While national and local media outlets have been speculating whether there will be a sharp downturn in housing, the commercial real estate market in Nevada remains healthy. Although it faces challenges due to rising costs for land and construction, plus slightly elevated vacancy rates in Southern Nevada, the outlook for the office markets at both ends of the state seems rosy.
The Market – Southern Nevada
Overall, it seems safe to say that demand for office space in Southern Nevada hasn’t kept pace with supply, but that it eventually will. The commercial real estate office market in Southern Nevada expanded by 422,000 square feet in third quarter 2006, but logged only 272,000 square feet of net absorption, according to Brian Gordon, principal of Applied Analysis. “More space came online than the market demanded, and that resulted in a rising vacancy rate,” he said.
The vacancy rate in the office market rose to 9.9 percent, up from the second-quarter rate of 9.6 percent, and compared to the third quarter 2005 vacancy rate of 8.2 percent. The 9.9 percent rate is actually below historical averages and a more normalized rate than when Southern Nevada bottomed out at 8.2 percent a year ago, said Gordon. At that point, market conditions were extremely favorable and there was still significant demand, so while vacancy rates have risen modestly, the market is still relatively healthy.
The question is whether it will be healthy enough to support the 4.4 million square feet of office space due to come online in the next two years.
The Market – Northern Nevada
At the other end of the state, things are less hectic, and absorption is higher. “Essentially what we’ve seen in the last three quarters of 2006 is a steady decline in the vacancy rate,” said Dominic Brunetti, vice president of Alliance Commercial.
In Reno, most of that decline occurred in the downtown office core, which fell 3 percent to a 17.23 percent vacancy rate in the second quarter, according to Colliers International Market Report. The downtown submarket is healthy again.
“There are two sides to the office market in Northern Nevada,” said Tim Ruffin, SIOR, CCIM, with Colliers International. “There’s corporate America leasing class A space, and that market has gone very quiet. I think they’re waiting to see what the economy does in the first half of 2007. And then there are the professional service firms serving the ever-increasing population in Northern Nevada, and that side is fairly active.” In that market segment, professional garden office buildings are moving well.
Northern Nevada’s office-space market doesn’t have any mega-projects coming online, and no buildings exceeding 150,000 square feet have been announced. No new buildings over 10,000 square feet have been built in Reno recently, but the NevDex IV building under construction on Kietzke Lane is due to bring 64,000 square feet into the market. In addition, the first building at Reno Corporate Center, at 30,000 square feet, is completing construction this quarter. Heading into next year, Northern Nevada Corporate Center started a third building, which is expected to bring 45,000 square feet online in October 2007.
Mixed-Use an Emerging Trend
One of the newest trends to appear in commercial real estate design is the mixed-use development. Urban markets running out of available land are embracing projects that allow people to live/work/play in the same area – or live/work/shop when retail is a component.
In Reno, existing properties are getting a new lease on life: Basin Street Properties recently acquired two large downtown buildings, 50 West Liberty and 200 South Virginia, and is creating mixed-use projects at both sites.
Mixed-use has hit Northern Nevada in the form of condominium projects in downtown Reno. Many are converted casino properties and office buildings that are emphasizing the live/work/play aspect of urban living. Town Center at Virginia Lake Crossing, which will be Reno’s first mixed-use office project, has begun construction on its first 13,000-square-foot phase. Only half of the total project’s 150,000 square feet is earmarked for office use.
In Las Vegas, the mixed-use for mula has already proven successful, as the area’s pioneer mixed-use projects quickly sold out and developers scrambled to deliver new mixed-use product to a hungry market.
Glen, Smith & Glen Development’s Sullivan Square is a 16.5-acre mixed-use project located at Sunset Road and Durango in southwest Las Vegas. Adjacent to the I-215 Beltway halfway between Summerlin and Green Valley, the project features one 13-story, 250,000-square-foot Class A office building, in addition to high-rise and mid-rise residential buildings, a retail component and a 1.5-acre Central Park, according to Kenneth Smith, president of Glen, Smith & Glen.
Arroyo Corp Center, slated for 450 acres on the Southern I-215 Beltway in Las Vegas, will utilize most of the land between Rainbow and Buffalo, according to Kirk Boylston, regional director of EJM Development. The project will eventually present 1.5 million square feet of industrial space and 2 million square feet each of office space and retail, with a projected 100 buildings at completion.
“It’s enormous,” said Boylston. “It’s the biggest commercial project in the Valley, with the possible exception of Summerlin Centre.” Two of the office buildings – one at 50,000 square feet and another at 75,000 square feet – have already broken ground, with two more 100,000-square-foot office buildings to follow.
Plise Companies, LLC is developing two Southern Nevada mixed-use projects. Centennial Corporate Center, an office park at Ann Road and U.S. 95, will contain a 125,000-square-foot Class A office tower and 12,000 square feet of retail offerings. Plise is also the driving force behind a 542,000-square-foot mixed-use office park at Rainbow Boulevard and Sunset Road. It will comprise 95,000 square feet of retail and between 442,000 square feet and 447,000 square feet of Class A office space in three towers, according to Jon E. Field, associate general counsel and director of leasing for Plise.
LEEDing the Way
Another trend occurring in commercial office design is the rapidly growing “green” movement and a rising environmental awareness among developers. To help fuel this trend, the U.S. Green Building Council created a program to certify well-designed, energy-efficient buildings as LEED (Leadership in Energy and Environmental Design) buildings. Because an increasing percentage of energy-conscious businesses are demanding LEED-certified office space, developers have begun to respond in kind. For example, Glen, Smith & Glen Development is planning for all its future commercial office projects to meet the strict LEED-certification standards.
