Just a couple of years ago Nevada was booming, economic growth was accelerating, construction was busy statewide and every sector of commercial real estate was scrambling to keep up.
Then the recession hit, and everything slowed, and all those projects were still out there, some as raw land, some half-completed, some gone into foreclosure or receivership and some sitting idly, waiting for new investors.
The office market took a hit, just like every other sector of commercial real estate. There are few new projects on the books for 2009 and anything in the planning stage is on hold. New buildings stand empty.
“We’ve seen the office market vacancy rate climb since before the beginning of the national recession from around 12 percent to now over 20 percent negative absorption, really high for the last few quarters,” said John M. Stater, research manager, Colliers International, Las Vegas. “We’re starting to see things trend more flat but obviously we’re not out of it just yet. We’ve had quite a bit of employment loss in office-based employment, we lost 8,600 jobs over the last 12 months, so clearly this is a challenging time, but hopefully things are starting to flatten out and in 2011 we might start to see some real growth again.”
The vacancy rate for office space in Southern Nevada at the end of the second quarter 2009 was 22.1 percent, according to Jake Joyce, project manager, Applied Analysis. “We’re looking to see when we stabilize. It was 16.9 a year ago and jumped to 19.6 end of first quarter. I won’t be surprised if it jumps another point or more,” said Joyce, who pointed out the amount of occupied office space is less today than it was two years ago.
Space Available
From a vacancy standpoint, things have leveled off in the last two consecutive quarters, but movement seen in the office market is primarily existing tenants moving within the market to save money. “We’re not seeing any growth, so expect to continue to see a slight downturn,” said Tim Ruffin, managing partner, senior vice president, Colliers International, Reno.
He added the office market is a lagging economic indicator and since unemployment continues to increase, occupation of office space is expected to continue to decrease.
In the south, “If you factor in some of the sub-lease space, or shadow space – those spaces currently occupied or leased or out of market – the vacancy rate could be in excess of 30 percent,” said Brad Schnepf, president, Marnell Properties, and incoming president of NAIOP Southern Nevada, a commercial real estate development association. “In fact, it probably is 30 percent, not could be. And that’s a significant change from where we were 24 or 36 months ago.”
The Place to Be
Schnepf isn’t aware of any new or planned construction in terms of product, and he’s expecting changes in the office market. Demand for office space is driven by economic growth, which has been reduced in terms of job loss, home starts and other indicators, which, Schnepf says, has an effect on the commercial market. “Office is not an industry in and of itself but a by-product of economic growth from businesses in our local economy that conduct commerce. So new development is moving slower, if at all. Financing is going to be difficult at best and to obtain new financing will require significant pre-lease. However, with all the existing product on the market, new products can’t compete financially.”
In fact, properties completed this year are running 70 percent vacant, according to Stater, with Class A and C the highest and Class B, medical, boasting the lowest vacancy rates. New properties are doing worse because they’re competing with existing space, while properties built prior to 2009 run about 20.5 percent vacant.
According to Joyce, there is 1.4 million square feet under construction in Southern Nevada, 350,000 to 400,000 square feet of which is stalled. “You can drive by and know it’s not being built.” Those projects are in the west and southwest and 338,000 square feet in the northwest. “All three of those sub-markets were really booking 23 months ago during the boom. That’s where investor dollars were going and people were living and moving and working,” said Joyce. “What’s under construction, those projects aren’t new, they were funded and capitalized, and have been on the books, and are in the process of wrapping up. We have a lot of planned space on the books and I don’t see any of that being put in construction phase in the near term and by that I mean years. We have probably 3.6 million square feet of proposed market space and have 11 million square feet in vacant space.”
“If you really look at development in the Valley, they went kind of crazy in 2007,” said Stater. “There’s a lot of supply on the market right now so unless you see demand really bounce back, there’s not a pressing need for office product. There will be some projects, a little construction, but the days of very high construction rates in Las Vegas are over for a while.”
A few projects carried on through the lean years of 2008 and 2009 and those that put the finishing touches on during 2009 have, not surprisingly, high vacancy rates, according to Stater. Some buildings, like the Rainbow Sunset Pavilion, are zombie buildings owned by the FDIC, and while there’s nothing to stop the buildings from being used – they’re up and ready for tenants – banks and FDIC can’t provide tenant improvements, can’t compete the way other buildings can and are a drag on the vacancy rate.
