2008 Las Vegas Outlook
Strong Momentum Keeps Vegas Construction Aloft
With demand for industrial, office and retail space still strong, the outlook for Las Vegas remains healthy despite the nationwide credit and housing woes.
Despite concerns over housing market conditions in the Las Vegas Valley and their impact on commercial markets, the industrial, office and retail markets in the Valley have performed well during the first three quarters of 2007-characterized by healthy, but more important, sustainable growth. Significant momentum exists to keep the Valley’s commercial markets relatively sound through 2007 and into 2008.
Absorption was strong at the beginning of 2007 but has since lessened with 449,400 sq ft being absorbed in Q3. This was down from the 1.2 million sq ft absorbed in Q2, 2007, and from 1.6 million sq ft in Q3, 2006. While demand for industrial space remains high with year-to-date absorption totaling almost 3.5 million sq ft, it lagged the 4.4 million sq ft of new completions added to the Valley so far in 2007.
Forward industrial supply (space under construction and space planned to begin construction within the next four quarters) totaled 8.75 million sq ft at the end of Q3. Of this amount, 36% was under construction with the remaining in the planning stages (see Figure 1). Given the substantial amount of space coming online, it is reasonable to expect construction activity to remain elevated during the next few quarters.
If all of the industrial space presently under construction or planned is completed (which is not likely), it would represent a 9% increase in the Valley’s industrial inventory. Additionally, if all available space (4.7 million sq ft) in existing buildings were added to this forward-supply, it would take approximately 14.3 quarters (3.6 years) to absorb it all, using the past four quarters’ average absorption of 942,300 sq ft as a guide.
The robust construction activity in 2007 should be seen as a welcome sign because the increases seen in vacancy have helped to relieve supply-constraint conditions. Vacancy rose for the fifth consecutive quarter, from a record low of 3.1% in Q2, 2006, to 4.8% in Q3 of this year (see Figure 2). The weakness in the residential market has contributed to this rise in vacancy as the construction industry is a key lessee of industrial space.
Overall, the past two years have seen low vacancy for industrial product in the Valley, and the recent trend of supply outpacing demand appears to be pointing to a return to more sustainable levels.
Industrial rents have generally forged ahead despite increasing vacancy and new availability. However, the drop in rents in Q3 to $0.76 per sq ft triple-net (NNN) broke the trend of increasing rates that began in Q2, 2006. Since rents are based on the remaining vacant space in projects and buildings, this is likely an indicator of less desirable space being available rather than a drop in demand.
Investment in the Valley’s industrial market will continue to be divided. High-ceiling space in areas along the interstate system will continue to attract first-class pricing and rents. Inland distribution centers like the Valley, with superior international airports, such as McCarran, will do well in 2008. Local manufacturers and retailers will continue to rent warehouse space, but new technologies are making some of these properties obsolete.
That being said, we anticipate investment performance to moderate and possibly decline from abnormally elevated levels to more normal, high-single-digit returns. The demand by pension funds for industrial space throughout the West should protect the Valley’s industrial market from pricing declines. In essence, the health of the Valley’s economy, the emerging credit crunch, land pricing patterns and the housing market correction will be the wildcards in the health of our local industrial market.
Demand for office space so far in 2007 has been satisfactory, totaling over 2.15 million sq ft YTD. This is only 357,600 sq ft short of surpassing 2006’s total of 2.5 million sq ft absorbed for the year. However, absorption did not match the 3.1 million sq ft of completions YTD as construction activity has been at its highest over the past five years. Forward-supply at the end of Q3 was over 6.4 million sq ft, of which 36% was under construction.
If all of the office space presently under construction or planned is completed (which is not likely), it would represent a 17.4% increase in the Valley’s speculative office inventory. Additionally, if all available space in existing buildings were added (4 million sq ft) to this forward-supply, it would take approximately 15.8 quarters (four years) to absorb it all at the past four quarters’ average absorption rate of 662,100 sq ft.
The start of this year saw a rise in vacancy-from 9.3% at the end of 2006, to 10.9% in Q1, 2007 and has since remained virtually unchanged (see Figure 3). With completions exceeding net absorption and with the large amount of forward-supply, office vacancy is expected to increase into the next year. Additionally, the slowdown in the residential sector will contribute to vacancies as the need for housing-related services are cut.
