The industrial market continued to struggle with low demand in the first quarter of 2009. Landlords and developers adjusted to the new realities of the marketplace by putting the brakes on new development. Leases signed this quarter were predominantly small in size and short in term. These deals mostly represented downsizing or bargain hunting by existing tenants, rather than new entries into the Valley. These small leases were overwhelmed by the large number of new availabilities that entered the market in the first quarter of 2009, keeping industrial vacancy on the rise.
Employment in traditionally industrial sectors continued to decline in the first quarter of 2009. Between February 2008 and February 2009, a total of 15,600 industrial jobs were lost, with the largest losses experienced by the construction sector. Over the same period, only two sectors of employment, education & health services and government, showed an increase in employment. The declines in construction employment were especially damaging to the local economy because construction employment accounted for 11.1 percent of total employment in the Valley, compared to just 5.5 percent for the United States as a whole . Unemployment in the Las Vegas MSA stood at 10.1 percent as of February 2009, up from 5.5 percent in February 2008.
A total of 739,048 square feet of new industrial space was completed this quarter, most of it in the Light Distribution category. Construction on most of this space began between February and June of 2008, before it was apparent that the nation was in a recession. Since then, approximately 307,000 square feet of new industrial space began construction. Vacancy in newly completed space stood at approximately 96 percent this quarter. Prominent new completions included Sunset Pointe Industrial Center (104,000 square feet), The Arroyo South Business Center (380,000 square feet), Sun Arville Business Center (50,000 square feet), The Seven Series at Hughes Airport Center (103,000 square feet) and phase one of Buffalo/215 Business Park (73,000 square feet).
Forward supply of industrial space in the Valley stood at 2.2-million square feet in the first quarter of 2009. This was 1.6-million square feet lower than last quarter. Most of this forward supply (60 percent) was in Warehouse/Distribution buildings, with the balance in Light Industrial, Light Distribution and Incubator. The North Las Vegas submarket had the lion’s share of this forward supply space (1.8-million square feet). Forward supply in the Southwest submarket once rivaled that of North Las Vegas, but has recently fallen to a mere 341,675 SF, with most of that space under construction.
Industrial vacancy increased to 11.1 percent this quarter, a 0.8-point increase from one quarter ago and a 4.2-point increase from one year ago. Industrial vacancy has increased for the past eleven quarters, from a low of 3.1 percent in the second quarter of 2006. The last time industrial vacancy was close to the present rate was in the fourth quarter of 2003, when it stood at 10 percent. The Valley’s highest vacancy rate was in the Northwest submarket, at 24.5 percent. The lowest was in East Las Vegas, at 8.5 percent. All submarkets except North Las Vegas experienced an increase in vacancy rates this quarter over last.
The weighted average asking rental rate for industrial space remained stable this quarter at $0.76 per square foot (psf) on a triple-net basis (NNN). If adjusted for inflation, the average asking rental rate has decreased by $0.05 since the second quarter of 2006. The 405 new direct lease availabilities that entered the industrial market this quarter had an average asking rental rate of $0.65 psf NNN.
The inventory of owner/user industrial properties available for sale increased this quarter to 4,065,448 square feet, an increase of almost 3,000,000 square feet since the first quarter of 2008. The inventory of industrial buildings up for sale as investments has increased from 241,053 square feet in the first quarter of 2008 to 1,050,278 square feet this quarter. Asking prices for both owner/user and investment properties declined over the same period. Similar declines have been seen in the number of industrial buildings selling for either owner/user or investment purposes and in the prices those sales have commanded.
