Offices reverse migration as South Meadows fills vacancies

Many small office tenants in South Meadows may soon be searching for new space.

Leases signed during the “flight to quality” in 2011 and 2012, where office tenants took advantage of low lease rates and record-level vacancy in South Meadows office properties to upgrade their office space, are set to expire in 2016 and 2017. Many tenants may be shocked at new terms offered by landlords for prime South Meadows office space.

As the regional economy continues to improve, and vacancy rates continue to decrease, lease rates have spiked since the depths of the recession. Tenants may have a tough time coming to terms with new lease rates in renewal negotiations, says Matt Grimes, vice president of the office properties group at CBRE in Reno.

“During the big flight to quality, Class A spaces leased up first, and now rates are rising,” Grimes says. “We may see some movement in the next few years from tenants out of those Class A spaces into more affordable spaces because lease rates have risen dramatically from when those leases were secured.”

The South Meadows submarket still has plenty of space available for lease in the 3,000- to 7,000-square-foot range, Grimes notes, but the same can’t be said for contiguous Class A space of 10,000-square-feet or more.

And that holds true for the entire office properties market.

Total vacancy in the South Meadows office market was 15.7 percent in the first quarter of 2016, which is half of what it was during the recession. But large freeway-fronting Class A office space in South Meadows is entirely leased, which is pushing lease rates up.

Class A rates in South Meadows are now north of $2 square foot full-service gross, Grimes says.

“The story across the market is that limited supply of large contiguous space,” he says. “Tenants looking for spaces over 10,000 square feet — especially in Class A — have few options to choose from. Tenants looking for space over 20,000 square feet, there are very few options to choose from and no options in freeway-fronting Class A office product.”

The largest available Class A office space in South Meadows is roughly 13,000 square feet, Grimes adds. But don’t expect to see any new office properties going vertical anytime soon.

The only new construction in South Meadows likely will be a build-to-suit project rather than speculative construction. Unlike the regional industrial market, which is exponentially larger and dominated by well-funded institutional investors, the regional office market tends to be made up of local ownership groups that have not forgotten the dark lights dominating their buildings not too long ago.

McKenzie Properties is slated to break ground in coming months on a speculative 40,000-square-foot office project in the Meadowood submarket, the first spec office project in Reno-Sparks since 2007, but that’s about it for large-scale new office development projects across the entire region.

“There is still memory of not that long ago when we had vacancy of 30-plus percent in South Meadows, and that makes everyone nervous to jump into the office market,” Grimes says. “And lease rates really don’t really pencil into new construction, either. In reality you need closer to $2.50 a foot full-service, and we are not quite there yet on the office side.”

Vacancy really began shrinking in early 2015, when South Meadows saw the highest rate of net absorption since the boom years of 2006. Health tech startup Grand Rounds of San Francisco, Coupa Software, also of San Francisco, and Everi games took down significant space. Renown also took 52,000-square-feet off the market with its purchase of 10315 Professional Circle in the second quarter of 2015.

Everi also took 17,138 square feet at 887 Trademark Drive, the former home of WMS Gaming. The rest of the building is being re-tenanted, Grimes says.

Everi, Grand Rounds and Coupa all leased space in buildings recently purchased by NevDex Properties. NevDex purchased 10615 Professional Circle in 2014, and added 10345 Professional Circle and 887 Trademark in 2015.

Melissa Molyneaux, senior vice president of the office properties and managing director at Colliers Reno, says NevDex renovated the lobbies and entryways of its new buildings and was able to command greater lease rates.

“Those buildings were not really that old,” she says. “They weren’t in need of any aesthetic upgrades, but the owner added suite doors with glass for a more contemporary look and has almost got the buildings at full occupancy.”

The exception is 887 Trademark, which was 100-percent vacant until Everi took down space. Other significant office purchases in the South Meadows office market in the past few years include 9790 Gateway Drive, 950 Sandhill Road and 10539 Professional Circle.

Molyneaux says the South Meadows market may see growth in smaller garden office space from users who want to own their own buildings and from office users in downtown/Midtown who want to relocate operations to the south end of town.

“There still is a lot of excitement about downtown, but some of my clients who have been downtown are looking to buy or lease or relocate to South Meadows, and we are starting to see a little bit of excitement out there again,” she says.