Declines in office rents pinch owners
July 26, 2010
Office rents in the Reno area have fallen so far that building owners increasingly find themselves in financial straits.
“Rents cannot continue to fall without permanently damaging the health of the overall office market,” says Tim Ruffin, managing partner and senior vice president of Colliers International in Reno.
The squeeze is particularly tight on owners of smaller and older office buildings owners who often are individuals who traded up out of the residential market when times were better as companies take advantage of low rents to move into top-quality office space.
Some landlords, meanwhile, are getting creative with strategies that allow them to generate at least a little revenue today with hopes of getting right-side up in three or five years, says veteran office broker Dick Johnson.
The root problem is high vacancy rates in office buildings across town.
Office vacancies stand at 27.4 percent in the downtown area 29.1 percent if space available for sublease is included and 23.6 percent in South Meadows, says Bram Buckley, who handles office properties for Lee & Associates in Reno.
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Office buildings in the airport area, where properties tend to be older and more modest, stands nearly 26 percent vacant, Buckley said in a report last week.
And Ruffin notes that the amount of vacant office space in the market increased by about 38,000 square feet during the second quarter alone.
As landlords scramble to get tenants into vacant space, they’ve cut rents. Office buildings in South Meadows that commanded rents of $2 a square foot or more a couple of years ago now are offered at $1.50 and some $1-a-foot deals are floating around.
That, in turn, pressures owners of more modest properties who are losing tenants to new office buildings that now rent for prices that once were available only for older offices.
A telling statistic: South Meadows and Meadowood, the two parts of town dominated by nicer and newer buildings, were the only regions that saw improved occupancy during the second quarter, Ruffin says.
Garrett Hallenbeck, a broker and property manager with Hallmark Investments and Management LLC in Reno, notes that a price gap of 50 to 75 cents a square foot historically separated high-end office properties from the rest of the pack.
“That gap has dwindled,” he says, noting that offices in the airport area often rent for $1 a square foot these days, a level that puts substantial pressure on owners.
Ruffin estimates the operating costs of most office buildings at 75 cents a square foot, which means $1 rents leave little for capital improvements and other needs much less a profit for the owner.
And he says some owners are feeling heat from lenders as falling rents mean that the values of buildings no longer support the amount of the loans that were used to buy them.
Current rents, Ruffin says, typically support building values of about $100 a square foot. But the costs of constructing a new building run more like $175 a foot.
“Without some relief for landlords in the future, banks can expect to start getting back a few more buildings,” he says.
But Hallenbeck says individuals who own many of the older office buildings in the market have the sort of stubborn pride of ownership that will keep them from throwing in the towel until all other options are closed.
Some, he says, are trying to hold on as long as they can by keeping tenants in their buildings, even at discounted rents, and making up the difference out of their own pockets for a while.
Others are controlling costs in any way they can. Property tax assessments are challenged routinely. Janitorial service may be cut back in some buildings from daily to a couple of times a week.
Johnson, owner of Johnson Group, a commercial brokerage in Reno, says owners of buildings often are negotiating shorter leases one to three years in hopes the market will stabilize or turn upward.
“Within three years, you’re going to know where things are at,” he says.
Another strategy, he says, involves bargain-priced leases with buyout agreements. In those deals, the landlord maintains the option to buy out a lease paying, say, the equivalent of four months’ rent to the tenant in case the market turns.