"Who the hell knows? But it seems to be getting better."
This is a common response of commercial real estate agents when asked the question of how the market is doing. In a recent national survey of commercial agents within the Society of Industrial and Office Realtors the majority of SIORs felt that conditions in their market would improve in the next quarter. This is a drastic improvement compared to an early 2009 survey, where less than ten percent of SIORs had a positive outlook on conditions in their market. No doubt we are in challenging times but the glass now seems to be half full rather than half empty. This survey parallels sentiment throughout the Reno-Sparks market.
On the positive side of the scale, corporate earnings are up, although mostly due to expense cuts, and cash held by corporations is very strong. Lack of financing and an uncertain economy has led companies to be conservative and hold cash. The good news here is once the economic picture clears and stabilizes, companies will have the funds to hire and grow. The dilemma we are facing is that companies don't want to spend until the economy gets better, but the economy will struggle until the companies spend a "A Catch-22" situation. Company CEOs and CFOs don't get into trouble taking the conservative approach during times like these, so we are not surprised when we hear our tenants say they are putting a move on hold and just renewing short term. Tenants are content to hold tight and renew their existing lease at a discounted rate or downsize to save costs. Buyers are hesitant to make a long-term commitment on their space needs, buying only if the price is very attractive. With more landlords and sellers in the market than tenants and buyers looking for space, the tenants and buyers are in a much better position at the negotiation table as building owners bid to get occupants.
Another positive sign for the market is the halt to rising vacancy. During the turbulent times of 2009, vacancy rose from 12.8 percent to 15.3 percent. This occurred during a time of no new speculative construction, so increased vacancy was from existing buildings being vacated rather than new buildings being constructed and added to inventory. Vacancy has held stable over the past three quarters with move-ins balancing the move-outs. Although we continue to see companies shutting down, adding vacancy to the market, we now have the positive news of move-ins backfilling the holes in the market.
Now, let's look at what we hear as the major issues causing companies to refrain from moving:
* November elections: For better or worse, change is occurring rapidly and the business community is struggling to wrap its arms around the changes and determine how it affects its operation. The November elections could provide some political balance, which is generally understood to be good for business. "Why make a change now, let's see what happens," seems to be the mantra.
* Bush's tax cuts: Will they expire, continue or will there be a blend picking and choosing which cuts are extended and which cuts are terminated. Companies want to see money in the pockets of individuals so they can buy their products. If the cuts expire as currently scheduled, less money will be in the pockets of people like Joe the plumber which could hurt expansion. "Why make a change now, let's see what happens."
* Health care: The ramifications to business are yet to be fully revealed or felt but this change is feared. "Why make a change now, let's see what happens."
* Accounting changes for tenants: Proposed new accounting rules by the Financial Accounting Standards Board expected to be adopted in 2011 will change financial reporting for the commercial real estate industry. Once implemented, it could force companies to include as a liability the full cost of a lease throughout the entire term. If a company has annual lease payments of $100,000 and a one-year lease, the liability on their books will be $100,000. If a company has a 10-year lease at $100,000 per year, the liability on their books will be $1 million. This should lead to tenants signing shorter term leases to minimize the impact on their income statements. Landlords typically like longer term leases to show income stability, so it will be interesting to see how this is reconciled. "Why make a change now, let's see what happens."
* Timing: Prices are dropping. Are prices at the bottom or do we have further to fall? Lower lease rates equate to lower sale prices. Also, difficult financing and more sellers than buyers equates to lower sale prices. "Why make a change now, let's see what happens."
There are certainly plenty of reasons to hold tight. On the other hand, if one waits too long, the great deals offered in today's market might go away. Timing is everything, and the timing might be right for those willing to take a calculated risk. Vacancy has stopped increasing and activity is picking up. Banks' unwillingness to lend on speculative projects will continue to hamper new development once activity and higher lease rates justify such development. With limited new construction, increasing activity will be restricted to existing buildings, which will help lower vacancy and result in prices firming up. This is already being seen in the big box (large deal) category with our market being one deal away from not having product available.
Those existing and new-to-the-area tenants comfortable with their business in this environment have slowly taken advantage of low rates by upgrading their facilities within new modern buildings over the past few years. We are down to one building which can accommodate a user of greater than 330,000 square feet. A 632,000-square-foot building is the likely target for a 600,000-square-foot user currently looking in the market. When and if this happens, we will be tight on large, quality big box space. This one deal will take a full percentage point off vacancy and may signal a turn in the market despite the "wait-and-see" headwinds.
With the slow sentiment change in the market which is backed up by the numbers, those saying "Why make a change now, let's see what happens" might in the future be saying "Would have, should have, could have done something in 2010 when I had the chance."
Dave Simonsen is senior vice president in the industrial properties group of NAI Alliance. Contact him at 336-4667 or dsimonsen@naialliance.com.
