Recently, a group of Nevada commercial real estate brokers sat down to discuss the challenges facing Nevada’s commercial market, such as recruitment, land prices, growth and broker education. Connie Brennan, publisher of Nevada Business Journal, served as the moderator for the event as part of the magazine’s monthly Industry Focus series, which brings industry leaders together to discuss issues pertinent to their profession. Following is a condensed version of the roundtable discussion.
Industrial Market
Connie Brennan (Nevada Business Journal): Will industrial rates continue to increase over the next year?
Perry Muscelli: If it keeps in step with the population, it will barely cover the costs to service the local economy.
Dan Doherty: I think rising costs are even more challenging for the companies that buy rather than those that lease because there’s a huge differential, even with a 13 percent to 16 percent annual rise in costs. Off the beltway now, 20,000-sqaure-foot industrial buildings are selling for $185 per square foot to $225 per square foot. Even in North Las Vegas, we’re putting 30,000- to 50,000-square-foot buildings into escrow in the $120s per square foot range. Just six months ago, similar-sized buildings were ranging in price-per-square-foot from the high $80s to the low $90s – that represents a significant rate hike.
Brennan: How does the purchase price of industrial buildings compare to what it was two years ago?
Doherty: I would say you are probably looking at a total increase of about 70 percent, or rather, 35 percent of the sales price per year, over two years.
Brennan: Do you expect that 35 percent rate of increase to continue for the next two years?
Doherty: I would say no, conservatively. However, supply is not increasing and I don’t see demand increasing for large, multi-tenant buildings. Investors are moving toward developing smaller single-user buildings with less than 50,000 square feet. People who are in it for the long term and don’t want to pay rent, or typically haven’t paid rent, rates are going to continue at a substantial pace. I think you are easily looking at 15 percent to 25 percent for the next couple of years, for user sales prices.
Kevin Higgins: I certainly think that the industrial rents are going to go up substantially, too. We have had some pretty unique circumstances in the last two years, and I don’t believe that’s going to change. Near the Las Vegas Speedway, the industrial lease rates range from 60 cents per square foot to 75 cents per square foot.
Doherty: The Speedway has almost the highest lease rates in all of North Las Vegas.
Dean Willmore: One thing people need to remember is that our industrial rents have been stable for quite sometime. For example, in North Las Vegas, they have held for 10 years at 33 cents per square foot to 34 cents per square foot. By comparison, the recent 25 percent jump in lease rates is if you spread it out over 10 years, a much smaller number. It’s the same with the other areas of the city, we have been quoting 55 cents per square foot to 65 cents per square foot for warehouse space and $115 per square foot to $125 per square foot for office space in an industrial environment. So, I think if you spread the increase out over a longer period, it’s probably going to fall in line with the rate of inflation.
Higgins: Yeah, but that’s historical. I think what we’re talking about is that over the next five years, you are going to see much more growth in lease rates, overall.
Willmore: Well, yeah, but I don’t think that you are going to see as huge of an increase.
Higgins: No. There certainly was some pent-up demand. But, it’s still a substantial increase when you are talking about a lease rate of 60 cents per square foot increasing by 6 cents to 9 cents each year.
Doherty: That’s a good point though, because it really depends upon where you were at. Did you buy a building 10 years ago, and sell it two years ago? Or did you buy a building two years ago, now you own it, and you’ve received 32 percent rent growth over two years?
Art Farmanali: The construction industry capitalized on that increase. As a result, the cost of materials went up, and so did the cost of labor. So, it is becoming a challenge, now, for an owner-user to pay $185 per square foot for a shell building, the interior of which he must hire a contractor to complete.
Tom Naseef: Well, it has to be more difficult for the office component on the industrial side because they are not building very much of it out to the economy’s scale that a user can take to the bank and get approved for financing. I mean, the bathroom alone is $8,000.
Higgins: I think it’s a plus when it’s built-out already, personally. We’re finding that to be true because there are so many unknown variables. It’s much more difficult obviously for office, but I think it’s smart to go ahead and build it out right away.
Doherty: If you plan to sell the building, you are better off with a shell. On the other hand, if you prefer to lease, a build-out facility is more profitable because once the interiors and other details are complete, the facility incurs a major jump in price point.
Willmore: Developers are getting real creative and they’re actually building a second floor, concurrent with building the first floor. By producing twice the square footage of office space, and increasing the overall space of the building, they are able to lease more square footage at a lesser rate. Appraisers are now buying into the fact that second floor space in an industrial building is part of the rentable footage, where they never used to accept that argument.
Donna Alderson: If you build-out every space with an office module, you may have multiple-bay tenants who don’t need those separate little office pods, and it could create problems for you.
