Dec 17th Issue
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Feature Stories - Dec 17th, 2008
 Foreclosures Bank Owned Properties Increase in Nevada by Jennifer Rachel Baumer As recently as the beginning of 2008, construction was driving Nevada, space was at a premium and the landlord held all the cards. Current businesses needed room to grow and new businesses relocating to our state needed space as well; everywhere you looked cranes were in the air and heavy equipment was pushing dirt. We expected the boom to end; they all do. But maybe we didn’t quite expect such a hard landing. We already know about residential foreclosures across the country. Now, in our own back yard we’re starting to see what happens when a “For Lease” sign sits too long in a window sill. We’re seeing foreclosures affect commercial real estate dramatically. Lenders and brokers looking into their crystal balls predict we’re at the beginning stage of commercial foreclosures in Nevada – and offering their thoughts on what’s to come.
Forecasting
Despite the boom that until recently was sending land prices skyrocketing and construction soaring, we’re only just seeing the start of commercial foreclosures in Nevada. “We’re seeing weakness in the commercial market,” said Bruce Hendricks, president and CEO of Bank of Nevada. “As far as how bad the problem is, I think it could get worse depending on how long the recession lasts.” “We’re seeing more foreclosures, bankruptcies and bank-owned properties,” said Mike Mixer, managing partner, Colliers International. “It’s been increasing in the high single digits in the last six months. There’s definitely considerably more than I’ve ever seen before and that’s a sign of the economic times we’re in.” “Typically in a down-cycle economy, commercial property is the last to feel it,” said Dallas Haun, president and CEO, Nevada State Bank. “So this is sort of playing out in the normal cycle. Residential is affected and then after that typically, in the last part of the cycle, commercial property is affected.” Which is where we are now. Commercial foreclosures are currently light, according to Haun. What happens first is that vacancies rise. Which they are. “So if the classic cycle plays out you will see commercial foreclosures.” The vacancy rates for new buildings are going up, according to Jim DeVolld, president, First Independent Bank of Nevada. While DeVolld hasn’t seen any commercial real estate office buildings or mini-storage or retail centers go into foreclosure, he’s seen a general softness in the office market, especially in the new south suburban area in Reno where new class A buildings are driving up vacancy rates. Some commercial property owners are giving concessions to tenants to keep occupancy rates up. This, obviously, doesn’t work if no one has ever occupied the building. Some new industrial buildings have never had one square foot of occupancy, according to Paul Perkins, senior vice president, NAI Alliance in Reno. “We’ve built over 4.5-million-square-feet of commercial space in the last two years and only 15 percent has been occupied. Of the buildings constructed since the second quarter of 2007, four are standing 100 percent vacant,” said Perkins.
Current Reality
While Northern Nevada hasn’t seen an increase on foreclosures on improved industrial, office and retail properties, Perkins predicts we may be seeing more of them over the next year. “Retail shopping centers are hurting from defaulting tenants, as are office buildings that have seen vacancies rise because of defaults by tenants tied to the residential market, such as title companies, lenders and home builders. Because lenders typically require a greater down payment percentage for commercial loans, we are more likely to see properties selling at significant discounts to avoid foreclosure rather than actual foreclosures.” In Southern Nevada residential land is the hardest hit, followed by commercial land, office and retail properties, according to Hendricks. Land is hit hard because there was so much speculation during the boom when developers expected land prices would just continue to rise. Industrial construction boomed in Northern Nevada between 2005 and 2007 and most lenders required interest reserves on their loans, so for the time being, Perkins said, most owners have been able to weather the unprecedented vacancy rate in industrial space. But demand for over-inventory isn’t picking up and vacancy rates – the highest ever recorded at the end of the third quarter of 2008, 12.7 percent – could well hit 14 percent by the end of the year. “Scarce demand for industrial space translates into low revenues, which means interest reserves could become exhausted,” said Perkins. “When that happens, we may well see industrial foreclosures increase.” “This is as bad as I’ve seen it in 20 plus years,” said Mixer. “Land may have been harder hit just because unfortunately land doesn’t provide rental income to bridge the gap while holding property to cover debt, so developers who bought recently to develop can’t obtain development loans.” Which means eventually they’re likely to have to give the property back to the original lender who helped them buy it in the first place. “All the while values are decreasing, in some cases, below the original loan amount.” Some commercial buildings echo the problem with vacant land because tenants are not paying and owners cannot service the loan. “Businesses try to downsize and restructure before defaulting on a commercial loan, but unfortunately, eventually, some haven’t been able to make it and have had to close,” said Hendricks. In retail properties, tenants going out of business or experiencing very low levels of income are expecting landlords to reduce rent. Landlords who are used to having income to cover their loans are now experiencing their own short falls. “Some owners can carry it and some can’t,” said Mixer. Owner-occupied buildings present their own special circumstances. During the height of the building and buying boom, often the costs of owning and renting were fairly similar, but owning offered tax benefits, so businesses bought and built their own. Now that the company is having financial trouble, it’s faced with a building it can’t just walk away from. As more small businesses run into trouble and more distressed properties hit the market, it depresses the price more and makes everything harder to sell. Buying activity levels are already very low in terms of sales on a monthly basis, and market prices for commercial properties are dropping across the state. There are fewer and fewer market deals because there are more and more distressed sales, so buyers are becoming used to buying properties that have gone into foreclosure, according to Mixer. Banks and lenders really don’t want to foreclosure and, if having to do so, don’t want the property. Banks typically don’t want to own buildings; they generally are not set up for it. But banks have been known to hold properties if prices are just too low to make sense for them to sell. Banks that are taking back properties are prepared to write down the amount of debt the property originally had, making it a painful experience for the lender and definitely for the original owner who loses whatever equity they had, Mixer explained. It’s up to the lender and the trustee in the foreclosure to decide how fast the property needs to get off their books. So there are some great deals to be had and some activity in the market, but at the expense of the lenders and the pain of the original owners.
Moving Forward
“This is going to be a while,” said Haun. “We don’t see this as a short-term situation. Our economy is extremely challenged and our hopes are that we start to see some stabilization with prices and some semblance of business as usual sometime in 2010. We continue to see 2009 as being challenging. We’re looking for indicators of a turnaround.” Hendricks believes we need to see more confidence in the global, national and regional economy, and more financial institutions in a position to start lending again. Haun sees the fix as job creation. “Job losses and unemployment in Nevada are pushing 8 percent, so I think the engine of the economy, the gaming engine, needs to get stabilized, because traditionally in Nevada that’s been the heart of the economic engine with job creation.” Mixer points to a need to put capital back in the hands of qualified developers so they can build the creditable projects their vision led them to originally buy land for. We need consumer confidence to rise and a steady, positive employment rate so that people are spending money in the local economy and local businesses can stay open and even expand rather than downsizing. And last, he stresses a need for more responsible development. “When money was freely flowing there were some developers out there that probably shouldn’t have built projects that did get built and helped perpetuate the glut of inventory that we’re experiencing in some sub-markets. But generally we need those first two things to happen.” All in all, we are looking at a tough couple of years for the commercial market in Nevada. Foreclosures will become more common in the next few months. There is a bright side to these problems, Nevada’s economic structure allows the state to bounce back much faster than other states facing similiar challenges. While the commercial market may look dim now, our state is still on track for a bright and economically stable future. 
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