It’s definitely a tenant’s market,” says Ruffin. Vacancy rates continue to rise slightly, “and I think they will continue to do so until we hit five years from the beginning of the recession, which will be 2012. At that point in time I think we’ll hit bottom and then slowly start to creep up.”
Hillis foresees a flat Nevada office market throughout 2011. “I just don’t see anything that is going to change dramatically.” The few unknowns that could alter the landscape, he adds, include some change in government regulations regarding refinancing that would impact what happens going forward.
The state will see a continuing glut of newly foreclosed properties coming on the market, Hillis adds. “We’re seeing that already: the first wave of foreclosures was on the ‘C’ properties, the kinds of things the banks looked at and said, ‘Jeez, we’re never going to get well on these, let’s get rid of this junk.’” Now, however, industry watchers are starting to see ‘B’ and even ‘A’ product come online.
There is, Hillis notes, over $1 trillion worth of these CMBS (commercial mortgage backed securities) loans that are going to be maturing in the next couple of years. “The challenge is that when most of the buildings come up they are upside down — there is more money owed than what it’s worth. And these products that are selling nowadays. It’s scary.”
The first stirrings of recovery will see office buildings that are “well located and quality buildings” begin to lease space, Peterson says. “Here’s my take on it: there is going to come a time toward the end of 2011 and the beginning of 2012 when we’ll see – it sounds kind of crazy – areas where tenants or users can’t find the right spot.” That will be because the higher quality and contiguous blocks of space will have been grabbed up. “All of a sudden we’ll be looking at each other saying, ‘We need to build some new buildings.’”
The fly in the ointment, though, will be that the credit crunch will continue to make it difficult to obtain financing. Thus, “by the time someone is actually able to finance a new office building and then build it it could be four years from now.”
From Brunetti’s perspective there have been few if any surprises. Rather, the market is “pretty much following the path we thought it would. We are seeing a lot more activity downtown just because I think people are realizing that downtown can be a fun place to work. People want to do business and be located where they are surrounded by other people who do business. Aside from that I think everything is pretty much on par with what we expected.”
What needs to happen in order to spur growth? “I think the answer there is job creation and consumer spending,” Brunetti replies. “Obviously those two things are paramount, but I think that if people right now can’t get a job then consumer spending is out the door. So it’s job creation first and foremost.”
On the residential side, though not directly impacting the office market, residents with houses under water will continue to focus their attention close to home. “No one is out there starting up companies if they are having to deal with $100,000 in negative equity.”
Restrepo doesn’t see the Nevada office market emerging from the doldrums “for a while,” saying it could be years before it gets back to the 9% to 10% vacancy rate, which is considered a stable market. “We’re thinking at least seven or eight years before we get there.” Job losses, a crucial factor, continue. “They aren’t as great as they were last year, but losing fewer jobs is not the same thing as generating jobs. That is the challenge.”
Restrepo also points out that after a year and a half of industry chatter about a wave of commercial foreclosures it looks like it may be close to imminent. “How big that wave is we don’t know yet. But you’ve heard the phrases extend and pretend and delay and deny. I think we’re going to see an increased number of commercial foreclosures, particularly in the office market.” That cloud will bring with it a silver lining. “I think we need that to reset the market. Extending and pretending and not foreclosing on projects that really have no ability to sustain themselves makes no sense. All you’re doing is prolonging the pain.”
Anything on the Horizon?
When will new projects begin to return?
Brunetti believes it will be another year or two before they begin again “because of the existing product out there. We have enough vacancy so that we can live with what we have currently. What would change that? One or two larger tenants coming into town who couldn’t find anything that really fit their style of operation and therefore did some type of joint venture with a developer to build some type of project and occupy a certain amount of space in that project.”
Hillis does not believe new projects will return for a while because of the inventory that exists. “We are seeing some transactions for smaller office buildings for owner-users – law firms, doctors and that sort of thing. With the price of real estate so low these days people are saying this is the time to buy. The good news is that the owner-users can get SBA financing. Investors can’t get any, so unless developers are doing something with cash nobody is going to be putting new product up.”
Nevada, Ruffin predicts, is still probably five years out before it starts to see new projects on the drawing board. At that point, a market balance could be achieved “that would dictate that developers should start building.”
Ruffin points out that “the beauty of Northern Nevada especially is that it is still a wonderful place to live. Rand McNally rated us the number-one city in the nation for outdoor recreation. We have four mild seasons. We’ve got Lake Tahoe in our backyard. We’re surrounded by mountains. So I think people will move to and retire here.”
The lack of jobs at present means the office market should stay slow until the surplus of homes is absorbed, he adds. “Once that happens we’ll start building, the economy will get back on track and we’ll start getting a normal growth rate. But nothing is going to happen quickly. I think it is going to be a very slow process.”