The industrial market in Nevada is experiencing the same slowdown that is affecting other segments of the overall economy. While several factors have contributed to rising vacancy rates and lower effective rents, real estate experts in both Southern and Northern Nevada agree that the industrial slump is part of a normal business cycle. Their consensus is that the market will return to normal by mid-2009.
Southern Nevada
Jeremy Aguero, principal of Allied Analysis, a Nevada-based consulting firm, estimated the vacancy rate for industrial projects in Southern Nevada was 6.7 percent at the end of the first quarter of 2008, compared to 4.5 percent a year earlier. “The industrial market today is fluctuating as much as we’ve ever seen it,” he said. “Cycles happen, but this one has been exacerbated by the housing market running up as quickly as it did and then cooling off as quickly as it did. We’d like to see the housing market improve. That would increase stability and open up some capital, not only for residential, but also for commercial development. It’s all tied together.”
Aguero noted that the “boom” phase of the current boom-and-bust cycle encouraged some unwise speculation. “A lot of developers and even tenants were programmed for a level of growth that just wasn’t sustainable,” he noted. “People had unrealistic expectations that job creation would be what it was 24 months ago. According to the Nevada Department of Employment, Training and Rehabilitation, at the peak [of the boom] in 2004 to 2006, just under 60,000 jobs were added in Nevada per year. Between March 2007 and March 2008, the state actually lost about 3,900 jobs. That’s a pretty sharp change in the economy,” said Aguero.
Shortage of capital is a major factor leading to the present slowdown in industrial real estate. “Investor purchases and speculative transactions have slowed to a crawl,” said Aguero. “Money is sitting on the sidelines, waiting for a signal that we’re on the bottom. I get calls all the time from people looking for bargains. They want to buy, but they want blood to be dripping off the deal before they’ll make an offer.” Kevin Higgins, senior vice president of Voit Commercial Brokerage, said, “The flow of money has slowed down greatly, and this is a national problem, not just local.” Higgins said lenders are placing heavier restrictions on development and “putting underwriting under a microscope,” making it harder for transactions to get approved.
Jason Kuckler, president of PAR Development, is one developer who has experienced the credit crunch firsthand. His company’s first project, Post Park, is a $31 million, 10-acre industrial project planned for southwest Las Vegas. “When we bought the land in August 2007, we didn’t foresee any problems with financing,” he said. “However, some of the local banks have now pulled back on their construction loans, and we have had to look outside the original lenders to find someone to finance the construction of the buildings.” Kuckler said he still plans to break ground in mid-2008, with completion of the first phase of for-sale buildings slated for the end of the year.
Fear and uncertainty among potential users have also contributed to a lessening of demand for industrial space. “Users are apprehensive about the economy,” explained Higgins. “They are asking, ‘Are we at the bottom or will the economy get worse? Is my business slowing down?’ Because of this fear factor, they’ve adopted a wait-and-see attitude. It’s a function of the larger economy, not the state of the industrial market.” In order to attract tenants in for-lease buildings, landlords have had to offer concessions to fill vacant space. Aguero noted that asking rates at the end of the first quarter of 2008 were 77 cents per square foot, compared to 81 cents at the same time a year ago. However, he said, “We’re not reading too much into those numbers. The lower lease rates are more a function of the mix of products available this year compared to 2007. Distribution space is priced differently than office/flex, for example. We are seeing some concessions, but less in industrial than in other segments [of commercial real estate.]”
John Ramous, vice president of regional operations for Harsch Investment Properties, noted, “Rent isn’t the only way landlords can create activity. Concessions include free rent, more money for tenant improvements and increased brokerage commissions. It’s really on a submarket-by-submarket basis. Some areas, especially the southwest part of the Valley, are still very strong, but away from the Strip and all the activity there, things do tend to get softer and effective rates are lower.” George Kallis, a senior vice president for CB Richard Ellis who has been working with Harsch, noted, “Our type of product is more flexible, because we deal with smaller tenants, usually occupying less than 5,000 square feet in light industrial parks. As the largest commercial landlord in Southern Nevada, Harsch can move people to larger or smaller spaces to accommodate their needs, and that allows us to retain tenants.”
