Nevada’s office market was hit hard by the 2008 recession, when often companies expecting to expand instead contracted and downsized their use of office space. Office product was vacated or underutilized. Vacancy rates jumped. New product stood empty. In the last 12 years, there’s been very little new product under construction.
Fast forward to today, when the office market was expected to struggle with higher vacancy rates due to post-pandemic cultural shift. COVID is the driving force behind the remote work trend, which was expected to keep employees out of the office much longer.
But workers are heading back into offices, whether because companies demand it, or because there’s a need in that particular industry for collaboration and communication that flows better in the office.
In northern Nevada the office market is pretty much status quo, said Scott Shanks, principal, Dickson Commercial Group. “We had a positive net absorption last quarter of roughly 55,000 square feet, so that boded well for the market. We’re seeing a slight decrease in vacancy to just below 11 percent, which is staying with what’s happened over the last year.”
Building On the Past
The last 15 years have seen changes in the office commercial real estate sector. Today employment is up in Vegas 5.1 percent, according to Cameron Glinton, regional manager, Marcus Millichap. “We have over 52,000 jobs created through 2022. In terms of new office, we expect 900,000 square feet of office construction to be completed.” That would add 1.6 percent to the market.
Some of the projects in northern Nevada have been considered speculative, including Skypointe located at South McCarran and South Virginia Street. Skypointe will add 171,500 square feet of six story office building to an existing 83,000 square feet onsite. Groundwork starts in December, but the project isn’t speculative: there are already leases signed or being signed prior to the project going vertical, said Shanks.
Another project bringing 121,000 square feet online is also in pre-lease phase, with Renown Health taking up 70 percent. “So again, pre-leasing activity in conjunction with the ability to start building,” said Shanks. “I don’t think there’s anybody who’s going to go vertical with zero percent occupancy and start building a building. I don’t think it would even be allowed, not going to go into that kind of risk with the economy in the present state it’s in.”
“We had well over 4 million square feet under construction at the time the recession hit,” said Taber Thill, executive vice president, Colliers International’s Las Vegas Office. “A lot of those buildings went into what we call zombie building.” Banks weren’t lending, land work wasn’t happening, there was no money for tenant improvements; buildings just sat until banks took them over.
The office market was the last commercial real estate sector to recover. “We didn’t start seeing any positive net absorption until probably third quarter 2021,” Thill added.
There hasn’t really been any speculative new development in southern Nevada in almost 12 years. Currently there’s roughly 663,000 square feet under construction, primarily concentrated in the southwest submarket, due to the proximity to master planned communities Green Valley and Summerlin.
The for sale market is more robust than ever now. Shell owner/user buildings are selling for more than $300 per square foot and being sold prior to construction or completion. “Along with that, our lease rates in certain areas like the southwest are higher than they’ve ever been,” said Thill. “We’re seeing lease rates in some cases north of $4 a foot.”
Vacancy rates are falling quarter after quarter, said Thill. “Third quarter 2021, our overall vacancy was 13.7 percent. Now we’re at 11.7. Our average asking lease rate for the market was $2.26 this time last year and now we’re at $2.42, so we’re seeing increase at asking rates and seen a decrease in vacancy.”
The Shape of Things to Come
“Diversity in office space in terms of product type continues to increase,” said Glinton. “There’s a lot of medical space, coupled with campus and hybrid workspace. It’s really across the board right now.”
One trend being embraced by office users is communal space. Companies are making room for places for employees to be quiet and alone and catch their breath, and at the other end of the spectrum, creating communal gathering places for collaboration.
Amenities is another definite trend. “Larger tech type companies, publicly traded Fortune 500 companies, are looking for ways to bring employees back to work or incentivize them to come back from remote working,” said Glinton. “They’re working to keep them engaged by providing that kind of atmosphere—an all-in-one stop.”
That can mean multiuse buildings with everything from restaurants onsite to living spaces upstairs. Private space is still important for employees who need a quiet environment in which to focus.
For sale
Sales activity in southern Nevada’s office market has been historically high through third quarter 2022.
“Despite some of the recent challenges, we’ve been up nearly 24 percent compared to the previous high set in 2018 for transaction volume,” said Glinton. “That’s a pretty strong comeback for office in terms of the numbers of sales. Average rent for the Las Vegas market is $23.60 a foot, which is a 5.1 percent increase year over year.”
Some of the current movement in the market may be from companies having downtime to consider what direction to move in, then coming back strong post-pandemic. Major metropolitan areas like San Francisco and New York were hit harder than a secondary market like Las Vegas; their vacancy rates are still around 16 percent.
Now as Millennials are buying more homes in the suburbs, there’s greater absorption of office vacancy in secondary and tertiary markets, because those employees want to work closer to home. Which in turn causes Class A space to be more competitive in metro areas with amenities and upgrades in order to lure workers back to the office.
