Monday, April 8, 2013

The Future of Vacancy in Las Vegas

Image by Lasvegaslover, from Wikipedia article
Imagine if you will a car accident on a busy street. The accident is a big one, and it is clear that the street will be blocked for some time. Naturally, drivers on their own would begin searching for alternate routes. Before too long, the side streets would be filled with cars avoiding the accident scene, and though things would be slowed down for a while, eventually they would be back up to speed (or close to it). In time, the accident would be cleared, and life would go on just as it had before.

Imagine, however, if the accident could never be cleared. Cars would simply take to those side streets as the “new normal” and the old street would fall into disuse. What I’m getting at here is the concept of being left behind.

Commercial real estate in Southern Nevada may be going through a similar situation. When the market was overbuilt in the mid-2000’s, vacancy rates skyrocketed. Now, having trudged through 5+ years of recession, the market appears to be returning to some level of normal demand for product. The assumption by some, of course, is that vacancy will now return to where it was before the recession – perhaps slowly, but inevitably.

The truth, however, is that it might not. Buildings that were completed during the boom may, in fact, never be filled with tenants. Location and designs are two reasons, of course, for why these buildings may remain unpopular with potential tenants, but age is now becoming a third. Some of these unlucky buildings are not 5 to 6 years old. Potential tenants of these buildings may begin opting for newer buildings – build-to-suits, of course, but also the new speculative product that is bound to be built over the next 5 years. What happens to these “lost buildings”?

On the one hand, they may find favor with tenants looking for second generation space; in essence, they can fill a temporary niche of virgin second-generation product – old enough to be had at a discount, but not carrying the baggage of former tenants and tenant improvements.

On the other, they may find themselves candidates, in due time, for redevelopment. The market, finding it has no use for so much single-tenant office or light industrial, decides it needs land for the developments that it does need in the future. If the latter is only partially true, we can expect to see a new floor on just how low vacancy rates can go for commercial product. Ultimately, though, we need to investigate whether theory is reality.

During the boom, we discovered vacancy “floors” of approximately 4 percent for industrial product, 8 percent for office and 3 to 3.5 percent for retail. The industrial market now has approximately 3,000,000 square feet of space that has been vacant for 4 to 6 years, corresponding roughly with the final phase of the construction boom and the initial phase of the Great Recession. If we were to assume that this space was so undesirable that it would never be occupied, it would represent about 3 percent of the total industrial inventory, and would thus push that vacancy “floor” from 4 percent to 7 percent.

For office product, about 2.5 million square feet, or approximately 6 percent of office inventory, has been vacant for 4 to 6 years, potentially increasing office’s vacancy floor from 8 to 14 percent. Clearly, office product has a more serious problem than industrial. For retail, the figure is 3 percent, potentially increasing the retail vacancy floor from 3 to 6 percent.

A full break-down of vacant commercial space based on its time-on-market follows:

While this investigation is not as thorough as it would need to be to classify it as fact, it is suggestive that even with normal demand for product Southern Nevada’s commercial market is likely to see elevated vacancy rates for the foreseeable future.

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