Warehouse/Distribution continued to be the healthiest product type in the Valley. It had the lowest vacancy rate among product types at 6.3 percent and the highest net absorption at 26,403 SF this quarter. The average asking rental rate for Warehouse/Distribution decreased this quarter by $0.02 to $0.58 psf NNN. The strongest Warehouse/ Distribution submarket was North Las Vegas, with a 4.3 percent vacancy rate, $0.49 psf NNN average asking rental rate and 114,382 SF of net absorption. Warehouse/Distribution vacancy has not yet begun to approach the high of 11.5 percent experienced in the first quarter of 2004. Recent tenants have cited the state of Nevada’s pro-business policies as well as competitive asking rents as reasons they leased Warehouse/Distribution space in Southern Nevada.
Demand for Light Distribution space was impacted negatively by weak employment numbers in both the leisure & hospitality and retail sectors. Light Distribution space in the Southwest, which often services the resort casinos on the Las Vegas “Strip”, experienced an 8.9-point increase in vacancy over the past twelve months, from 8.6 percent in the first quarter of 2008 to the current 17.1 percent.
Development of Light Industrial space became quite popular over the past two years as land values exploded due to the housing bubble. From 2007 to present, over 2.2-million square feet of Light Industrial space was completed in the Las Vegas Valley. Over that same period, Light Industrial vacancy increased from 3.8 percent to 11.2 percent. Much of the Light Industrial space that is now on the market is for sale. Since sales are now almost non-existent, we think Light Industrial vacancy will remain high for the foreseeable future.
Vacancy in Incubator space stood at 14.1 percent this quarter, an increase of 7.5-points since the first quarter of 2008 and a clear sign that the creation of new businesses in the Las Vegas Valley has decreased significantly. A reinvigoration of the market for Incubator space will be an indicator that recovery is ahead.
The Las Vegas industrial market will not experience significant recovery without a marked increase in employment, especially in the construction and leisure & hospitality sectors. New leisure & hospitality jobs will boost demand for Light Distribution space near the Las Vegas “Strip”, and the resulting revival of retail jobs throughout the Valley will help both the Incubator and R&D/Flex markets. While Warehouse/Distribution space remains comparatively healthy, increasing unemployment in California and Arizona could prove harmful.
On the upside for the local economy, institutional problems in California could drive employers and entrepreneurs to the more pro-business environment of Nevada. The Nevada Development Authority (NDA) has seen a slight uptick in inquiries from California over the last few months. If we see sustained employment gains in 2010, we will see a corresponding increase in demand for industrial space in 2011.
Metrics for Recovery
Despite the somewhat bleak picture painted above, the national and local economies will recover. We think that several metrics can be established to predict how quickly that recovery will occur for the commercial real estate market. The health of the commercial real estate market is tied directly to employment. Employees take up space, and thus increases in employment eventually translate into demand for more space. Our study of the Southern Nevada real estate market for the past ten years has taught us that there is usually a 9 to 12 month lag between employment gains and increases in occupied square footage. Employment will, therefore, be the best indicator of impending recovery for the real estate market. Of primary importance to the Southern Nevada economy is employment in the leisure & hospitality and construction sectors. Gaming revenue is probably the best indicator of employment growth in the leisure & hospitality sector. Renewed employment growth in construction requires an increase in demand for new homes. A good indicator of renewed demand for new homes, and thus an increase in construction jobs, is a shrinking gap between the median price for a new home and the median price for an existing home. As employment in leisure & hospitality and construction grows, employment in other sectors will follow suit and we will begin to see an increase in demand for commercial space.
The Congressional Budget Office and Federal Reserve chairman Ben Bernanke recently predicted that economic recovery should begin by the end of 2009, while some economists have offered more dire predictions for the future. Whoever turns out to be correct, there can be no doubt that we are seeing the imposition of business fundamentals in our economy. Businesses that want to stay in business will need to show a profit. Lenders who want to stay in business will have to lend money only to people who can pay it back. For genuine recovery, American citizens, businesses and governments will need to pay down their debts, which will require both time and discipline. In the meantime, growth, when it comes, could be slower than we have become accustomed. We think that if there is an end to the recession in the last quarter of 2009, we will see gains in employment in 2010 and increases in the occupancy of commercial real estate in 2011.