Another challenge for the industrial market at both ends of the Silver State is a shortage of industrial-zoned land that is close to a major city, with the necessary infrastructure, and available at a price that makes sense in the current market. Aguero recalled, “It wasn’t too long ago that industrial land was being bought up to be used for housing developments.” Now that the housing boom is over, “To some extent, the damage [to land prices] has been done, and it’s still hard to make projects pencil.” As with most financial transactions, timing is a vital component in industrial development. Kallis noted that Harsch’s basis for both land and buildings is relatively low because they have owned most of their projects for several years. However, those who are just now entering the market with land at premium prices face more of a challenge.
“It’s hard to make industrial projects pencil with current lease rates and land pricing,” said Aguero. “And that brings up another question: how does Southern Nevada remain competitive from an industrial perspective without a relatively significant adjustment in land pricing?” Southern Nevada’s main competitors for industrial users have historically been Phoenix and the Inland Empire in Southern California. Aguero said he is starting to see some indications that land prices are undergoing an adjustment. “I believe we will have a land correction this year,” he said. “I have heard anecdotally that we’re going to see some land transactions that will reflect a more market-based price. The question is the ability of people to wait out the market. Some land owners are saying, ‘I’m not going to sell my land at a loss – I’m going to hold it and wait for the price to come back to what I want.’”
Northern Nevada
The industrial broker team at NAI Alliance in Reno estimated Northern Nevada’s industrial vacancy rate hit 10.5 percent at the end of the first quarter, up substantially from the 6.73 percent at the same time last year. In some respects, the Reno market is a victim of its own success. According to Par Tolles, president of DP Partners, a member of Dermody Properties, “In an average to good year, we have 1.5 [million] to 2.5 million square feet of absorption. In 2006 we broke the bank with 3.2 million, which was a banner year. Because of that, Reno got the reputation as a growth market and developers came in from out of state and started to build here.”
Before that time, according to Tolles, four developers, DP Partners, Prologis, Trammel Crow and Panattoni, were the major players in the region; they all knew each other and avoided overbuilding. “In 2007 developers from outside the market came in and built a lot of product, which skewed the vacancy rate,” said Tolles. “As a longtime resident and developer, I believe everybody’s welcome to build here, but it’s frustrating to see somebody build and then go away, leaving us to deal with oversupply.”
Paul Perkins of NAI Alliance said 3.4 million square feet of spec industrial space was added in 2007, more than three times the average of the previous seven years, and another 1.2 million square feet is currently under construction. “On average, less than 500,000 square feet of new spec space is absorbed each year,” he noted. “We’re going to have a lot of standing inventory unless we see some significant improvement in absorption.” Mike Hoeck, another member of the NAI Alliance team, agreed, “We’re overbuilt for the current market, but it will gradually be absorbed. Some spec projects that were announced probably won’t be built. We needed construction, but the products came online just when the economy was slowing down, so absorption will take a little longer than we’d like.”
Because of the high vacancy rate, Doug Roberts, senior vice president and principal of Panattoni Development, called Reno “a tenant’s market in every sense of the word.” He noted, “Tenants have more choices now than they used to. If you’re a tenant, that’s great, but if you’re a landlord, it’s not. Most developers in either end of the state aren’t complaining, because that’s the way the market goes, and things will eventually flip around again.” Roberts said concessions to attract tenants include free rent, flexibility in lease terms (for example, leases of less than five years), lower rent, or more allowances for tenant improvements.
