Industry Focus: Commercial Real Estate

Commercial Real Estate in Nevada is recovering from a tough recession. Brokers agree that the industry has improved, but some markets are clearly bouncing back more quickly than others. Recently, commercial real estate experts met at the Las Vegas Law Offices of Snell & Wilmer to discuss the factors affecting the overall health of the industry in the Silver State.

Connie Brennan, publisher of Nevada Business Magazine, served as moderator for the event. These monthly meetings are designed to bring leaders together to discuss issues relevant to their industries. Following is a condensed version of the roundtable discussion.

What Challenges does the market face today?

LISA CALLAHAN: One of the challenges we’re facing is expectations with clients. Land prices have rapidly escalated, and a lot of our clients are trying to figure out if it’s going to stabilize. Is this something I’m really going to have to live with? Was this a rapid escalation that’s going to bottom out or de-escalate in a little while? People are trying to figure out whether to put their foot in the market or not, and they’re looking to us for guidance.

MIKE MONTANDON: A lot of people are still waiting for us to hit a high point in the business cycle where they can see absorption. Employment rates are normalizing and the macro-economists are telling us we’re three years or less from the next downturn. We’re still waiting for the upturn. Just trying to figure out where we’re at in the cycle.

DANIEL ADAMSON: Consumer confidence is pretty good, but if there’s some wage growth, that will help in my retail world. Time is a problem. Contractors bidding on things, employees, governmental bodies, it still takes an exorbitant amount of time. When you couple that with the more expensive land prices, the short fuses that these land owners give you can be a huge challenge.

CATHY JONES: It’s a challenge to provide high quality advice to clients who are now operating in a very global economy. We’re working with a lot of investors who are operating across a broad geography in the United States. The transactions are more complex. You really have to be able to provide a comprehensive solution. I see a lot of commercial brokers going to more of a team format to try to address that so that you can have different skill sets within your team to provide the best solution for your clients.

Which market segment is doing best right now?

ANGELA POWERS-ARMSTRONG: I have the least of the challenges at the table because I think apartment complexes are the hottest market right now. For our clients, it’s a matter of when do I sell? Do I sell this year? Do I sell next year? For many, it comes down to cap rates and what debt is going to be in the spring. When I tell clients that cap rates across the board for Class A, B and C is a 5.33 percentile, they kind of cringe when you apply that to Class C product. But then, you have Class A institutional buyers, clients and sellers who are chasing yield and the debt component rolls into that fold.

PATRICK SAUTER: If you wanted to purchase an apartment, there’s not a lot out there. As soon as we bring a property to market, it’s sold. We just sold a property and we had 20 offers on it in 21 days. The problem is finding those properties that you can sell. We have about 6,000 units under construction. In the next 24 months, they should come online, but they’re all Class A deals trying to get rents that haven’t been paid in Las Vegas before.

MIKE MIXER: On one hand, that’s healthy, but if you’re a broker selling apartments, it’s not healthy because you have nothing to sell. Depends which lens you’re looking at.

TOM FENNELL: Similar to Southern Nevada, our [Northern Nevada] recovery has been led by apartments and industrial. The low-hanging fruit for us to talk about is Tesla. One of the things that is a result of that is the perception has changed of the area and we’ve seen a lot of people that couldn’t even find Reno on a map a year ago that now are looking at the market a lot more seriously.

How healthy is the industrial Market?

RICHARD TRUESDELL: Industrial is very healthy. We’ve absorbed, in the last nine to 12 months through sales or leases, over 1 million square feet of space. Whether it’s a good industry, whether you like it or not, it’s here. We’ve also bought an incredible amount of industrial land in the Apex market. You’ve seen industrial business sales spike to an unrealistic high on a sales basis, but there are still buyers.

MICHAEL NEWMAN: There’s actually about 5 million square feet that’s either under construction now or scheduled to be by the middle of next year in Southern Nevada. We’re seeing a rebirth of speculative development. We’re seeing tenants come in to fill the space so that’s the better part of the story.

MIXER: We’re tracking a 5.8 percent vacancy, and rents have gone up considerably, which has triggered the construction of spec development.

FENNELL: We started doing spec building last year. Right now, we’re in the mid-eights on vacancy. We do have a large old K-mart building that’s coming on the first quarter of the year that’s about 1 million square feet that’s going to kick our vacancy rate up to 11 percent, but overall, it’s the same trend as Southern Nevada. We’re seeing spec building. Rents aren’t jumping a lot yet, but as far as on the Class A side, they’re getting the rents to justify [building].

What Challenges is the retail market seeing?

BRENDAN KEATING: I think we’re around an 8 or 9 percent vacancy rate right now. There’s retail projects that are being built or refilled now at peak rents, which is a little scary because a lot of retailers can’t sustain that long-term. Retail is feeling a lot more healthy, although there’s segments of the market that are still hammered.

