Analysis - Dec 19th, 2007

Northern Nevada Office Market

A Story of Subleasing

by Matt Grimes

The recent slowdown of the residential market has made a significant impact on the Northern Nevada office market. Homebuilders, home loan lenders or any trade closely associated with residential real estate, many of whom made their riches during the home buying craze, are now facing leaner times. A stricter lending criterion has made it more difficult for home buyers to gain financing. The new lending criteria coupled with an already lackluster housing market, has resulted in lackluster financial results for some of Northern Nevada’s largest companies.

In order to mitigate the damages of this economic down-shift, Northern Nevada’s homebuilders, title companies, home loan lenders, architects, and more have restructured and therefore have had to lay off or relocate large portions of their staff and downsize their office space requirements. Sublease vacancies have risen significantly, and these vacancies are being offered at a 15%-25% percent discount. Vacancy rates have risen in nearly every submarket in Northern Nevada and have exceeded 20% in Reno’s second largest office submarket, South Meadows. With no residential rebound in the near future, we expect to see this submarket exceed a 25% vacancy rate by the end of 2008.

With vacancy rates on the rise (with the exception of downtown Reno), we believe lease rates will modestly adjust downward through 2008. Landlords will need to become more aggressive if they plan to compete with the increasing sublease vacancy. The office market overall is transitioning to a buyer/tenant market. With the abundance of empty offices available, tenants should expect greater leasing incentives through 2008. Landlords with vacancies in shell condition may have the toughest time finding tenants, as there is an abundance of second generation class A space available at rates difficult to pencil in a shell building.

The downtown office market is holding strong. The City of Reno recently approved plans to develop a baseball stadium which will become home to the Reno Sidewinders (formerly the Tucson Sidewinders), which is the Triple A affiliate of the Arizona Diamondbacks. A number of downtown redevelopment projects have revitalized Reno’s central business district and therefore, more companies are relocating downtown. Lease rates in the downtown submarket are holding steady, and we don’t foresee a decline in downtown lease rates as we believe a positive net absorption of downtown vacancy will continue through 2008.

New construction has slowed significantly and should remain stagnant through 2008 as developers are cautious to take on new projects. Tanamara is developing an 80,000 square foot build-to-suit office building at Reno Tahoe Tech Center for Employers Insurance. Employers Insurance will be vacating their current 80,000 square foot facility located at Thomas Creek (South Meadows) in Q3 of 2008. Trammel Crow Construction is developing a 30,000 square foot office building in the Meadowood submarket. Approximately half of the building will be occupied upon completion.

California continues to produce a steady stream of investors seeking to place investment dollars into the Northern Nevada market. As a result, capitalization rates continue to hold strong in the 6.5% - 7.5% range. Prices are still primarily based on rents contracted before the office market slump. However, as landlords begin to fill their upcoming vacancies at current market lease rates, these inflated prices will subside.

The economy’s residual affects on the office market should linger for the next 24 months. Northern Nevada will experience one to two more quarters of negative net absorption. Yet, to reiterate the good news, lease rate increases should subside and Tenant Improvement costs, due to the availability of tradesmen, should continually become much more affordable. This will be a catalyst in helping Northern Nevada corporations endure due to savings in overall occupancy costs.