Dave Simonson of NAI Alliance said the asking rate for new bulk distribution space is about 33 or 34 cents per square foot. However, he said, “People are not signing deals at that price. I would guess the actual price is running about 10 percent less than the asking price.” Another member of NAI’s industrial team, Dan Oster, said, “The concessions we’re seeing now are partly a function of the slower market, but you might make the case that the trend will continue even after this business cycle corrects, as a result of the increased competition in the area. This would favor tenants in the long run.”
Although there are virtually no large parcels of industrial land in the Truckee Meadows, developers have been successful in building large distribution centers north of Reno in Stead and Spanish Springs, and east along I-80 in Fernley and Patrick, home to the Tahoe Reno Industrial Center, touted as the largest industrial park in the world. Land in these outlying areas is still reasonably priced, according to Roberts, who added, “The pricing of land isn’t near as big an issue as ‘tenant velocity.’ If there were more tenants in the market, people would be buying more land. It doesn’t make much sense to build now, because you’d be sitting with a vacant building.”
Developers who built in 2006-2007 are at a disadvantage compared to people starting now, because their cost basis for both land and materials is higher, according to Roberts. “There’s not as much upward pressure on land now to drive prices up,” he noted. “In addition, we had such a run-up in the past few years in construction costs that we’ve seen prices going down lately, and the slowdown in the housing market means more subs are looking for work. That’s a positive note. So it’s actually better to be starting a project now.”
Waiting for a Turnaround
Some of the challenges facing the industrial market will not be solved in the near future. For example, the shortage of land for industrial projects in Southern Nevada will remain until infrastructure is brought to Apex, north of Las Vegas, or the Ivanpah Valley south of town. Higgins said, “Apex isn’t a viable option in the short term, because it doesn’t have the infrastructure. Ivanpah has excellent potential for the future because of its location on the way to California, but that’s far down the line. They’re still in the process of conducting the environmental impact statement.”
Other challenges, such as an imbalance between supply and demand, will be solved by waiting out the business cycle. Roberts predicted a general market stagnation or slight turndown for the next 12 months in Northern Nevada. “I would like to be delivering product around the end of the first quarter of 2009, or the beginning of the 2nd quarter,” he said. “I think that’s when there will be a general recovery.” Simonson added, “When East Coast people are looking for a distribution center to serve the West Coast, they look to Reno. That portends well for the long-term health of our market. Our phone is starting to ring again, which is encouraging. Vacancy will go up in the second quarter of 2008 as two more big buildings come online, but after that, absorption will eat away at that vacancy and it will drop into the single digits by the end of the year.”
According to Tolles, “Reno will continue to chug along. We’ll be at least two or three percentage points above our average vacancy for a couple of years, but we’ll continue to attract our fair share of industrial tenants. Reno has the largest warehouse square footage per capita of any city in the country. It’s the bread-and-butter of our business base and will continue to do well.”
In Southern Nevada, more than $35 billion in huge construction projects along the Las Vegas Strip, including Project City Center, the Fountainbleu and Echelon, is fueling a demand for industrial and warehouse space by contractors and suppliers helping to build these mega-resorts. “If the next swell in the gaming industry has the same impact on industrial demand as it has had historically, we will need an additional 30 million square feet of industrial space to serve it. There’s a substantial amount of pent-up demand, and as soon as that happens, a lot of capital will flow right into Southern Nevada,” said Aguero.
Although long-term prospects for the industrial market seem optimistic, it can be difficult for individual developers or landlords to wait for the cycle to swing back in their favor. “For industrial brokers, it’s tough to hang in there, and for industrial developers, it’s tough because of the lack of available money,” said Higgins. “If you’re holding onto existing inventory for sale and it’s not selling, that’s hard. It will be a very trying year in 2008.”
However, Higgins pointed out that industrial real estate is subject to the same cyclical market forces that drive the rest of the economy. “It’s a herd mentality, just like with the stock market or anything else,” he said. “Once the market hits a certain level, everyone will rush back in and try to tie up whatever deals they can to hit the next wave. The smart ones do that now instead of waiting for later.”