Land Profitability
Brennan: At what point does the dwindling supply of land begin to erode the profitability of Southern Nevada’s real estate developers?
Doherty: I would say we’re pretty close now.
Alderson: Well, I spend a lot of my time researching outlying markets – as far out as Kingman, Ariz.
Brennan: So the outlying markets are the key to the future?
Alderson: That’s the way I’m thinking. A lot of the companies we’re entertaining cannot afford the prices in the Las Vegas Valley, so they’re likely to consider another, less expensive market, such as Reno or Phoenix. Nevertheless, we’re actively trying to keep them close within the service area.
Suzette LaGrange: Well, they still have industrial space in downtown Los Angeles. We’ll always be creative when it comes to finding industrial space here in Las Vegas for the companies that have to be here. It’s just going to get more expensive no matter what. I mean, it’s just going to be more expensive if they move from Los Angeles. If they don’t need to be in Las Vegas, they will go to other markets.
Doherty: I think we’re going to see a shift over the next 10 years. Companies that typically just service Southern Nevada, will move to an area within reasonable proximity, and by that I mean within 50 miles. To me, not one outlying area is a clear winner right now. We can’t really identify that area and its one of our challenges. I think you will see these companies moving to North Las Vegas and the companies in North Las Vegas that don’t require frequent access to central Las Vegas and the Strip will perhaps to Kingman, Mesquite, Pahrump or Coyote Springs.
LaGrange: I think eventually we will be seen as one big submarket. We are not going to have all these separate individual markets – Henderson, southwest, North Las Vegas, etc. It will all merge into one big submarket. Here, we are seeing tenants move from the southwest Valley market to North Las Vegas, and they can still reasonably service the Strip from there, plus, they take advantage of the rent decrease savings.
Buying Versus Leasing
Brennan: Is the demand greater for buying offices or leasing the space?
Peterson: I think there has always been a greater demand for businesses leasing their office space. But I think that the number of companies choosing to buy has risen significantly over the last two or three years.
Soozi Jones Walker: I think demand for buying has leveled off and leasing has increased.
Ron McMenemy: I agree. It’s trailed the slowdown in housing development. A number of developers have to pull the trigger and proceed with their projects because they’ve already got the financing and everything’s in place. Furthermore, any delays or interruptions can be very expensive because of the rate at which construction costs are rising.
Jones Walker: Property is still being built on dirt that developers acquired for $7 to $13 a square foot. They’re not yet developing on that $20-to $25-a-foot land that they bought along the Beltway. The real pressure of the market is showing.
Farmanali: I think the owner-user market – as far as office is concerned – is still stable. We have had several projects, ranging from 4,500- to 5,000-square-foot buildings, sell-out before completion. And we were dealing with a select group of individuals, like physicians and attorneys, who need to be in their own building.
Brennan: How do you advise a small business owner whether it’s a better deal for them to lease or buy their building?
Stanley: You do a buy-versus-lease analysis; which CCIM- and SIOR-designees are good at doing. Usually, the analysis is conservative on the interest rates and realistic on the dollars potential buyers might have to spend. And that’s the whole thing, when you’re leasing and putting your money into somebody’s pocket and leave after 10 years, you don’t get any of the money back.
Steven Santanna: And there is a 6 percent appreciation per year for a small building owner at the end of 10 years. So it’s a nice return on their investment.
Doherty: I think it’s based on the operation of the company or the philosophy of the company. How much money are they going to put into the building? Is it a manufacturing firm? Is it a medical or law outfit? What is their exit strategy? Do they think they’re going to test this market for three years and see if it’s going to work? Or do they know that they want to be here for 10 or 20 years? Appreciation is the only upside in owning a building. In the first 10 years, you are only going to pay off 18 percent of the mortgage.
Muscelli: We’re at very low cap rates and interest rates right now. I think interest rates are going to go up and then the cap rates are going to go up, too. If cap rates go up, it’s going to wipe out a lot of that appreciation for a couple of years.
Jones Walker: Whether you lease or buy, you still have to pay to occupy that building. It’s just a matter of which you pay less for.Muscelli: But if you’re gambling, the building could go up 6 percent in a year and that would be a real bad bet.
McMenemy: Aside from the economics in the submarket and trends, are they mentally prepared for this? If it’s a large group that comes together to develop a building, they can tear an organization apart.
Generation Gap
Brennan: Do you see young people coming into this field as a profession?
Naseef: I have five people who are between 26 and 30 year sold.
Higgins: I see a huge gap – a 10- to 15-year gap. In 10 years, it’s going to be an interesting deal.
Willmore: There’s only about 60,000 people in the country who do what we do. Because of attrition and the fact that we are getting older, experts believe that there are only going to be about 40,000 commercial brokers by the year 2010. The United States has a population of 300 million people. I mean, compare that to about 1 million physicians in the United States, and two times that amount of attorneys. So for 40,000 people to service 300 million people, there’s a huge gap.
