Northern Nevada's office development submarket continues to lag

RENO, Nev. — Development of new office properties has lagged well behind other sectors of commercial real estate during the region's extended building boom, and the financial metrics that have stifled new construction aren't expected to change anytime soon.

There have been a few new office projects in the past few years — mainly, McKenzie Properties' development of a multi-story complex at South Kietzke Lane and new product at the Reno medical campus on Longley and Double R Boulevard. However, those projects pale in comparison to the flurry of regional activity in other sectors of commercial real estate.

There are several reasons why the office submarket remains in the doldrums, Northern Nevada commercial real estate experts say. The region's core business strengths remain rooted in manufacturing and distribution rather than back office business functions and call centers, so there hasn't been pressing need to add any new large office buildings, says Kevin Annis, broker and principal of sales, leasing and investments with ArchCrest Commercial Partners.

“If you look at the pure macroeconomic benefits of Reno, we are a manufacturing and distribution location with the ability to hit eight states within a two-day drive, along with our proximity to California and the Bay Area,” Annis says. “That's why we've see so much development in the industrial sector. But from an office standpoint, we really haven't seen that big headquarters transition yet.”

“We are an office community that's built to service the employment base — local homebuilders, title companies, insurance agents and the like,” Annis adds. “A lot of (companies) are staying in the Bay Area and bringing in some back office (functions) out here, and there's been some good development in the startup community, but we haven't seen those big HQs land like we need.”

When McKenzie Properties broke ground on 5520 Kietzke Lane in 2017, it was the first new speculative office property to be built in nearly a decade. Now, the Class A office building is nearly full of upscale tenants. Lease rates for the remaining 2,200-square-foot vacant space on the third floor of the building are approaching a regional high of $3.25 a square foot.

That's not to say there aren't any back office headquarters or large call centers in the market — Henry Schein, Blackhawk Network and Teleperformance operate regional call centers, to name just a few. But Reno isn't on pace with direct competitors such as Las Vegas, Boise or Salt Lake City for back office or call center headquarters, Annis says.

And without a spate of shiny new Class A office buildings to draw in prospective tenants, commercial brokers have been hard-pressed to lure larger office users to the region. Across Greater Reno-Sparks, there are just six vacant office spaces larger than 20,000 square feet, and it's primarily dated Class B product constructed in the 1980s.

There is some new office product coming online, but it's smaller build-to-suit or preleased buildings. For instance, Tolles Development Company is erecting two new office buildings at Rancharrah, but it has law firm Fennemore Craig in tow for the first 12,000-square-foot building.

Tanamera Construction, meanwhile, has erected three new build-to-suit medical office buildings at the Reno medical campus at Longley Lane and Double R Boulevard. Tanamera delivered the first building there in 2017 and has since completed a total of 35,000 square feet in the “north” portion of the project, with about 14,000 square feet left to build. There's also an adjacent 8.5-acre parcel in the “south” phase with another approximately 100,000 square feet of medical office product in the planning stages.

The campus is near Northern Nevada Medical Center's new Sierra Hospital under construction, and although the new facility will certainly buoy medical office users in the area, leasing interest was strong well before NNMC announced its south campus, Annis says The burgeoning population growth in South Meadows is sparking need for additional medical services in proximity to residents.

“There's no question that South Reno has been our biggest path of growth, and it's not slowing down,” Annis says. “It's really no longer South Reno — I call it central Northern Nevada.”

Despite the lag in office development, absorption remains strong. Nine consecutive years of positive net absorption has dropped the regional vacancy rate to a healthy 7.5 percent, ArchCrest Commercial Partners reports.

In most markets, that rate is a signal for developers that it's time to start building; however, that's not necessarily true for Northern Nevada.

Lease rates for office space and sales prices on office buildings haven't kept pace with escalating construction costs, Annis says. As the latter outpaced key office financial metrics, land prices also soared. As a result, developers are for the most part unable to financially justify the merits of new construction.

“The only way it works is if lease rates go up 20 percent or construction costs go down 20 percent,” he says.

Average lease rates on turnkey Class A properties is about $2.25 a foot for a full-service lease, ArchCrest reports, and they can go north of $3 a foot for premier turnkey space. Older second-generation product is between $2.25 and $2.50 a foot depending on location.

As usual, Meadowood remains the region's strongest office market with direct vacancy of 7.5 percent. The downtown region stands at under 12 percent, Dickson Commercial Group reports.

While that may seem high compared to other submarkets, downtown office properties are as viable today as they have been at any point in the past two decades, says Dominic Brunetti, principal with the office properties team at DCG. The company has inked leases for upwards of 10 smaller tech firms in downtown office space over the past 18 months.

“Downtown has become a fun place to be,” Brunetti says. “You are seeing the younger demographic coming back.”

The nine-story office building at 200 S. Virginia St. — formerly known at the Wells Fargo building — has become the standard by which Northern Nevada's downtown office properties are judged, Brunetti says. Owner Basin Street Properties has completed several impressive tenant improvements for many of the new companies that landed in the downtown market.

Scott Shanks, principal with the office properties team at Dickson Commercial Group, says downtown office properties also are in a bit of a pricing crossroads. A year ago, Shanks says, market rents hovered around $2.10 but have since jumped to $2.25 to $2.50 a square foot for older, second-generation office product.

And although downtown hasn't seen any new office construction since 1987, Brunetti says, a handful of developers could potentially add new product there if there's strong interest from potential tenants.

Many of the new users looking at Northern Nevada would require new space rather than repurposed digs in older buildings, he adds.

“When we speak to prospects that pass over Northern Nevada, they may move here because of that product type — they don't want to go from a really nice office building to something that's not as nice. They don't want to make a lateral move from a quality standpoint.”

