The Red Rock Business Center.
Last year was one for the record books for industrial real estate.
Just under 9 million square feet of new Class A warehouse buildings were constructed in Northern Nevada in 2023, a high-water mark far outpacing the five-year annual average of 3.5 million square feet, Kidder Mathews reports. Despite robust leasing activity, with 105 deals inked over the course of the year, the copious amount of new development pushed overall industrial vacancy rates just south of 7 percent.
Nearly 2 million square feet of industrial buildings were delivered in the fourth quarter alone. Despite the robust look in the rearview, however, the road ahead for new industrial development is as barren as U.S. 50 through central Nevada.
“In 2023, we saw the largest volume of speculative industrial construction our market has ever had,” said Shawn Jaenson, executive vice president and industrial specialist at the Reno office of Kidder Mathews. “We are a growing market and are up to about 112 million square feet, but that’s just a massive amount of new product that our market had to take on and weather.”
Although vacancy steadily inched upward over the course of the year in 2023, it actually was a good thing, Jaenson noted. The industrial market in Northern Nevada was sub 1-percent at the start of the year, with almost every building coming out of the ground getting pre-leased before the roof was constructed as companies rushed in to secure space – else they would be left out.
“We had almost 2.7 million square feet of net absorption in 2023,” he said. “We had an increase in direct vacancy, but it was a healthy increase.
“Sub 1-percent vacancy is not healthy at all,” Jaenson added. “It was a feeding frenzy, and you saw a lot of new developers come to town that were getting their feet wet in the (Northern Nevada) market. Now it’s back to a healthy market where there are options for tenants, and they have the ability to really find what they need and not try to make an existing building work for them.”
Tahoe Reno Industrial saw the bulk of new development over the course of the year, but other submarkets also fared well. Tolles Development Co., delivered three buildings totaling more than 750,000 square feet at Airway Commerce Center south of Reno-Tahoe International Airport, and Dermody Properties added two buildings totaling 429,000 square feet just west of Cabelas off Interstate 80.
Looking ahead, though, the pipeline for new industrial construction is nearly empty, Jaenson told NNBW. Last year’s flurry of development stemmed from plans already in play; this year, high costs for capital and debt will stifle additional industrial development, likely for the next 12 to 18 months, he said.
“In 2023, developers had capital lined up and debt secured at tolerable rates. Now, capital markets are stagnant, and debt is so expensive it is eroding any returns. There’s no real way to develop under the current economic structure.
“Hopefully interest rates come down and we see developers able to pen deals and get some development out of the ground,” Jaenson added. “But right now, no one has been able to make anything make sense financially.”
Tim Schaedler, Northern California and Nevada Partner with Panattoni Development Co., said Northern Nevada remains an in-demand market for industrial users, as evidenced by the continued absorption of new Class A warehouse, distribution and fulfillment facilities.
“Tenant demand, albeit not as strong as it was during the pandemic, is still very healthy,” Schaedler said. “There are tenants touring, and there aren’t a ton of vacant buildings for them to choose from. From a macro standpoint, we look at Reno as a very healthy market.
“The challenge developers have is that we saw costs increase 50 percent over a 24-month period, and then layer on debt that costs 8.5 percent for a construction loan when it was 3.75 percent. That creates an environment where the rents needed are higher than what tenants are paying. Without those headwinds, you would see a lot of buildings constructed, but because of those headwinds, you will see a significant dropoff in speculative construction.”
Schaedler said Panattoni has two significant land positions in north Reno that could hold as much as 3.8 million square feet of new industrial buildings. Schaedler told NNBW that Panattoni has invested more in speculative land in Northern Nevada than any other market in the country.
“We believe in Reno,” he said. “The challenges of construction costs and interest rates are real, and it will slow down the amount of spec buildings that are built. But long-term, we believe in the demand; that’s why we took such large land positions in Reno.”
Schaedler said Panattoni is using this time to master-plan its land positions in Northern Nevada to have them ready for new tenants. In the current cost and interest rate environment, developers who do come out of the ground with new facilities in 2024 are likely to construct build-to-suit buildings since that reduced risk profile significantly changes development requirements, he added.
The slowdown in new construction will likely prove beneficial to the market, however, with vacancy rates compressing and lease rates continuing to climb, albeit slightly slower than recent years of double-digit gains in asking rates, Kidder Mathews Jaenson added.
“The market is still feeling itself out right now,” he said. “In almost every quarter, bulk rates are going up (currently $.91 to $.94 per square foot per month). We still have very strong demand, and I think bulk rates will continue to go up, but probably not the growth that we’ve seen in the last two years where market rates almost doubled.”