WESTERN SNAPSHOT, JANUARY 2009

Las Vegas Office Market

The Las Vegas office market is definitely down for now and should remain so for most of 2009, but it is expected to begin bouncing back around first quarter 2010.

At end of third quarter 2008, the Las Vegas office market had an inventory of approximately 48 million square feet with a vacancy factor of approximately 17 percent, increasing to more than 18 percent when sublease space is added. The year-to-date net absorption of approximately 470,000 square feet is well below average for the past several years.

Approximately 460,000 square feet of new shell space came on the market during third quarter 2008, and approximately 2.6 million square feet was slated to come online by year’s end or now during first quarter 2009. This obviously will increase the office vacancy factor and will take several years to burn off before most new planned projects commence.

As of late September 2008, the weighted average lease rate for available space for all office building classes was approximately $2.35 square feet per month on a full-service, gross basis, which is still a fairly healthy lease rate.

A major challenge to leasing up the new shell space in the market and the new shell space under construction is the difference between the tenant-improvement (TI) allowances provided by the developers and the actual cost of the TI build-out. Most TI allowances fall in the $35 to $50 usable square feet range, while the actual TI costs can easily exceed the TI allowance by $20 or more depending upon the tenant use. The challenge is who pays this difference, which can often times be a large amount. Most tenants do not want to come out of pocket for this, and if it is amortized into the lease rate, the rate can become excessive. Landlords try to increase their TI allowance, if possible, but are usually constrained by their development pro forma and their lenders.

This has driven many tenants to look at second generation or sublease space where TIs are already built out or to sublease space in general. It is usually less expensive to reconfigure second-generation space at a lower TI cost than to pay for new TIs in new shell space. Another major factor in tenants looking at second-generation space is that it can take from 120 to 150 days from lease execution for the developer to obtain the permits and build out the TIs in new shell space, and many tenants simply can’t wait that long for occupancy.

Office investment sales have dropped dramatically primarily due to the credit crunch, fostering a wait-and-see attitude. Also, many investors used 1031 exchanges to purchase small office buildings in the past and then leased them up. With the high vacancy in the market and the high TI build-out costs, this has mainly dried up also. Foreign investment interest has picked up for the Las Vegas Valley, but with the spread of economic concerns worldwide and the weakening of the pound, euro and Canadian dollar, the near-term future for foreign investment interest is uncertain.

What moves the new administration will make regarding tax structures, such as the capital gains tax, will be critical to commercial real estate nationwide as well as in the Las Vegas Valley. What happens with the credit market will also have a very significant impact on office leasing and sales.

The economy is definitely down in Las Vegas even with more new hotel/casinos coming online or under construction. Las Vegas has always been innovative in bouncing back, as evidenced by its continued growth immediately after September 11th, but much will depend upon the national economy as tourists have to have the discretionary dollars to spend in Las Vegas for hotel rooms, entertainment and gaming to once again flourish.

While bullish is the view here for the future of the Las Vegas office market, its bounce back will be a gradual increase in 2010 in net absorption and a gradual decrease in office vacancy. It will still take several more years to get back to the previous strong office market.

Chuck Witters is a senior vice president at Lee & Associates’ Las Vegas office.

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