Industrial space tenants face market crunch

The Truckee Meadows industrial market shows unprecedented activity with occupancy growth off the charts and a vacancy rate that approaches the lowest ever seen.

Meanwhile, new construction stymied by steep construction costs has lagged behind demand. And vacancy rates crashed.

As a result, companies increasingly must look to the outlying areas of Stead, Patrick and Carson City for industrial space.

And, some newcomers may bypass the northern Nevada market altogether and take their business elsewhere.

So far this year, the market has seen more than 2 million square feet of gross absorption for the second quarter in a row, a situation that has never happened before, says Paul Perkins, senior vice president of industrial properties at Alliance Commercial Real Estate.

And vacancy rates are dropping, says Aaron Somer, associate, Industrial Properties Group at Colliers International, from 6.2 percent at the beginning of the quarter to 4.7 percent at the end of the quarter as nearly 1.5 million square feet of industrial space was absorbed.

"This continued decline in available industrial space is a result of strong demand and a lack of new industrial product in area," he says. "We expect the vacancy rate to remain close to the current 4.7 percent into next year."

"The market," says Perkins, "absorbed more than 2 million square feet of space, an appetite never before seen here."

Figure in space vacated and the market absorbed nearly 1.6 million square feet in one quarter. The combined total of 3.5 million square feet translates to a whopping 114 percent of the highest annual total ever recorded, he says.

"With absorption rates shattering records and new construction well behind the curve, the vacancy rate is approaching the all-time low of 4.4 percent set at the end of 1993 when California was hemorrhaging businesses," says Perkins.

As absorption rates rise, vacancy rates fall.

Right now, available industrial space totals just under 3 million square feet, for a vacancy rate of 4.84 percent, he says.

If all the leases and sales pending for the third quarter are successfully completed, the vacancy rate will be the lowest ever recorded, standing at 4.2 percent, says Perkins.

And, he adds, vacancy rates could plunge through the previous record by the end of the third quarter.

That may seem like good news for landlords, but Perkins cautions that when there are too few choices, tenants will turn elsewhere.

As vacancy rates fall, lease rates rise.

Compared with last year, spaces less than 20,000 square feet have climbed in cost 13 percent, says Perkins. Spaces between 40,000 and 100,000 square feet increased 7 percent and spaces over 100,000 square feet were priced at 8.5 percent more.

And perks such as tenant improvement allowances?

"They're getting as rare to find as a teenager without a cell phone."

But new construction may ease things.

Matt Riecken, senior vice president, Trammel Crow Company, sees a significant increase in space coming on the market.

The spike in construction costs over the past few years had put a damper on new construction but the current demand for space has sent rents high enough to cover the increased building costs, says Riecken. Rents are up 7 to 10 percent over this time last year.

"It's the strongest momentum the market has seen," he says and expects to see that momentum continue for the next five years.

Kirk Olsen, leasing and business development manager for DP Partners, cites another reason for the limited supply of new industrial product in Reno and Sparks:?The short supply of industrial-zoned land, the high cost of this land, and rising construction costs.

Construction costs have risen 6 percent over the past 6 months and are expected to continue apace.

So developers are relying on healthy rent increases to make new projects pencil.

Despite this challenging environment, says Somer, there are some industrial projects underway in the Reno/Sparks market. Such as Trammell Crow Company's Brookside Corporate Center at Longley Lane and Rock Boulevard. And McKenzie Properties' new industrial complex on South Rock Boulevard.

Nearly 800,000 square feet of industrial space is coming online in the next few months in Stead, Somer adds. It's being developed by DP Partners, Trammell Crow Company, and Panattoni. And at the Tahoe Reno Industrial Center next year.

Developers, says Perkins, are scrambling to close escrows on new land acquisitions, but no appreciable amount of new space will be ready for occupancy until next year.

The reason? From the end of 2000 into 2003, the market was flat, he says. Then, in 2004 construction costs spiked dramatically. Builders looked at the leap from former lease rates to the new rates required by higher building costs. Many decided not to jump.

This spring, he says, Trammell Crow and Panattoni Development were the only two developers to complete new product. And Panattoni had more than 80 percent of its new 200,000 square footer in the Lear Industrial Center leased even before the walls were tilted.

"Several big bombers in the Tahoe Reno Industrial Center are on the drawing boards, but they won't be completed until early 2007," says Perkins.

Other behemoths are going up in the Patrick Business Park and at Lear Industrial Park.

"Ultimately the growth will need to occur in some of the outlying areas," says Somer.

Small to medium-sized industrial users are being forced to look outside the traditional Truckee Meadows markets to growing areas such as Spanish Springs and Carson City.

"With the Highway 395 freeway expansion, we expect that Carson City and its environs will become an extension of the Reno market."

Meanwhile, large industrial users seeking distribution and manufacturing sites are being forced to look to growing areas such as Stead, Patrick and Fernley.

The future looks to hold more of the same.

"We expect to see something in the 3.5 percent range by the end of the quarter," says Perkins, "and that's an unhealthy low. When tenants can't find space, or find little choice, they will go to other markets."

Of today's market, he says, "Unprecedent-ed, yes. Sustainable, no. But fun to experience."