By: Dean Willmore, SIOR

Two years ago, our industrial real estate market was completely out of control. Investors were ignoring all of the fundamentals (just so they could buy something); Cap Rates were at a 50-year low (perhaps the lowest of all time); Investors engaged in bidding wars to try and secure a property; Vacant buildings actually sold as “Income Producing Property”; Developers Pro-formaed small industrial buildings for sale at twice the price the same building would have sold for four years prior (and built 5 times more than we typically absorb in one year); Per-square-foot prices for shell industrial buildings were exceeding those for shell office buildings; Developers were paying more than $1 million per acre for industrial dirt, believing rents and building prices would continue to escalate; and The hi-rise condo craze pushed the price for industrial properties located near the Las Vegas Resort Corridor between $4,000,000 and $10,000,000 per acre. All of this was fueled by banks and other lenders making overly aggressive loans and Equity Dollars available everywhere. For some, those were the “good old days” of commercial real estate. As I have watched that real estate bubble burst and the market change I still feel that there is a great deal of opportunity in the Las Vegas industrial market.

Although our current market conditions are troubling for many, I am thankful that our market is correcting itself. The good news is that 2008 proved to be a relatively good leasing year. Preliminary estimates put our total 2008 absorption of industrial space in Las Vegas for around 5 million square feet. That is in-line with our average net industrial absorption during the past six years .

Industrial Trends

Even better, is the fact that over 80% of our 2008 industrial net absorption is comprised of tenants leasing space. That is good news for landlords, because in 2007 over 50% of net absorption was owner/user building purchases. As for 2009, I expect the percentage of lease absorption vs. owner/user sales to be even higher. I also believe that 2009 will present some of the best industrial real estate buying opportunities not seen in 20 years.

Since I began tracking this market in 1989, I have witnessed average industrial real estate appreciation of about 5% per year. My forecast is that in 2009-2010, we will see industrial property values drop 15% to 50% from where they were during the First Quarter of 2008, which is when our market peaked. Still, given the amount of appreciation industrial real estate owners gained during the past 5 years, few will get hurt, because most of the value lost was “phantom” and not real in the first place. In addition, leasing activity should remain strong in 2009 and most owners should, at a minimum, be able to cover their debt service.

Here are some other trends and observations I forecast for 2009:

1. Owner/User financing will be cheap and readily available to credit-worthy borrowers; Non- Owner/Occupied financing will remain very difficult to obtain;
2. The credit-worthiness of prospective tenants will be a much bigger issue than normal for Landlords;
3. Industrial vacancy rates will climb slightly and then level-off by mid-year. Expect lower vacancy and less landlord concessions by the end of summer;
4. Inflation will cause higher operating expenses and utility costs;
5. Rental rates will remain flat for most of the year;
6. Cap Rates will increase to between 9%-10% in order to move old inventory;
7. Operators of small bay, multi-tenant properties will fare the best in 2009 as tenants will migrate from bigger spaces to smaller spaces to save costs;
8. Operators of flex space with a high percentage of office and big box distribution will fare the worst because of plummeting office rents;
9. Industrial land prices are still searching for a bottom and will continue to do so;
10. Expect to see more sale lease-backs as companies search to raise operating capital

Remember that the FSLIC (Federal Saving and Loan Insurance Corporation) did not begin closing down the Savings and Loan (S&L) industry until 1986 and the Resolution Trust Corporation (RTC) was not created until 1989. The RTC’s involvement with the disposition of S&L assets finally ended in 1995, with total estimated cost to taxpayers of $160 Billion. Some of the reasons for the Savings and Loan bust in the 1980’s are the same reason Commercial Banks are failing today.

However, the commercial real estate crash we experienced in the early 1990’s was also sparked by Federal Tax breaks that encouraged over investment and over building. This time around, the real estate frenzy was fueled by cheap credit, which allowed investors and developers to bid up prices of existing properties.

How much of a correction will we see in 2009? The answer depends on how much “phantom” appreciation a particular property gained during the past 2-3 years, during the era known as “cap rate compression”. I call it phantom appreciation, because many Sellers were showing 50% to 100% gains in value within a 12 to 24-month time frame, which is just not real. Real appreciation comes from rent growth and operating expense containment.

I believe the adjustment in land values in Las Vegas will be very healthy for our market in the long run and keep it one of the most vibrant and healthy commercial real estate markets in the United States. I believe that now more than ever.

It is a fact that our Las Vegas economy and commercial real estate market has been one of, if not the most resilient economies in the U.S., generally speaking. Las Vegas has always been the last community in America to experience a slow-down and the first to recover. The high land prices we have experienced actually worked in our favor by keeping construction in check. Our industrial market is not over built and we may actually start to see a shortage of industrial space in 2010. Businesses still want and need to be in Las Vegas to take advantage of our geographic location, tax and business incentives, quality of life and service our expanding population and infrastructure needs. As for industrial real estate prices, now is the time to buy. Sellers, who a year ago were asking exagerated prices for their assets are no longer in a state of denial regarding current values and are now anxious to make deals. Many are also willing to carry first trust deeds, eliminating the need for buyers to obtain financing. Investors with access to syndicated, private equity sources will also be able to take advantage of this current real estate correction. The cost of financing will dictate CAP rates and therefore, prices. I believe true “buy” opportunities must be at least 1 to 1.5 points above cost of capital. Today, that would be about 8 to 8.75%. Also, the current income on a particular buy opportunity must match current market rents, as many existing leases are over-inflated. Remember that industrial rents today are about 10-15% less than they were a year ago.

Needless to say, these are interesting and exciting times. Every investment is subject to fluctuations in value and commercial real estate is no exception. Many of my clients made their fortunes during the Savings and Loan Crisis in the 1980’s and 1990’s. Those with the foresight and courage to take advantage of our current market correction in Las Vegas may have the same opportunity to make fortunes as well.

 For more information about the Las Vegas Industrial Market contact Dean Willmore, SIOR at 702-363-7600.