Owner/User
Something to take note of, said Shanks, is the sublease market in northern Nevada which is around 400,000 square feet.
“Of that, approximately 300,000 square feet is in South Meadows, so that the lag time from when we went through COVID and the dynamics of how these office users are treating their employees and their use of space is changing, and the reason it’s coming up now as opposed to right after the pandemic is that some people are either coming out of their lease and/or just putting it on the sublease market, so the dynamic stay home or go to work is certainly showing itself a little right now. We’re just going to have to wait and see how that affects us in the long term,” Shanks said.
How the real or remote determination is made depends on industry and individual companies. Service industry businesses like accountants and lawyers mostly remain intact in office spaces, where companies whose employees work primarily on computers can save money and take smaller spaces with work from home policies.
“We’ve had a very successful year in owner occupied buildings,” said Shanks. “The price per square foot has jumped up. The average is over $200 a foot but what we’re seeing mostly in owner occupied is actually in the medical field. Growth has been very steady absorption and [buildings] seem to be on the market less time than general office buildings.”
Is there enough room?
With the continued boom of businesses moving to southern Nevada, and the continued absorption of existing product, are there enough properties to meet demand?
“There’s still quite a bit of vacancy to absorb in Las Vegas in comparison to other assets, so office vacancy is a little higher than multifamily, industrial, or retail vacancy,” said Glinton. It’s hard to tell how remote work and changes in technology will influence which properties will be able to successfully absorb that vacancy, and then what demand will be like for new product.
Existing buildings being retrofitted for today’s office users can adapt more easily through redesigned floor plans and updated common areas for collaboration. Existing buildings with outdated designs will struggle more on the market.
“Certainly in that second-generation space it’s still attractive but I think that the open space environment has been trending upward as opposed to private offices,” said Shanks. “That whole collaborative way of working seems to be the general trend.”
Upgrades generally include building systems and more technology, whether stronger wifi or cell service, said Thill. Also in demand: contactless entry points and sometimes touchless elevators.
According to Michael Young, broker, IREPLV, many of the existing properties changed hands over the last 10 years and upgraded at the time in order to compete with newer properties.
Location–Location?
So does the office market face the same challenges as industrial? Depends on the location.
“Land costs have certainly increased over the past couple years, and so have construction costs,” said Glinton. “Part of that is due to rising interest rates and labor shortages, so definitely office faces similar challenges in comparison to say a product type like industrial or retail.”
Then there’s the question of parking. What was common in the past–-surface parking-–faces challenges in the present from lack of land. Parking structures take up less space but more money—they’re expensive. There’s a trend in southern Nevada for Class A properties to be more competitive with parking structures, but construction costs can make that difficult.
In northern Nevada where the vacancy rate for industrial is below 1 percent, finding any available land to do any form of development is extremely difficult. On the office side it’s not so much about finding the land as it is about being able to afford building.
“With construction costs and inflation hitting the market, it’s really difficult to pencil out what you can build a building for versus what you can get on the asking rents side,” said Shanks. “You’re building the building at over 400 bucks a foot so you’re going to have to ask $3 to $4 a square foot on a lease basis and in this market where you have older product available down to $2.25 a foot, you’re going to go tell somebody they need to pay $4 a foot? That’s a significant jump in how they have to spend their money.”
At the start of 2022, there was virtually no office space in the southwest Las Vegas Valley, first or second generation, said Young. “Fast forward to today, we have several projects coming online. There is space available, in shell condition, so we’re dealing with newly constructed buildings. Rents have gone from $1.75 to $2 a square foot in the southwest and jumped all the way to $3 a square foot by the time you occupy a new building.” By the time tenant improvements are in, it’s $3-plus rent, maybe $3.50 to $4 per square foot. “It’s somewhat doubled in 12 months of what we could deliver to our clients.”
Class A projects are running between $3 and $4 per square foot. That’s a huge jump. The concern is whether clients can pay such rents.
“In 2012 we built buildings for $70 a square foot. Ten years later we’re at $250 a square foot. Construction costs are up 300 percent,” said Young. There have been periods of time with no price increases, followed by massive increase to construct a shell building, costs not even including land.
“The fundamentals in the office sector are still pretty good,” said Young. “Vacancies are low. We don’t have excessive inventory. We don’t have a ton of projects on the plans to be built. A couple of sizeable projects but I think the square footage is needed in the market. I’m really curious to see how the pricing is going to work.”
Still, it feels like more change is coming. “We don’t know what’s going to happen,” said Young. “Do landlords let the properties go so the next guy who buys them can lease the properties at rates the market can afford? Do the assets have to be repositioned? I don’t know the answer. Can people pay the rents that the market is asking now? We’ll know within the next six months.”
