In its third year of being depressed, Nevada’s office space market continues to experience high vacancy rates, lease rates comparable to ones ten years ago, several distressed properties, no new construction and few sales. However, some activity is taking place, positive signs of a stabilizing market.
In Southern Nevada, office space is “bottoming out, sluggish but also transitioning,” said Randy Broadhead, senior vice-president in the Las Vegas office of CBRE, commercial real estate services firm.
Southern Nevada: Bouncing Along the Bottom
“People feel like we’re bouncing along the bottom, but we’re seeing real minor improvement,” said Michael Dunn, executive director in the Las Vegas office of Commerce Real Estate Solutions, a commercial real estate brokerage. “The goal is to improve on that some.”
The region boasts about 43 million square feet of total office space, according to Commerce Real Estate Solutions’ 3Q11 office report data. Nearly one-quarter of that, about 10.2 million square feet, is vacant. The current 23.6 percent vacancy rate is close to its peak of 24 to 25 percent, which took place in the first quarter of 2010.
The submarkets with the lowest vacancy rates for Class A and B space are Downtown Las Vegas (18.4 percent), Central West (18.9 percent) and the Airport (20.9 percent). Class A buildings are the highest-quality, typically multi-story, buildings with steel frame construction, high-end exterior finish, distinctive lobbies with upgraded finishes, and amenities like on-site security, state-of-the-art communications and data infrastructure, and covered parking. Class B space, also often multi-story, is buildings with steel frame, reinforced concrete or concrete tilt-up construction. They typically contain common bathrooms and hallways, and their lobbies may feature granite and hardwood detailing.
Net absorption, the difference in occupied square footage from one period to another, in the third quarter brought the year’s total to a positive 183,376 square feet. This is the first positive year-to-date result since 2008, when net absorption was 637,764 square feet. In comparison, net absorption at the end of the third quarter last year was a negative one million square feet.
This prolonged high vacancy and low absorption for the last three years is kind of unprecedented,” Broadhead said.
Lease rates, which have dropped about 30 to 40 percent from their highs, remain relatively flat. Today’s rates are similar to what they were in 1999-2000. Buildings that leased for $1.85 per square foot in 2006-2007 are now leasing for about $1 per square foot. The current asking lease rate is $2.01 per square foot.
“I don’t pay much attention to them because they’re asking rates, a starting point,” Dunn said. “Everybody is either providing a lot of free rent, or they’re having to come off their asking rate plus some free rent.”
The market is seeing a “flight to quality” trend, in which tenants are taking advantage of the lower lease rates and available space and moving from lower-class buildings to nicer ones in better locations. For example, someone in a Class C building (the lowest office space classification, typically older buildings needing renovation and in less desirable locations) in the inner city paying $2 a square foot might move to a nicer building on the beltway, closer to more amenities, and still pay the same rent, when previously the rent was $3 to $4 a square foot.
“If you’re a tenant with an expiring lease and you have a decent business, everything’s on sale, wholesale,” Dunn said.
This milieu of decreased demand and diminished property values is challenging for landlords. To lease their space, they’re having to drastically discount the rent and offer deals, decreasing their potential net income.
“It’s not an environment for seeing great volumes of transactions opportunities,” Dunn said.
Some transactions, however, are taking place. For example, Caesar’s Palace leased 52,000 square feet for expansion, and other gaming companies are looking for space. Ameriprise bought a 98,000-square-foot building for a call center for $14.5 million, and Henderson 1 LLC purchased a 58,000-square-foot building for $6.8 million.
“It’s a good sign that we’re starting to pick up, but it hasn’t translated into significant net absorption in the marketplace,” Broadhead said.
The only sales that are taking place are those of distressed office space (ones defaulted on or somewhere in foreclosure) and owner/users buying a building for a specific use. These buildings are selling for about 25 percent of replacement value.
“Right now, most people are looking at our market as a means to pick up stuff, bottom fishing,” Dunn said. “It has to be on the bargain basement shelf or close to it to get it moved.”
Southern Nevada has about 5 million square feet of distressed office space.
“We’re a third to halfway through, if we’re lucky, all the buildings that are still distressed,” Dunn said.
To get rid of these properties, banks and other institutions are auctioning them off, hoping to get the highest value possible. In May of this year, 765,813 square feet of office space (13 properties) sold for an average auction price of $78 per square foot, according to Colliers International’s Las Vegas Q2/11 Report. This compares to the average original investment price per square foot of $74.
“We need to cleanse this excess out both from a leasing standpoint, which is tied to job growth, and, secondarily, we need to wash them from the banks’ hands and then get some new ownership that has the ability to infuse capital back into the properties,” Dunn said.