Peterson: It takes between two and three years before you really start making a living in this business. That’s why you have to start young – when you don’t have as many obligations and bills.
McMenemy: There is a definite generation gap and a work ethic challenge. When these folks come out of college, they want to drive BMWs, make $200,000 a year, and be a vice president. Most of us are baby boomers, and we just get the job done. The members of generations X and Y need a lot of nurturing, direction and plenty of pats on the back. They’re very bright and quick to pick up on things, but it’s a work ethic challenge.
Doherty: The other thing that really creates a safety net for those of us who have been in the business is that you either enter this business directly out of college, or you come from money.
Flynn: There is an expectation of instant gratification. No matter how many times you tell people they will not make money in the first two years, it goes in one ear and comes out the other. And three months into the business, when they haven’t gotten a check – they quit.
Jones Walker: We have different ethics – our work is everything.
Galit Rozen: I think the gap is in the way people first get into this business. A lot of young people are willing to do the work. They need to come in under a mentor-type position, where they’re getting paid to learn, and they’re also benefiting the team.
McMenemy: A lot of young people want to get into the business, but they don’t want to apply themselves. I think the other challenge we have here in Las Vegas is that they can go to the casinos and get much higher-paying jobs.
Doherty: I think it might be a socioeconomic issue. If you ask students at UNLV what they want to be, they say, “Doctors, attorneys and dentists.” But you ask kids at schools like USC or Stanford, and they say, “Broker.” It hasn’t caught on as an elite profession in smaller markets like Las Vegas.
Santanna: That’s why we see these bigger gaps. From college, they work at a casino to make ends meet, but then, they establish this expensive lifestyle for themselves. They have a mortgage, a family and a high overhead. It’s hard to go from a constant flow of money to possibly no money for six months to a year.Educati
Brennan: Do commercial brokers need more education than residential brokers?
Alderson: We need different education, that’s for sure. We are all lumped together, and we all go through the same licensing procedures, the same renewal procedures, but our businesses are completely different.
McMenemy: You know, in Europe, they do require a special education, college education, and it’s focused primarily on real estate.
Flynn: Well, as the residential market has slumped, we’re seeing more and more residential agents who, instead of referring the business, are wanting to run with the clients and do the complete deal. They are doing a disservice to their clients, and giving the entire industry a bad name.
Farmanali: Twenty percent of the business I’ve done in the last two or three years was referred to me by residential agents. They are realizing the rewards of the business and want to move into the commercial side. I am working with a few right now who are eager to come onboard as trainees.
Doherty: Or they want to keep their residential business, and instead of referring commercial leads to you, they want to supplement.
Willmore: But, commercial brokers have to know about planning, zoning, architecture, civil engineering, accounting and utilities.
Naseef: It’s a potential source for new business, but you need to convert the business, and then you have to conduct and finalize the business.
Flynn: That takes years to learn.
Doherty: I don’t think we need more training, just different training.
Mike Hillis: It’s got to be totally different training. The problem is, there are so many more residential brokers or agents than there are commercial agents. It’s like a 10-to-1 ratio. There wasn’t two minutes of that session that had anything to do with what a commercial broker does. It’s all residential.
Jones Walker: The education is more expensive and harder to find.
Naseef: However, Coldwell is pouring a lot of money into Commercial Alliance for education. So we are really starting to make it a priority.
Jones Walker: The CCIM (Certified Commercial Investment Member) program is where so many people go to get commercial education. In the past five years, we’ve gone from 25 percent residential agents to between 50 percent and 75 percent. Now, in that particular line of education, by the time you get through those first commercial real estate courses, it gets exponentially harder from there on out.
Santanna: There are so many more variables to a commercial transaction as compared to a residential sales transaction. We not only have to understand what the lease says, but we need to know how to speak intelligently to a landlord. We need to understand tenant motives. Numerous variables, analyses, market data and other factors are key components of a commercial transaction; these requirements far exceed those called for in a typical sale of a single-family home.
Brennan: How important is the SIOR (Society of Industrial and Office Realtors) designation?
Willmore: I think it’s extremely important because it ties right into what we’re talking about – education. We’re actively trying to recruit new, young talent and train them.
Muscelli: There’s no way to teach these skills in a classroom. The most successful brokers in this room have all worked for someone else and experienced hands-on exposure to the many facets of the business.
Alderson: I agree that working under a mentor is the best way to learn.
Naseef: You don’t learn how to drive by watching your parents drive. You learn by doing it.
Residential Factor
Brennan: What impact does the slumping housing market have on the commercial real estate industry?