When buildings do stall and stand vacant, it suggests the lenders and investors have reserved against or written off assets, according to Joyce. Some are in receivership, though the commercial market doesn’t move as quickly as the residential to put a product back on the market through a trustee sale. “So we’re not sure what will happen to them but they are out there and probably an eyesore to people who drive by and an awakening to people inside the office market that if you’re a well capitalized tenant at this point you can go negotiate your own deal with a great rate and a wealth of options.”
Joyce suggests stalled buildings indicate investors reconsidering the value of the development. Asking prices haven’t declined like they have in retail and industrial markets, which have lower vacancy rates. “And the inventory is 50 million square feet and we have 1.5 million square feet under construction, which includes some buildings that are stalled, about 350,000 square feet, so we’re not likely to see those projects finish in the near term.”
While there doesn’t seem to be any specific geographic or sub-market location in the Las Vegas Valley that’s doing better than others, some older parts of town have done fairly well, according to Dean Kaufman, vice president, Colliers International, Las Vegas. Simply by virtue of being older space it’s more affordable and probably occupied by longer-standing tenants. “Everybody is hurting,” said Kaufman. “But looking at numbers here, downtown has a 10 percent vacancy rate, which is the most mature market, and right next to downtown is at 14 percent. The southwest has a 31 percent overall vacancy rate.” The southwest, by comparison to the more mature office sub-market, was the newest building up during the boom years of 2006-07, so a large proportion of the shelf space on the market is in that area.
In the same vein, some of the traditional office sub-markets are still showing a little stronger than others. Core sub-markets like the airport remain relatively strong, according to Schnepf, as do developments up and down the I-215 corridor. Some of the newer areas where the office market was expanding into during the economic boom aren’t fairing as well simply because they are new – amenities that follow such development, such as restaurants and banks, didn’t have time to build out before the boom collapsed. “Most office users are still looking to locate near other offices users and want proximity to residential, commercial amenities, the airport, etc.,” said Schnepf.
In Northern Nevada, some of the newest high rise and strategically located buildings in downtown are still doing well, while the South Meadows sub-market, by virtue of being the newest area under construction when the recession hit, is fairing the worst.
Looking at office users by industry, medical in Southern Nevada was still hiring until last quarter and in Northern Nevada medical is probably down 10 percent, versus the 30 to 40 percent other industries are down. Which means medical is relatively stronger than some industries, says Ruffin; not that it’s doing well, just that it’s stronger. Some legal fields are also fairing well, but transactional law, especially related to real estate, is weak.
“We know for a fact that office is a lagging indicator of the economy, and we know unemployment has risen every month since the beginning of the year,” said Ruffin. “As unemployment increases, occupancy is going to fall, so expect higher vacancy rates than today. Will it go from 21.2 to 25 percent? I don’t know, but I think it will rise before it starts falling.”
Crystal Ball
In the northern half of the state, very little is being built other than build-to-suit. Ruffin doesn’t expect to see much construction for several years. “We’ve got a vacancy rate of 21.2 percent, and a balanced market is a 10 percent vacancy rate, so with [the rate] being 11.2 percent above a balanced market, a little over a million square feet of vacant space needs to be absorbed or occupied before we get back to a balanced market.”
In a normal year, Ruffin says, some 200,000 square feet of office product are absorbed. “So it could take another five years to get in balance, because we’re not in a normal year, we’re in recession years. I think you could say we’re not going to be in balance for six years, so another year to hit post-recession and hope for normalcy after that.”
In the south, Stater says, “The local recession is not ending this quarter; maybe next or first of 2010. I know I’ve seen the local indicators still moving down.” He expects the local economy to start recovering in 2010, but slowly, with a return of tourism (auto traffic from California is already up) but with residential construction remaining depressed. With fewer people moving into the area for work, there won’t be major demands for real estate. “We could be surprised by some sectors but probably it’s going to be 2011 when we see significant recovery for the office market in Southern Nevada.”
Joyce expects continued downward pressure on asking rates and more favorable lease rates for tenants along with increased tenant allowances and services offered by property owners and landlords. Vacancy rates will continue rising and product under construction or proposed will be sidelined – anything not under construction isn’t likely to start in the next year.
“The crystal ball is smoggy at this point but it will ultimately come down to jobs,” said Joyce. “Our community is built on growth and until growth continues or picks up again we’re going to continue to see a downward pressure on all commercial spaces and office space. Typically the time for ultimate correction will extend beyond 2010. And of course if you have the ability to access capital markets and financing and are a well capitalized and good standing business, now is the time to look for an opportunity to move up; one person’s bad time is another’s good time.”