As far as new construction, little to nothing is being built, perhaps only a few by owner-users.
“If anything’s being built, it’s an aberration. It’s not spec, I’ll tell you that,” Dunn said.
The prediction for the short-term future of office space in Southern Nevada is likely more of the same.
“I don’t think we’re out of the woods yet,” Broadhead said. “But I’m hopeful that we continue to gradually move forward in a positive way with positive momentum.”
Northern Nevada: Flat But Trending Better
The office space market picture in Northern Nevada resembles that of its southern counterpart. Vacancy rates are high, lease rates are low, new construction is stagnant, sales are few, tenants are moving up, and net absorption is positive. However, unlike Southern Nevada, the region has only a few distressed properties.
“I don’t think the market’s ever seen this level of negative impact since I’ve been doing this, for the last 20-some odd years, said Scott Shanks, senior vice president in the Reno office of NAI Alliance, a real estate brokerage. “For the most part it’s remained relatively flat, but overall, I think it’s trending to the better side.”
The current vacancy rate is 19.1 percent, a slight decrease since Jan. 1, when it was 19.4 percent, Colliers International’s Third Quarter 2011 Office Market Newsletter data showed. The high was 21 to 22 percent when the first recession hit. Vacancies translate into about 9.2 million square feet of available office space.
“For as long as we’ve tracked the office market, since the mid-1990s, we’ve never seen vacancy rates this high,” said Tim Ruffin, senior vice-president and managing partner of the Northern Nevada office of Colliers International, a commercial brokerage.
Class A space overall has the best vacancy rates, particularly in downtown Reno and the Meadowood area. The overall Class C vacancy rate is 22.6 percent, which compares to the overall Class A vacancy rate of 15.1 percent. Overall, Meadowood seems to be the strongest of the submarkets, likely due to its numerous amenities, location between downtown and south Reno, and nice new buildings.
“The vacancy rates need to get into the low teens, upper single digits, before things start to shake loose,” Shanks said.
For the first time in a while, the market shifted from negative to positive net absorption in the second quarter. About 40,000 square feet have been absorbed so far this year, with 75 percent of that taking place in downtown Reno. The two areas with the best net absorption numbers are downtown Reno and South Meadows.
“A good amount of velocity is heading to downtown because of the restaurants, the amenities and the ballpark,” Shanks said. “Downtown does seem to be doing a good deal of business and certainly a lot more than it has in the past five years.”
Lease rates are stable with a slight bias towards a lower level. They’re comparable to those in 1999. In downtown Reno and Meadowood, they’re anywhere from $1.50 to $1.90 per square foot, on average $1.70 to $1.75 for Class A space. In South Meadows, which saw major expansion earlier in the decade, they’re $1.50 to $1.60 per square foot. At the market’s peak, highs were about $2.40 to $2.50 per square foot.
“That same deal is seeing a 35 to 40 percent reduction,” Shanks said. “On a typical quoted rate of, say, $2 a square foot, they’ll maybe ink a deal at $1.85. I’ve seen other deals getting done at $1.”
Because rents are so low, tenants are moving from Class B and C office space to Class A space.
“The market has been fairly active with existing tenants evaluating their options,” Ruffin said. “A couple of years ago, they were frozen in place and didn’t know what was going to happen. Now they’re looking around for great opportunities in nice buildings and committing to five-year leases.”
Expansions continue to happen as well. In the third quarter, McDonald, Carano, Wilson expanded by 10 percent into a 35,000-square-foot building; Prospect Education expanded to 18,000 square feet; and Jimmy Beans Wool expanded its space by more than 400 percent.
The only sales taking place are of the occasional distressed building when it comes onto the market. They’re selling for about half the replacement value.
“We’re just not seeing sales when a seller puts a building on the market because what the seller and buyer want are so far apart,” Ruffin said.
New ground-up construction isn’t happening and probably won’t for a few years, as there’s no demand and too much inventory. Before anything gets built, the overall vacancy rate will have to decrease and rents will have to increase. It’s possible new Class A buildings might come online, however, if all the existing vacant ones get absorbed.
“The economics don’t support building,” Ruffin said. “With the rent level and construction costs, you can’t get a decent enough return to build.”
Experts expect the office space market in Northern Nevada to stay the same through the end of 2012 but with hints of improvement.
“I just think we’re kind of treading water as it stands right now,” Ruffin said. “There won’t be a dramatic change in the marketplace for a couple of years. We need the overall economy to improve before that will happen. We need to have jobs increase.”
