Nothing wrong long-term

"The reports of my death are greatly exaggerated."

Mark Twain

It seems you can't read a story in the mainstream national press that doesn't include a dire forecast about the state of the US economy. Many local reports follow that same line of thinking. I am not here to refute the facts of the current difficulties that the Northern Nevada economy is facing; however, I do take issue when the current difficulties are extrapolated to long-term forecasts. Such prognostications are particularly short-sighted when applied to commercial real estate and more particularly the local office market.

Too often in my career I have heard people mistake a short-term market correction for a long-term trend. In few other industries is this more problematic than the office sector of commercial real estate. The NAI Alliance office team, Scott Shanks, Dominic Brunetti and Matt Grimes, are reporting a current office market vacancy rate of 15.4 percent. When unoccupied sub-lease space is included in the calculation, the availability rate is 16.2 percent. While these statistics are very real and problematic, the Office Team will tell you that they do not reflect the whole picture. Looking at current occupancy statistics can be like viewing two minutes of a three hour movie; it doesn't show you the whole picture.

Some may point to occupancy statistics as an indicator of ill-health in the local office market. In my mind this situation is nothing more than a short-term disruption in the supply and demand for office space not necessarily an indicator of long-term problems. The demand for office space during 2006 and 2007 was artificially inflated by the "irrational exuberance" surrounding the residential housing boom. National and regional homebuilders entered the market and rapidly expanded their operations. Mortgage companies, engineering firms, contractors and subcontractors, fueled by the perception that the housing expansion would continue, increased their office needs. Developers brought new projects on line to meet this growing demand, but compared to past boom cycles, developers remained somewhat restrained, partly due to the fact that the housing boom was severely impacting their cost of construction, thus making some projects too uncertain. The result was that demand outpaced supply and prices (rents) increased dramatically. Now that artificial demand created by the housing bubble has vanished, we are left with a complete reversal in the supply/demand equation and we are experiencing downward pressure on rents.

But does this mean that the demand for office space has completely gone away? Absolutely not! New lease transactions and expansion continue. We are currently assisting a number of new and existing clients to address their growing need for new office space. The same fundamentals that drove the economy of northern Nevada prior to the housing bubble will continue to propel this market in the future. Population based office demand will continue to grow as banks, insurance companies and other financial service companies will expand to meet the demands created by a growing population base. Efforts to attract new businesses like Microsoft Licensing, Charles River Laboratories, and Intuit will meet with success. Most importantly, small companies will continue to grow and flourish here due to the entrepreneurial spirit and quality of life this area possesses.

This may all sound a bit overly optimistic given the current state of the economy, but that is exactly the point. When looking at an asset class like real estate, it is important to have a long-term view of the economic fundamentals. While the long-term supply of well located office space is not fixed; it is constrained. And while short-term demand for office space is cyclical; long-term, demand for such space should (at a minimum) grow at a pace equal to the population. Demand can potentially grow even faster if new business is attracted to the area.

While I accept the statement that the market for office space in northern Nevada is facing a disruption in the relationship between the demand and supply for such space, I do not accept that this disruption is due to a fundamental problem in the market. Rather, it is a short-term correction creating opportunities for smart investors and space users. Rumors of the demise of the office market in northern Nevada are greatly exaggerated.

Scott Beggs is vice president in the investment sales group of NAI Alliance in Reno. Contact him at 336-4644 or sbeggs@naialliance.com.