ADAMSON: [Grocery stores] used to be the gem of the investment world for a shopping center. Now, it’s wrecking centers. I feel like I’m in the stands watching an Indie 500 race with 50 cars in it and, all of a sudden, 15 cars go into the wall. You’re still going to have a good race, it’s still entertaining, but we keep having all these spin-outs. There are hot spots in the market that are very healthy and in very high demand, and there’s a lot of dead spots.

CHARLES CREIGH: Online retailers are now expanding into brick and mortar. That was the big fear, that everything was going to go digital, and it’s not. You have Duluth Trading, which is an online store, doing brick and mortar now. There’s Sierra Trading Company, which was acquired by TJX companies that’s doing brick and mortar. It’s healthy because it’s really pushing the retailers to up their game. They are reducing their square footage a little bit because of inventory control, but it’s interesting to see.

MIXER: The byproduct of that is we’re seeing more industrial space being taken by some of these major retailers for fulfillment centers to get the product to the customer faster and less retail space. We’re seeing a little transition there.

POWERS-ARMSTRONG: I did hear an interesting commentary [on retail] the other day. The summary of it was online shoppers get information on the product and then run to the store to get the tangible experience.

MANDY SHAVINSKY: I think there will always be brick and mortar retail because, let’s face it, without brick and mortar retail, many people would have nothing to do on the weekend. You can see from some of the lifestyle centers that are being built, the retailers are not just offering a product, they’re offering an entire retail experience. I think that explains part of the success of IKEA because you go in the stores and you’re entertained for hours just looking at various displays and furniture placements.

TRUESDELL: They’re repositioning a lot of the retail. Centers can create the experience that you’re looking for by creating little villages in communities where people use their retail for walking, jogging and meeting their neighbors more so than they do in their residential neighborhoods.

How have changing consumer patterns affected the market?

KEATING: I’m pretty concerned about the future of technology and retail. We had a presentation from a gentleman from New York City on what challenges they see from technology. From 2010 to 2014, there was $5 billion invested in start-ups. In 2015, there’s already been $25 billion invested in start-ups. Start-ups are made to just disrupt a normal pattern of consumers. If you’re designing a brand-new junior anchor shopping center today and you’ve got 20,000 to 30,000 junior boxes, it scares me what that will look like in five or 10 years because of all the technology that’s disrupting our shopping patterns.

ADAMSON: Couple that with Millennials and the way they shop and eat and the way they want unique experiences. They want transparent experiences. They want to go to Starbucks because they give all their employees health insurance. The Millennials will shop with a company where they like the culture and they like what they’re doing as much as liking the product.

MIXER: Add to that the 3D printing that I hear is catching fire and will be another disrupter to retailers because you can, basically, create any product to sell in your warehouse and that will level the playing field for lots of different kinds of stores to sell multiple products they don’t sell today. We spend time trying to understand what can change for the better. Some of those things go back to interacting with people and convincing them to change their minds or get passionate about something. Those are things computers can’t do, so it gives me hope that the commercial real estate industry will not [cut out the middle man] any time soon.

How is the office market faring?

FENNELL: Our Class A office is doing a lot better. We’re going to see the first spec building in Reno in almost 10 years. That should go up this year. There’s been a flight to Class A office and there’s not a lot of large space left. It’s getting better. Nothing’s as bad as it was last year, but there’s still a ways to go.

JONES: You have certain pockets within the Valley that are very strong, but it’s being more than offset by other areas where they’re actually still in decline. Unlike some of the other property types, we do a lot of investment sales on the office side, and the buyers are very much still looking at price per square foot. To re-tenant that building down the road is a lot higher cost on an office building than it would be for industrial or retail, so it’s a concern they still have. We are starting to see more stabilized office product trade [in the market]. Buyers that are willing to look at Las Vegas for stabilized office is not a huge buying group. You still have an overabundance of value ad buyers and there isn’t an overabundance of value ad office product. [Vacancy rates] from the third quarter are about 17 percent. It varies quite a bit across the Valley, depending on the submarket.

NEWMAN: We’re showing 19.5 percent, and a year ago it was 21.9 percent. If it’s well-located and well-designed, there are more and more tenants out there willing to pay the price.

MICHAEL DUNN: It depends on who’s reporting and what they’re tracking. You’re seeing it from 17 to almost 26 percent. I expected that the Class C market was really going to take it in the shorts, so to speak, but that hasn’t happened. You go up West Sahara and a lot of those buildings have had great leasing traction. They’re doing short-term deals, but they’re now fairly stabilized up in that market. We’ve done a good number of deals, but we’re still fighting the rollover of some larger tenants pulling out of the market or downsizing. We’re not having the stimulus that we had during our boom period with companies relocating here. It’s more of a local musical chairs-type market still.