Muscelli: I think we have a temporary reprieve from the increase in construction costs because of the slowdown in residential construction. It’s made material suppliers hungrier than they have been in a while. There’s also extra labor in the market that we haven’t seen for some time.
Higgins: I disagree, Perry, with your statement about the labor and supplies a little bit. I think if it hadn’t been for the construction on the Las Vegas Strip, we would have seen an economic nightmare occur in this town, not only in rising construction costs, but also from a standpoint of lost jobs.
McMenemy: Thank God we’ve got the Strip to sort of absorb the functions and push things back into the marketplace. Labor flows in and out of the Valley and we have been very lucky with that. But fundamentally, when housing is stopped, it affects everything.
Jones Walker: We have been really fortunate on the commercial side because we haven’t experienced the slowdown affecting the residential market. Our market is built upon financial stability that stems from a commercial property’s cash flow and net proceeds.
Doherty: If you ask someone outside the market, especially from the institutional sectors standpoint, to compare Southern Nevada’s overall real estate market from two years ago to the same market today, you’ll hear a far less optimistic opinion. The source of this disillusionment was the setback of the residential housing market.
Taber Austin Thill: It’s definitely affected the institutional buyers from coming to our market and looking at large portfolios.
Higgins: It’s not like it was in 2005 or even 2006. There is a significant feel in the air when I’m not pre-selling all my buildings.
Brennan: How has the slump affected land cost?
LaGrange: The homebuilders are unloading their extra land that they don’t plan to build on. It’s not like housing has stopped – we’re just back to a more reasonable pace.
Frear: Still, 6,000 people are moving here each month. We used to see a doubling in housing demand that was an artificial inflation caused by speculating investors from California coming in and buying inexpensive houses. Now the speculators are gone.
Naseef: That is bringing in around 12,000 jobs – permanent jobs.
David Frear: That’s why construction hasn’t slumped off too. I’m in construction up in Northern Nevada too, and I’m starting to make 20 percent up there.
Doherty: They haven’t gone down, but they haven’t continued to go up by 20 percent either.
Muscelli: Otherwise I think prices would have probably dropped another 20 percent in the industry.
Stanley: The prices are actually coming down. I look at deals I tried to make two years ago, and the prices are $5 to $8 a square foot lower. Not where I want them to be yet, but they are starting to come down.
Willmore: We have hurt ourselves a little bit because there’s been probably no less than 12 to 15 articles in the newspaper in the last year that said, “We’re running out of land,” when it’s really not the case. Instead, we are running out of land that’s affordable. Property owners are reading the paper saying, “Hey, my land is more valuable today than it was yesterday.” If we got the facts out there as to exactly how much industrial and office land there is still available in Las Vegas, then I think prices will come down a lot.
Higgins: I disagree. You can talk about land on the moon, but the reality is that for brokers who make a living selling to users and developers, by and large, they’re all looking for land and I don’t see any reduced prices.
Doherty: To say land is going to go down, or is going down, that needs to be a general rule across the board. I just don’t think that is the case. I mean, the comps we’re closing out with developers are higher than ever. And the reason we’re buying those pieces is because the alternatives are more expensive.
Higgins: And again, you just closed out a piece at over $12 a square foot? A year ago, it was $8 a square foot.
Doherty: The alternatives were more expensive, and they had characteristics that made them more expensive.
Willmore: There’s too much land and too much is master-planned. And if we’re going to talk about industrial, there’s 47,000 acres master-planned vacant industrial land.
Higgins: It’s all undeveloped land.
Doherty: But it has to have utilities and roads and zoning, not just master-planning.
Brennan: Will land prices ever go down?
Higgins: We have no alternatives, now. In five to 10 years, we might have alternatives, but that doesn’t do anything for the price today on a piece of land. It’s called supply and demand.
Frear: Don’t expect to see any changes in land availability for at least five years.
Doherty: Or if the residential market slowed, and for whatever reason, the gaming industry slowed, I think we would be dealing with an entirely different market. I would completely agree that land prices are coming down.
Flynn: There’s so much product, especially in the office market and so much product coming out of the ground and so much planned. So far, the demand has been there to take that away. My concern is that as the rates keep rising, people are going to find other alternatives, and then we are going to see a slowdown on the development side.
Doherty: I think that’s completely true on the office side, but not in industrial.
Naseef: What about those tenants that are coming up for renewal and don’t have lower options?
Doherty: We are seeing some big users that are really looking to move out of the Valley, and some will. As prices continue to go up, we become less and less competitive on a regional basis.
Muscelli: The point is that we don’t have enough competition in the trade because of the shortage. I know in Phoenix, construction costs are much lower. There’s adequate supply and demand for the next guy to get in and compete with everybody else.
