Key factors may cause more office foreclosures

A 33,072-square-foot office building near Bartley Ranch Park was in the midst of foreclosure proceedings when a Bay Area investment company swooped in a few weeks ago with an all-cash $4.1 million offer.

Brokers who specialize in office deals expect more foreclosures as the market remains soft, and they doubt many cash-laden investors are ready to swoop in with last-minute offers.

The building near Bartley Park at 6121 Lakeside Drive a building that's been the home of RE/MAX Realty Professionals was just a couple of days from foreclosure when it was sold, says Brian Armon of Trinity Commercial Real Estate in Reno.

Armon represented the buyer, a unit of Balboa Funds Inc. of Corte Madera, Calif.

Owners of other office buildings throughout Reno and Sparks are beginning to feel the pinch, too.

"I would not be surprised to see a lot more office buildings coming into foreclosure," Armon says.

The problems? Little demand for space as office users scale back. Declining rents. Falling property values.

Tim Ruffin, managing partner of the Colliers International office in Reno and a specialist in office properties, says the vacancy rate in office buildings around the area stands at nearly 20 percent and nearly 30 percent of the space in South Meadows buildings is vacant.

In fact, Ruffin says, the amount of vacant office space grew by 176,000 square feet during the third quarter alone.

Landlords eager to attract the few potential tenants looking for space have cut rents dramatically. Current rents of $1.60 to $1.70 a square foot for top-quality space are at levels that haven't been seen for a decade, Ruffin says.

But the costs of operating buildings haven't fallen at the same pace, and landlords are feeling the squeeze.

Says Ken Stark, president of Stark & Associates Commercial Real Estate, "We're finally seeing some landlords who are saying,

'I give.'"

But he says the reality of the marketplace has been slow to sink in with some owners who are surprised at the currently low valuations for office property.

Ruffin explains that a 20 percent decline in rents results in a 32 percent drop in building values, assuming everything else remains the same.

But everything hasn't remained the same as buyers now expect to pay a price that will pay them a higher immediate return and that, too, acts as a drag on prices.

The squeeze isn't limited to owners of larger office buildings. Ruffin says owners of some garden office projects smaller buildings that typically house two or three professional firms also are strapped when they can't get all their space filled.

The vacancy rate in garden offices is 16.9 percent, Colliers International says.

Buyers who pick up distressed office properties at bargain prices can cut rents, and that's going to put further pressure on existing property owners.

Armon says the new owner of the building at 6121 Lakeside, for instance, is looking to lease up the space at $1.25 a square foot well below rents at many comparable buildings.

"We're going to be a value offering, which is tough on other landlords," he says.

Even though there's little demand for office space, Armon says Balboa Funds thinks the combination of attractive rents and the building's location in the Meadowood area is likely to be a winning formula.

Long-term, the office market will return to health only as supply and demand get back into balance.

Almost no new office buildings are currently under construction, which helps on the supply side of the equation.

Demand, however, is more difficult to control as it depends largely on decisions by existing companies to expand or new companies to move into the region.

"Job growth is our No. 1 concern," says Stark.