MIXER: The trend, too, is companies that are becoming more efficient and learning to do more with less workers. Therefore, the office space requirements are diminished.

LARRY SINGER: That’s a big problem. Law firms are looking at that too. Particularly, law firms that have figured out ways to increase the volume of people they have. Associates are not getting offices anymore. Partner offices are shrinking. Most buildings are not built to accommodate the parking needs. Some landlords are giving away too much parking. If they get fully leased, they’re going to have a problem. If we get back down to a 9 or 10 percent vacancy, people will have to park out in the street. That’s one of the challenges that nobody mentioned. We do not have the public transportation infrastructure here that urban environments have.

TRUESDELL: One thing this market doesn’t have, like other major office markets, is a major local developer pushing the office market forward like Hughes did for years. They were enough involved in the market to have that building come online when the tenants were rolling over. Now you’ve got a minimal amount of really Class A space available right now. If somebody needed 30,000 to 40,000 feet, they’d have a hard time finding it.

KEATING: We have to have a massive growth rate to pencil new construction for office. If there was growth, developers would spec on it. They would find people to finance it.

Is financing an issue?

SHAVINSKY: The biggest challenge is the availability of financing. There’s more money out there than there used to be, but the underwriting requirements are tight and loan to value ratios are much higher than they used to be. Coupled with increased regulation, it creates an environment where it’s much harder to get money, especially for raw land where you’re not looking at any income-producing asset to collatoralize.

MIXER: Lenders look at the vacancy rates and rents and are just not going to lend the money. It’s a double-edged sword. It’s great because we’re not getting money out there to cause the problem we had in the first go-around. It’s more responsible, but at the same time, it’s frustrating.

DUNN: They’re going to want pre-leasing. That’s why we have a bunch of suburban, small buildings because they didn’t require the pre-leasing.

SINGER: The tenants do not exist to really substantiate lending money. It doesn’t make any sense to build smaller than a 120,000 square-foot building anymore because of the cost of land and the cost of materials. Lenders are not going to lend without 60 percent pre-leasing. We don’t have the volume of tenants to justify that. You have to put two or three of them together just to kick off the building.

SAUTER: We have clients who raised hundreds of millions of dollars looking for a product, and there’s a very limited number of any type of real estate for them to purchase. That’s going to continue to be a problem to drive cap rates down and values up. Even today with trying to get properties appraised for loans, it’s tough. I think we’re getting ahead of ourselves a little bit on our value side.

KEATING: We represented a developer for Starbucks who took down the northwest corner of Stephanie and Wigwam. It was the first loan I had seen in the market where Bank of Nevada lent money to a developer on a land acquisition, not construction financing, but land acquisition financing because they felt so strong about it. There was low loan-to-value on it, but still, to see a traditional lender lend on acquisition financing for land just shows where we are in the recovery cycle.

What role does economic development play in this industry?

CREIGH: On a statewide level, the issue is our economic diversification and our education system. We’ve really got to solve those problems in the state, and then we can really start to attract a lot of business when that happens.

KEATING: We’re always ranked at the bottom of education and I think it’s important we get more quality individuals here. Retailers and employees want to be around better-educated people. Higher education and better workforce is something that concerns me for the future.

NEWMAN: If you look at the national cycle, we’re probably two to three years away from where we don’t want to be. We haven’t reached a point of recovery yet in Southern Nevada. Of course, much of that is a result of the fact that we’re non-diversified. We have a very fragile economy here.

SINGER: I would say perception is one of our biggest challenges. Perception on the behalf of lenders who perceive us as still having a weak economy, not wanting to lend here when they can lend in San Francisco, New York, etc.; perception of the lack of diversification; perception of a poor workforce – not well-trained, not well-educated [are all issues]. If we can’t get financing, then we can’t build. We can’t diversify and train our people. If the perception is the only jobs here are within the tourism industry, then diversification isn’t going to happen.

NEWMAN: We worked with GOED to bring a number of site consultants from around the country to Nevada. The comments we continually get back from them is it’s hard to move people to Southern Nevada because we are perceived to have a transient workforce. As soon as a new hotel is built, they’ll pick up and go someplace else. The other concern is job training.

TRUESDELL: [Economic development organizations] put out the message to come to Nevada and don’t address these problems. Now we’ve got a one-size-fits-all for the whole state. Southern Nevada is different than Northern Nevada in a lot of ways. They need to find a way to reach out to [brokers] and really root for their success. If they’re successful, we’ll do business.

MONTANDON: I know we’re a biased industry, but that’s a real issue. We should be hearing from managing directors that, yes, the economic development agencies are taking advantage and working through us and have some sort of relationship.