Recently, more than a dozen SIOR (Society of Industrial and Office
Realtors) commercial real estate executives gathered at the Las Vegas
offices of Holland & Hart, LLP. The commercial real estate industry
was among the hardest hit when the economy entered the current
recession. The brokers discussed how business has changed, the
increasing number of commercial foreclosures and the silver lining.
Connie Brennan, publisher of Nevada Business Magazine, served as
moderator for this monthly event that brings leaders together to
discuss issues pertinent to their professions. Following is a condensed
version of the roundtable discussion.
State of the Industry
Commercial real estate has been struggling to find balance in
today’s economy. The panel shed light on the biggest changes the
recession has brought to their industry and the way they have adapted.
Donna Alderson: We’re cold calling a lot again, which I haven’t really had to do aggressively in over 15 years.
Tom Naseef: “Hunker down” is what characterizes my plans.
Xavier Wasiak: I feel like I’m always trying to reinvent myself.
I find myself sitting down with my team on a more regular basis than
usual and trying to think about ways to reach users.
Mike Hillis: One of the challenges we are facing is that lots of
out-of-state brokers are trying to do transactions in Nevada where they
aren’t licensed. Nevada is unique in that it has strict laws regarding
licensing. I get it from our brokers all the time when someone from
out of market is trying to do a deal here and that’s illegal. It’s a
problem for everyone, especially the out-of-state broker because the
developer can just refuse to pay. The broker wouldn’t have legs to
stand on. It’s pretty prelavent and anybody representing landlords sees
it all the time.
Tenants Versus Owners
The commercial real estate industry is currently adjusting itself
to the role reversal of tenants and owners. The brokers offered their
opinions about the current opportunities for the end user and the
uncertainty that plagues the marketplace.
Dean Willmore: We’re seeing the exact opposite of what we saw a
year ago, where sellers were absolutely unrealistic about pricing. Now
buyers are totally unrealistic. With prices in a free fall, how do you
value real estate right now? You can’t use comps because there are no
comps, you can’t really use the income approach because rents are all
over the place, and what cap rate do you use? In my opinion, the only
way to really value it is the replacement cost approach.
Art Farmanali: Also, there is some substantial rental
abatements. If someone is signing a five- or seven-year lease, I’ve
seen landlords giving as much as six months free rent. So that’s an
incentive for a lot of end users because the consumer confidence still
needs to be restored.
Alderson: What I’m finding is that landlords are seeing the
picture a little more clearly and are listening to us. If we have ideas
and recommendations, at least my clients are saying, ‘Okay, we’ll offer
different incentives, we’ll be more aggressive or we’ll lower the
rent.’
Dan Doherty: I don’t think that end users are taking advantage
of the current situation. I think they should be committing to longer
term deals and taking advantage of the market, whether it’s upfront
rent abatement concessions or flat leases.
Pat Marsh: As much as the landlord doesn’t know what the market
is going to look like in three years, tenants don’t know, either. They
don’t want to commit to five or seven years, because they may need more
or less space in five years or they may have to walk away from the
lease.
Wasiak: I think it’s more internal economic issues that are
affecting them [the tenants] that we really never get to hear about.
They don’t have a clue, like a lot of us, about exactly what’s going to
happen, so they’re really waiting to pull that trigger.
Charles Witters: It seems like all the tenants we are dealing
with are here in town and they are moving from one building to another.
Very few are upsizing, in fact, they’re mainly downsizing. When a
tenant moves from one building in town to another building in town, it
doesn’t help net absorption at all.
Randy Broadhead: A few years ago, we had 30 to 40 percent of tenants coming from outside markets; today that number is very small.
Brad Peterson: Falling tenant improvement costs are allowing
landlords to be a little more competitive on other concessions in the
market. They can give a little more free rent and discount the rental
rate. They are not having to the spend tenant improvement dollars the
way they would have two to five years ago. Now they can use that same
pool of money and be more competitive to get tenants.
Asking Prices
In the recent past, per square foot rental rates varied widely
across product type, the turn in the market has narrowed that gap. The
participants discussed the current rates as something they haven’t seen
in the last decade.
Willmore: There is tremendous rent parody in the market right
now. You used to have a pretty wide range, where warehouse rents were
42 to 45 cents a square foot and Class A industrial product was up to
$1.45 a square foot. There was a big range in rents depending on
location and amenities. Now that spread has gotten really narrow. None
of the previous criteria matters anymore because only the best
locations right now are even seeing offers to lease. Some tenants have
pretty unrealistic expectations on where the rents should be because of
the media telling them the market is so bad; as such, the offers are
really low.
Doherty: We are back to the rental rates of 12 or 13 years ago.
The process of valuing a building is so difficult to determine right
now. Appraisers are looking at asking prices right now, which I have
not seen them do in 19 years. So if there’s one or two comps that they
can put their fingers on, and then they’ll use seven to eight asking
prices, which is really crippling the people who are still making good
deals.
Taber Thill: We’re seeing fully improved office buildings that
are trading at shell prices right now because the people that did the
improvements are not getting the credit for those improvements, maybe
50 cents on the dollar.
Marsh: I think we’re even beyond that. I submitted a proposal,
a three-year lease and asked for three months free rent. The landlord
countered and gave me a three-year lease and offered six months free
rent without me even asking for it. So I would say turn the clock back
further than 12 years.