RENO, Nev. — Development of new office properties has lagged well behind other sectors of commercial real estate during the region's extended building boom, and the financial metrics that have stifled new construction aren't expected to change anytime soon.

There have been a few new office projects in the past few years — mainly, McKenzie Properties' development of a multi-story complex at South Kietzke Lane and new product at the Reno medical campus on Longley and Double R Boulevard. However, those projects pale in comparison to the flurry of regional activity in other sectors of commercial real estate.

There are several reasons why the office submarket remains in the doldrums, Northern Nevada commercial real estate experts say. The region's core business strengths remain rooted in manufacturing and distribution rather than back office business functions and call centers, so there hasn't been pressing need to add any new large office buildings, says Kevin Annis, broker and principal of sales, leasing and investments with ArchCrest Commercial Partners.

“If you look at the pure macroeconomic benefits of Reno, we are a manufacturing and distribution location with the ability to hit eight states within a two-day drive, along with our proximity to California and the Bay Area,” Annis says. “That's why we've see so much development in the industrial sector. But from an office standpoint, we really haven't seen that big headquarters transition yet.”

“We are an office community that's built to service the employment base — local homebuilders, title companies, insurance agents and the like,” Annis adds. “A lot of (companies) are staying in the Bay Area and bringing in some back office (functions) out here, and there's been some good development in the startup community, but we haven't seen those big HQs land like we need.”

When McKenzie Properties broke ground on 5520 Kietzke Lane in 2017, it was the first new speculative office property to be built in nearly a decade. Now, the Class A office building is nearly full of upscale tenants. Lease rates for the remaining 2,200-square-foot vacant space on the third floor of the building are approaching a regional high of $3.25 a square foot.

That's not to say there aren't any back office headquarters or large call centers in the market — Henry Schein, Blackhawk Network and Teleperformance operate regional call centers, to name just a few. But Reno isn't on pace with direct competitors such as Las Vegas, Boise or Salt Lake City for back office or call center headquarters, Annis says.

And without a spate of shiny new Class A office buildings to draw in prospective tenants, commercial brokers have been hard-pressed to lure larger office users to the region. Across Greater Reno-Sparks, there are just six vacant office spaces larger than 20,000 square feet, and it's primarily dated Class B product constructed in the 1980s.

There is some new office product coming online, but it's smaller build-to-suit or preleased buildings. For instance, Tolles Development Company is erecting two new office buildings at Rancharrah, but it has law firm Fennemore Craig in tow for the first 12,000-square-foot building.

Tanamera Construction, meanwhile, has erected three new build-to-suit medical office buildings at the Reno medical campus at Longley Lane and Double R Boulevard. Tanamera delivered the first building there in 2017 and has since completed a total of 35,000 square feet in the “north” portion of the project, with about 14,000 square feet left to build. There's also an adjacent 8.5-acre parcel in the “south” phase with another approximately 100,000 square feet of medical office product in the planning stages.

The campus is near Northern Nevada Medical Center's new Sierra Hospital under construction, and although the new facility will certainly buoy medical office users in the area, leasing interest was strong well before NNMC announced its south campus, Annis says The burgeoning population growth in South Meadows is sparking need for additional medical services in proximity to residents.

“There's no question that South Reno has been our biggest path of growth, and it's not slowing down,” Annis says. “It's really no longer South Reno — I call it central Northern Nevada.”

Despite the lag in office development, absorption remains strong. Nine consecutive years of positive net absorption has dropped the regional vacancy rate to a healthy 7.5 percent, ArchCrest Commercial Partners reports.

In most markets, that rate is a signal for developers that it's time to start building; however, that's not necessarily true for Northern Nevada.

Lease rates for office space and sales prices on office buildings haven't kept pace with escalating construction costs, Annis says. As the latter outpaced key office financial metrics, land prices also soared. As a result, developers are for the most part unable to financially justify the merits of new construction.

“The only way it works is if lease rates go up 20 percent or construction costs go down 20 percent,” he says.

Average lease rates on turnkey Class A properties is about $2.25 a foot for a full-service lease, ArchCrest reports, and they can go north of $3 a foot for premier turnkey space. Older second-generation product is between $2.25 and $2.50 a foot depending on location.

As usual, Meadowood remains the region's strongest office market with direct vacancy of 7.5 percent. The downtown region stands at under 12 percent, Dickson Commercial Group reports.

While that may seem high compared to other submarkets, downtown office properties are as viable today as they have been at any point in the past two decades, says Dominic Brunetti, principal with the office properties team at DCG. The company has inked leases for upwards of 10 smaller tech firms in downtown office space over the past 18 months.

“Downtown has become a fun place to be,” Brunetti says. “You are seeing the younger demographic coming back.”

The nine-story office building at 200 S. Virginia St. — formerly known at the Wells Fargo building — has become the standard by which Northern Nevada's downtown office properties are judged, Brunetti says. Owner Basin Street Properties has completed several impressive tenant improvements for many of the new companies that landed in the downtown market.

Scott Shanks, principal with the office properties team at Dickson Commercial Group, says downtown office properties also are in a bit of a pricing crossroads. A year ago, Shanks says, market rents hovered around $2.10 but have since jumped to $2.25 to $2.50 a square foot for older, second-generation office product.

And although downtown hasn't seen any new office construction since 1987, Brunetti says, a handful of developers could potentially add new product there if there's strong interest from potential tenants.

Many of the new users looking at Northern Nevada would require new space rather than repurposed digs in older buildings, he adds.

“When we speak to prospects that pass over Northern Nevada, they may move here because of that product type — they don't want to go from a really nice office building to something that's not as nice. They don't want to make a lateral move from a quality standpoint.”