The Northern Nevada office market finished the year with three of the four quarters with increased vacancy and negative net absorption for the first time. The second quarter of 2007 represented the only positive in vacancy, but was really a factor of sub-lease space not effecting direct vacancy. Increasing vacancy was the trend for the year when the market included all available space whether it was direct or sub-lease. The total market vacancy increased to 18.5% up from 17.9%. When including the available sub-lease space which continues to increase, the total market has a vacancy factor of 20.4%. The office market and specifically the Class A office market has traditionally been a strong market that was able to sustain the positive absorption even during national economic downturns, yet the net absorption for Class A product in 2007 was a negative 94,190 square feet. The increasing direct space and sub-lease space with the prospect of additional space returning to the market doesn’t present a pretty picture for the coming quarters and potentially all of 2008.

Although Class A office product’s vacancy increased by nearly two percentage points from the beginning of the year, the classification finished the year with the lowest vacancy by classification at 15.3% or 19.5% including the available sub-lease space. As a bright spot in the overall market, tenants searching for value continue to reduce Class B vacancy. The product class finished the year at 20.4% down from 22.9% at the end of the third quarter and down from 23.7% at the beginning of 2007. Class B product has remained basically unaffected by sub-lease space with only a minor up tick in vacancy when including the available sub-lease space. Garden product remained statistically flat again at 22.1% a slight drop from 22.3% at the end of the third quarter and down from 21.7% from the beginning of the year. Average asking rental rates remained flat at the end of the year versus the previous quarter. Tenants remain in control of the market and the tenants who are actively searching for new space or to renew leases are in a great position to secure space at reduced rental rates along with increased concessions. The average asking rate for class A product in the fourth quarter was up slightly at $1.97 per square foot per month and class B was minimally down at $1.54 per square foot per month. Informed tenants are driving hard bargains and those landlords willing to bend are winning business. With few tenants of size searching the market and ever increasing vacancy, tenants are looking for aggressive terms to finalize transactions. Concessions from turn-key build outs to free rent continue to be available. The question of who is going to pay for the tenant’s required improvements continues to be a big issue in most negotiations as improvement costs continue to hover near all time highs. The answer in more-and-more transactions is the landlord. Average tenant improvement expenses continue to be
around $60 per square foot, when starting with shell space, for a basic office and expenses of higher end improvements are above $100 per square foot and specialty uses are near $150 per square foot and some as high as $300 per foot have been seen. Most tenants are still apprehensive to spend large amounts of money to improve leasehold space. In order to complete transactions
landlords are providing additional concesions - creating a good time for tenants to secure space. Land costs remained flat between $10 and $16 per square foot after seeing a drop in the third quarter of 2007. The current market conditions increase the risk for developers and will continue to reduce demand for office development land thus posing a threat to pricing. Our quarterly survey f commercial general contractors indicates that construction costs have slipped slightly, but most don’t believe a major price drop will be coming soon as concrete, steel, and copper prices remain high. The land prices and construction prices make speculative building risky. Most new projects will require a secured tenant or tenants to proceed.

The Meadowood submarket continues to be attractive to tenants. The total submarket finished the year at a very respectable 13% vacancy down from 13.4% at the end of the third quarter of 2007. Class A product vacancy in the submarket was the lowest of any classification in the entire market at 9.7%. When adjusting for sub-lease space Class A increases by nearly three percentage points, but remains low compared to the overall market. Class B product also performed well in the fourth quarter and finished the year down at 17.1%. Garden product vacancy which had been trending higher regained traction and dropped a full percentage point to 16.5% to finish the year.

The South Meadows Submarket continues to struggle. The submarket has been drastically impacted by the downturn in the residential real estate market. Many tenants who either expanded or relocated during the boom in residential real estate located in this submarket and the change in the housing market resulted in many tenants leaving either direct space or sub-lease space in their wake. The result is an overall submarket vacancy of 22.7%. Class A product has felt the largest impact with direct vacancy of 23.8% and this number jumps nearly ten percentage points when the sub-lease space is included. With the sub-lease space potentially coming to an end via buyouts or lease terminations, the direct vacancy is bound to rise. The buzz of the Downtown submarket has not only caught the ear of some tenants but also investors. The owners of 50 West Liberty and 200 South Virginia expanded their portfolio of downtown properties with the purchase of 300 East Second Street. The latest acquisition leaves only two major downtown office buildings owned by other parties. Expect to see asking rates rise as the competition is narrowed. All the product classifications remained basically flat in the submarket for the fourth quarter of 2007. The total submarket vacancy finished at 16.9%, Class A product finished at 11.8%, and Class B product finished the year at 24.9%. Sales of office product continue on pace with nearly twenty sales transactions per quarter. The average office sales price during the fourth quarter of 2007 was $259 per building square foot. _is price includes investment and user purchases and includes buildings that are both built out and in shell condition. Investor demand remains reasonably strong despite the overall market conditions and sellers are more willing to work to complete transactions. Transactions are being completed at cap rates of around 7% for Class A product with credit tenants and around 8% for Class B product. These rates are close to a full percentage point higher than they were a year ago and market conditions should continue to provide buying opportunities for investors.

NATIONAL OFFICE MARKET
After a very impressive string of sixteen consecutive quarters of lowering office product vacancy, the national office market vacancy rose to just under 13% in the fourth quarter of 2007. The market has been impacted by an increase in newly available product and tenant fears of a potential slowdown or even recession. Similar to our local market, the national market has been hit by housing related businesses vacating office space. Most major cities that benefited from the housing surge are now seeing the declines of the housing market hit their office market the hardest. Cities such as Miami and Las Vegas increased the direct office vacancy by two or more percentage points during the fourth quarter and showed increases in available sub-lease space. The Orange County market which has traditionally been one of the strongest office markets in the U.S. was similarly affected by the housing downturn. A bright spot in the national market place has been the cities with large amounts of tenants related to the energy business. Cities such as Dallas, Houston and Denver have seen increases in effective rents and reduced vacancy.

Posted by Lance Faulstich, SIOR, CCIM / Newsletters