Always a trendsetter, the Molasky Group of Companies has also met the difficult challenge set forth by the Green Building Council. Its landmark, Class A development – the Molasky Corporate Center – will introduce a new shade of green to downtown Las Vegas when the project opens in summer 2007. Located at the convergence of City and Grand Central parkways, the Molasky Corporate Center is the largest Class A development in Nevada to receive the LEED certification. The property’s centerpiece – a 16-story, steel-and-glass tower (using 70 percent recycled steel) – rises above the 1,400-space, six-story parking garage that anchors it to the property. The building will contain 265,000 square feet of Class A office space and an additional 20,000 square feet of retail space.
The Molasky Corporate Center, which will earn a minimum silver-level LEED certification – and may even rate a coveted gold-level certification – is already more than 80 percent pre-leased. The property’s anchor tenant – the Southern Nevada Water Authority (SNWA) – elected to assume a leadership role and project a public image defined by environmental responsibility. In addition to its 20-year, $63.3 million lease agreement for 129,375 square feet on five floors in the Corporate Center tower, SNWA has retained the future option to purchase the 16-floor tower outright. Furthermore, SNWA’s affiliate organization, the Las Vegas Valley Water District (LVVWD) will also establish its headquarters at the Molasky Corporate Center and has signed an agreement to lease two additional floors in the tower.
Vacancy Rates
Location, as always, is paramount in real estate. Crescent Real Estate Equities, Ltd., a real estate investment trust (REIT), saw an opportunity in the Howard Hughes Center, a 115-acre business park located between Sands Boulevard and Flamingo Road just east of the Las Vegas Strip.
“Across the country, cities usually have a downtown or a central business district,” said Bob Boykin, senior vice president, leasing for Crescent. “When you look at the Hughes Center’s mix of national, international, local and regional firms, we’re really the business center of Las Vegas with large law firms, accounting firms and service firms.”
And the Hughes Center is growing. Currently under construction and with customer move-in slated for February 2007, 3883 Howard Hughes Parkway will bring 239,000 square feet of new office space to the market.
But can the markets sustain this growth?
Northern Nevada’s office market expects a corresponding slowdown in lease rates as residential building slows. The office market often lags behind other economic indicators, but currently office space leased by real estate companies is coming back on the market as home sales and construction slow. The return of these properties to the office market will drive up vacancy rates.
In Southern Nevada, vacancy rates vary by sub-market. The eighth of 10 buildings in Marnell Corporate Center in the airport sub-market will be ready for occupancy first quarter 2007. It is already 60 percent pre-leased, according to Brad Schnepf, president, Marnell Properties. Schnepf keeps an eye on vacancy rates, but currently the airport sub-market is tight, with a lower vacancy rate than other Southern Nevada markets. Marnell Corporate Center will contain close to 700,000 square feet when complete; and aside from the newest building, it is 100 percent pre-leased. Marnell’s other projects include McCarran Marketplace, a large community retail center, and the adjacent Marnell Airport Center, 250,000 square feet of Class B office space.
Currently, Class B space has a higher vacancy rate than class A. Molasky’s Worthington said, “I think you’re going to see a bump upward in Class B vacancy because there’s a lot of supply in the pipeline.”
Part of that supply comes from condo office space where companies overbought expecting to grow, and then started sub-leasing the space. But Class B space is tied to population growth because it’s often used by support services office tenants. “We still have 6,000 or 7,000 new residents a month with the newest mega-resorts coming online, so I think as long as we keep a lid on new supply ss B space very soon,” said Worthington.
The Market’s Future
Vacancies may be down in Class A and up in Class B, but rents are up all the way around. “I think rents will continue to rise because land prices and construction costs have gone up,” said Boylston. “Rents may rise in excess of 10 percent a year. In order for developers to get sufficient returns for constructing this type of product, they’ll have to charge higher rents.”
But, while there’s speculation on how much rent the market can bear, Boylston pointed out Las Vegas isn’t solely dependent on new companies relocating to the area. A great deal of internal growth has also been fueled by added resort projects on the Strip, and he predicts a bump in rents and a drop in vacancy rates as a result.
Boykin agreed. “Gaming is a huge economic engine that continues to expand. Therefore, law firms and accounting firms and other companies that provide services to the gaming industry are all growing to take care of their expanding client base. We certainly have experienced that in our own development.”
While the market remains healthy, the future remains open to speculation. The 4.4 million square feet of planned office space in Southern Nevada is a response to conditions as they were 18 months ago, according to Gordon. So what’s going to happen when all of these projects open their doors, despite the optimistic visions of the future and pre-lease rates?
“The majority of it will be absorbed as it comes online,” said Gordon. “That having been said, it’s not likely all of it will be leased in the next 12 to 18 months. This will put upward pressure on vacancy rates, and we expect lease rates will continue to escalate.”
Lease rates will continue to escalate even as absorption slows? Yes. “It’s in contrast to normal thinking,” agreed Gordon. “You would assume when vacancy rates go up, lease rates would pull back. However, given where construction costs are today, it’s difficult for many of these projects to come online at price points lower than what the market is experiencing today, so asking rates are going to continue to escalate due to the cost side of the equation.”
In Northern Nevada, lease rates haven’t kept pace with rising land and construction costs. “As the price of land has escalated, and construction costs and operating costs continue to climb, rents have not kept pace. That’s the reason we’re not seeing more large buildings being constructed,” said Ruffin. “So, unless you can pro forma at a much lower rate of return to an investor and they’re willing to accept that, it’s not as profitable to build a large office building as it was three or four years ago. Rents have to increase if developers are going to pursue more large office buildings in our market.”
In the end, the commercial real estate office market in Nevada holds promise. “It’s all good,” said Boykin. “I wish all of our markets across the country were like Nevada. There is lots of growth, everybody’s business plan predicts growth, it’s a very healthy economy, and one that we see continuing to grow and expand.”