Sue Smith: In our market up north, ProLogis is just saying, “Make an offer.” Not even putting a price out there.
Bouncing Back
When the brokers were asked if the market had hit the bottom, a variety of responses were put forth.
Connie Brennan: What do you feel will cause the market to turn around?
Michael Dunn: Job growth.
Smith: Job security.
Broadhead: The national capital markets have to loosen up.
Peterson: You’ve got to see development in the Valley again to really have it come back.
Soozi Jones Walker: It’s consumer confidence. That’s going to
create everything else. I think people are bombarded 24/7 and all they
see is doom and gloom. People need to be able to feel confident that
they can go back and start purchasing and going on vacation again
without the fear that they’re going to lose their job tomorrow
afternoon.
Doherty: I think we’re close to the bottom on for-lease product.
There are still landlords out there who are living in yesterday’s
prices, but they’re going to have to face reality. On for-sale product,
there have not been enough transactions to say we’re at the bottom.
Naseef: I think what’s happening in the market is that people
don’t understand the movements the government has made with the
stimulus package. There’s a lot of confusion out there as far as people
going out and feeling comfortable and secure. The federal government
has to do a really good job in their public relations efforts to get
more people to understand what they’re doing and what the future
effects are going to be before the developers start building.
Willmore: CoStar did a survey, and the results indicated 80
percent of the respondents felt the market had not bottomed yet. But I
still think it’s all public perception. And just like this market
turned on a dime, it’s going to turn on a dime for the better before
you even know it. And I agree 100 percent with Dan that, tenants are
taking advantage, but maybe not as much as they should be, and buyers
are definitely not taking advantage of being able to buy buildings
right now and get the land for free.
Doherty: I think the recovery is going to happen like a
mushroom cloud. It’s going to start right near the resort corridor,
and it’s going to work its way out. Just like it happened in reverse on
the downturn.
Banks Reclaiming Properties
Foreclosures are affecting every aspect of the commercial real
estate industry. The brokers discussed what future foreclosures could
mean.
Willmore: We keep expecting this enormous wave of foreclosures
in the market. But if you look at the commercial notices of default
that the title companies send out every week and you really go through
the APN numbers, most of it is vacant land or residential. I think it’s
a bunch of bull that we’re going to see this huge wave of industrial
foreclosures in the market.
Jones Walker: From a banking perspective, when they gave all
these construction loans, they had interest reserves built in, and
typically, it was a two-year construction loan with a guaranteed
roll-over of either 12, 18 or 24 months, depending on what you wanted
to prepay in the way of points. Well, on the guaranteed roll-over, they
got interest reserves, too. The reason we haven’t seen this come out is
there’s interest reserve accounts set up on virtually all these
construction loans. They’ve been sitting there, the banks have been
paying themselves, and that’s why the banks have tanked, because nobody
really knows what’s in there because that’s privileged information. So
the question is when did the big construction loans start?
Doherty: On the industrial side, I think we’re going to see some
effects of the foreclosure market. There was about a million and a
half square feet of for-sale buildings built last year, a portion of
which will probably be foreclosed on. But it’s not significant in the
scheme of 105 million square feet in the whole market. So we will see
some effects of the foreclosures, but by no means is it going to be
significant and affect the whole market. You’re going to see some
substantially below market sales when that stuff is unloaded, or
whoever buys these notes and ends up taking the property back can do
some incredibly aggressive lease deals.
Wasiak: I think we’re seeing telltale signs of that now. I’m
starting to see some buildings for sale, especially on the user side,
with prices in the southwest that I don’t think we’ll ever see again.
Silver Lining
The brokers shared their thoughts on the opportunities the market has created as well as where solutions will originate.
Dunn: We went to an extreme here in residential and on the land
side. Frankly, I think we need this land that’s been leveraged to go
back to lenders, because they’re the only ones really capable of being
able to write it down far enough to benefit us in the long term where
future development is more feasible because the land is priced back
down to reasonable levels.
Doherty: That’s really the solution to the scarcity of land in
the Valley. To take all the owners, you take all their property away,
and you sell it at 40 percent of market, and then your scarcity goes
away. That’s going to happen to a fair amount. I mean, there are people
out there still looking at land at the Speedway at $12 bucks a foot.
That’s a $4 to $5 market, in my opinion.
Witters: On a positive note on shell space, all of us office
brokers have worked on deals in shell space buildings, and thought we
had the deal done until the TI bids came in, and then we had to go to
second generation. Tenant improvement costs have come down so
dramatically that landlords are able to provide turnkey at a reasonable
rate. I think, instead of the trend for the last year of just having to
go to second generation space, hopefully we’re going to be able to fill
up some of these new buildings, or at least start putting tenants into
shell space buildings.
Jones Walker: I think Class B space is going to be what leads us
out of it. A lot of our Class B office space is owned by regional or
local developers that do have deep pockets, and they’ve got the ability
to turn that big ship on a dime. The silver lining is that so many
buildings are actually controlled and owned by local people. It’s local
people that solve local problems, not governments.
Peterson: More and more now, it’s not just location, location,
location, but it’s who can provide the competitive deal. All of a
sudden you’re seeing a little shift and certainly in economics, people
look at the bottom line. They’re willing to move from Class A buildings
to a Class B building for the first time I’ve ever seen.
