Sophisticated businesses study trends that can affect the intensity and frequency of business cycles and try to mitigate downturns and take advantage of upswings.
Real estate cycles are no different. Knowing when to build is both an art and a science, particularly during the frequent and intense cycles of the past 15 to 20 years.
The Las Vegas real estate market has been extremely volatile during and since the Great Recession. For many years, commercial developers were cautious about building new product — retail, office or industrial space — on speculation due to worries about high vacancy rates, a lack of financing and a general lack of confidence in the market. While other parts of the country experienced new speculative construction since 2010, the Las Vegas Valley had been slower to make the turn.
In 2013, developers started considering new speculative projects after reviewing reports of decreasing vacancy rates, increasing rental rates, reasonable land costs and increased tenant activity. ProLogis, in particular, came out of the gate with a large speculative project in North Las Vegas that essentially was leased before the slab was poured. The company was rewarded for being bullish on the market.
Industrial development in the valley usually is focused on three submarkets: North Las Vegas, the Southwest (generally west of Interstate 15 along the 215 Beltway) and Henderson.
Each submarket has its appeal, and each varies materially on rental rates. North Las Vegas offers the lowest rental rates in the valley, and the Southwest is the most expensive.
As we saw in 2015, the factors that help new development get started also can change quickly. Although rents still are increasing, vacancy rates are decreasing. Land pricing is escalating, and the time it takes to secure necessary permits is growing longer as workloads for municipalities have grown faster than their ability to add staffers.
So is the market in danger of overbuilding industrial product? The way I view a project’s viability is based on two main questions: First, if you build the project, how many existing and planned options would a tenant have that would compete against your project? Second, what is the historical amount of product the market has absorbed on average over about 15 years, and how does that compare with what is being absorbed now?
It would be logical to think that if the amount of space being built, coupled with the amount of existing vacant space, greatly exceeds the average amount of annual absorption, we likely are overbuilding. At this point, we appear to be in good equilibrium.
However, escalating land prices may push developers to raise rental rates, which tenants may or may not accept. If tenants push back, developers then can decide whether to lower their returns or simply not build until rental rates rise.
Doug Roberts is a partner at Panattoni Development Co.