The record amount of industrial development underway in Northern Nevada — roughly 7.5 million square feet of speculative construction is expected to be delivered over the next one to two years — seemingly flies in the face of a high interest rate environment and the looming threat of a national recession.
There’s a good reason why industrial developers haven’t pumped the brakes on the construction pipeline throughout greater Reno-Sparks: Projects currently underway or just coming out of the ground were started 18 or more months ago, back when money was still cheap and readily available.
Mike Nevis, executive vice president of the industrial team and a shareholder in the Reno office of Kidder Mathews, told NNBW last week that the industrial buildings being built today were inked under much different financial terms for developers.
“The capital and debt markets were completely different,” Nevis said. “What you are seeing in the pipeline now was started back when access to capital and debt was easier.
“(Now), yield requirements are a lot higher, and interest rates have effectively doubled,” Nevis added. “Developers are pushing forward and are all-in on Reno with the vacancy level what it is and the absorption rate we have had over the last six years. They are all in – but beyond 2024, that is a really big question mark.”
Since resuming in 2014, industrial development has continued basically non-stop across all corners of the Truckee Meadows. The COVID-19 pandemic only hastened the region’s need for new distribution, warehouse and fulfillment space as dozens of companies added or expanded their western region operations. Vacancy tumbled to a record low sub-1 percent in 2022, and rents escalated sharply.
Looking ahead, though, there may be a plateau in development efforts, since access to capital has dried up faster than a spilled beer at Burning Man. The market fundamentals of Northern Nevada haven’t changed – affordable land, quick development timelines, a business-friendly climate that’s in proximity to major West Coast markets – but developers are having a much more difficult time either funding new projects or making them pencil out.
“What happens in 2024 is a big question mark for all of us once we get through delivery of this pipeline that we have in 2023,” Nevis said. “It might just be that we deliver all this product, lease it, and then pretty much sit idle until the capital and debt markets come back down to reasonable levels, or access to each is better.
“Right now we are trying to get projects out of the ground, and the requirements are much different,” he added. “Capital is basically sitting idle, or if someone is willing to fund a project it’s on a much smaller scale. You are digging into developer profits, which doesn’t incentivize them. It is a backward-looking picture.”
Industrial developers may have encountered their first speed bump in nearly a decade, but a slight brake-check may actually work in the region’s favor, Nevis noted. The push to deliver new industrial buildings to eager tenants resulted in almost 2 million square feet coming online in the first quarter of 2023 alone, Kidder Mathews reports. As a result, overall vacancy inched upward to 3.14 percent, with direct vacancy at 2.5 percent.
When vacancy rates dipped to those record lows in 2022, industrial brokers across Northern Nevada had little to no space to show prospective tenants. As a result, businesses looking to expand their western footprint often looked elsewhere.
“When companies start looking at adding a West Coast fulfillment operation, they look to Reno, Las Vegas and Arizona,” Nevis said. “We were concerned going into last year about losing deals to other markets.
“With vacancy going up, it means we have more availability. It’s good for us brokers, but it’s good for the community as a whole because we have more opportunity to put (spaces) in front of businesses instead of losing them to Arizona or Southern Nevada.”
This last big round of development could lead to an uptick in vacancy to around 5 or 6 percent, which is where the region was pre-COVID,” Nevis added.
“Vacancy will tick up because the market is settling down,” he said. “But we don’t really get concerned until we get to that 8 to 10 percent range. If we get back to 6 percent, that is a balanced and healthy industrial market.”
An uptick in vacancy may ease pressure on tenants, who saw significant rent hikes across all product types in 2022. Lease rates for flex space were up 14 percent, mid-size spaces jumped 35 percent, and big box spaces skyrocketed 53 percent year-over-year, Kidder Mathews reports.
Brad Elgin, partner and industrial specialist with Stark Accelerators, said some tenants are not exercising options to extend their leases and are willing to test the waters to see how the market shakes out.
“They recognize the risk, but there is a confidence level that there may be opportunities for them to relocate, or maybe the market will become a little more tenant-friendly than it has been and lease rates will not be such a drastic increase as what’s being requested today,” Elgin said.
Looking ahead, industrial brokers expect the coming years to feel a bit more like 2018 and 2019 rather than the frothy pace of 2021 and 2022, which saw a staggering 7 million square feet of net absorption during COVID years. The slight slowdown has given tenants some time to reflect upon their business strategies, Stark Accelerator’s Elgin said.
“The way it has been the last few years, it was difficult for tenants to take a minute to evaluate their decision-making processes and properties. If they hesitated, they might lose the deal,” he said. “Tenants were making decisions in haste for fear that the property wouldn’t be there. Now there is some optimism that the environment may lead to some discussion with landlords.”