Similar to the trend seen in vacancies, asking rents have also stabilized after a spike in Q1, 2007, settling between $2.51-$2.52 per sq ft, full-service gross. The higher rents from newer, more expensive office space, together with increased expenses in insurance, maintenance and property taxes, are expected to drive up office rents in the Valley.
The Valley’s office market is likely to be more susceptible to a supply-demand imbalance because of the larger volume of office-condo space built in the last three years. In our opinion investors will stay on the sidelines, while long-term holders will enjoy moderate gains.
New project developers and owners will likely grit their teeth and hope the local economy supports their bets on future rent appreciation. The odds against these developers could get longer. We expect that some developers will need to withdraw and the economy will have to dodge more spillover from housing-related implosion.
In our opinion, high-occupancy buildings will likely ride out the market because of long lease terms and the Valley’s office market is at or close to equilibrium - a 10% vacancy rate. However, we do not anticipate a return of “no cap rate is too low” or significant rent increases because of national economic jitters and the problems we are seeing in the office-condo market and its impact on spec Class B and C projects rents.
Accordingly, 2008 will be a tenant’s market.
Supported by population growth and increasing incomes, demand for retail space in 2007 continued unabated. The 2.19 million sq ft absorbed YTD has already surpassed last year’s net total of 2.18 million sq ft.
On the supply side, construction activity also continued to push higher, with over 2.3 million sq ft of anchored retail space added to the Valley YTD. Of the 3.65 million sq ft of forward-supply at the end of Q3, 54% was under construction and the remaining in the planning stages. Notably, the Valley has seen no completions of power center space (retail centers dominated by several large anchors), since 2003, but more than 1.2 million sq ft is currently under construction.
Vacancies fluctuated in a tight range in the past two years, hovering between 2.7-3% (see Figure 4). At 2.9% recorded for Q3, the retail market has the lowest vacancy among the Valley’s three commercial markets.
If all of the anchored retail space presently under construction or planned is completed (which is not likely), it would represent a 9.2% increase in the Valley’s retail space inventory. Additionally, if all available space in existing buildings (1.2 million sq ft) were added to this forward-supply, it would take approximately 5.9 quarters (1.5 years) to absorb it all, (using the last four quarters’ average absorption of 819,400 sq ft).
Given the large amount of new retail space entering the market and with operations at virtually full occupancy, it is not surprising that rents continued their ascent in 2007, settling at $2.25 per sq ft NNN in Q3. Compared to Q3, 2006, when asking rents were $1.68 psf, rents have increased $0.57.
For the retail market nationwide, pressing concerns include how consumers will respond to problems in the mortgage industry, the impact of housing deflation on discretionary spending and the perception of lost wealth by consumers. Additionally, high debt levels could restrict further growth in retail sales.
At the local level, Clark County’s negative year-over-year growth in August’s taxable retail sales is a cautionary indicator. Clark County taxable sales were down 5.2% in August 2007 over August 2006, marking the first time since 2001 that annual sales tax growth has been negative. This was caused, in large part, by challenges in the housing market because a number of major retail categories include construction-related purchases.
In our opinion, the worst-case scenario for the Valley’s anchored retail market is a potential beating from a recession. However, our research and discussions with other analysts and brokers indicate that we remain underserved from an anchored retail standpoint. And, while the Valley’s retail market will probably cool off in 2008, we are likely to weather the national economic uncertainties.
That being said, wage increases and low unemployment will be needed to mitigate the Valley’s anemic housing market. Regardless, we expect market risk increases and returns to further drop from off-record highs in 2004-2007. The big X factor-where is consumer confidence heading as we hover around $95 per barrel for oil and deal with a credit crunch?
Though there are concerns of a slowing economy led by a slump in housing, it is important to keep in mind that the Valley continues to see healthy job creation (largely due to the $45 billion of construction on the Las Vegas Strip through 2012), ongoing in-migration and strong tourism numbers. Additionally, demand for speculative commercial space is continuing and vacancies are still relatively low compared to other markets.
These positive factors should help to offset any market jitter concerns while keeping the Valley’s commercial market healthy.
John Restrepo is the principal of Restrepo Consulting Group LLC, based in Las Vegas. He has been providing real estate and economic consulting services in Nevada for 19 years. He received his B.A. in Economics from the University of Louisiana and holds a M.A. Economics/Latin American Studies from Louisiana State University.
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