Industrial Market Review

(Las Vegas Quarterly/ Fourth Quarter 2010)

Positive news was short lived

The return to positive net absorption was short lived as the industrial market suffered through -376,545 square feet of negative net absorption in the fourth quarter of 2010, and -1,177,068 square feet for 2010 as a whole. The industrial vacancy rate increased to 15.8 percent while asking rents remained fairly stable at $0.53 per square foot on a triple net basis. The employment picture is beginning to deteriorate at a slightly slower pace, but industrial jobs are still being lost, and that suggests more pain in 2011. yearover- year numbers show improvement in 2010 over 2009, but still paint a picture of an industrial market mired in troubles. Sales of industrial space have improved somewhat over last year, with some signs of a rebound in values. Between November 2009 and November 2010, Las Vegas-Paradise MSA employment in sectors that traditionally occupy industrial space declined by 15,000 jobs. The construction sector lost 13,400 jobs during this period. The manufacturing and transportation & warehousing sectors posted losses of 700 and 600 jobs respectively, while the wholesale sector lost 300 jobs. Unemployment in the Las Vegas- Paradise MSA stood at 14.3 percent as of November 2010, a slight increase from 14.1 percent in October

2009.

Looking at job losses in the construction sector, one gets a clear picture of the current situation for

Southern Nevada’s industrial market. While year-over-year job losses are on their way down, a good

sign by any measure, the total jobs lost continues to rise and the prospects of replacing those lost jobs are slight. We have an industrial market built to accommodate almost 200,000 industrial workers, but only 118,000 industrial workers utilizing it. The dark blue line in the graph on the next page does not just represent lost construction employment; it also represents industrial buildings the market does not need. That means industrial vacancy rates that will likely remain in the double digits until either the industrial workforce catches up to our excess capacity, or we lose excess capacity to redevelopment. From 2000 to 2006, a period with both booms and busts, industrial vacancy averaged 7 percent in Southern Nevada. During the period 2008-2010, industrial vacancy has averaged 12 percent. We expect that over the next few years, the prospect of hitting a “low” vacancy rate of 10 percent will be our “new normal”. There were no industrial completions this quarter (and given our aforementioned excess industrial capacity, thank goodness). Total industrial completions in 2010 were a mere 341,000 square feet, compared to 1.8 million square feet in 2009 and 4.4 million square feet in 2008, the other two years of our “Great Recession”. In essence, this shows that the market has indeed responded rationally to our lack of demand for industrial space. More importantly, as our excess capacity problem continued to be exacerbated by job losses, we can take solace that it is not further exacerbated by industrial construction.

Given current predictions for job growth in Southern Nevada, it is likely that we now have a 10 year

supply of industrial space on the market. This should keep industrial construction at a minimum for at least the next 3-5 years (assuming job growth remains low during that period), further dampening

prospects for a renewal of job growth in the construction sector. Industrial projects

completed in the past five years are currently 20.5 percent vacant. Forward supply of industrial space in the Valley increased to 239,630 square feet in the fourth quarter of 2010, bolstered by the announcement that U.S Micro is planning to construct a build-to-suit project in the Southwest submarket. Two other light industrial projects, 7040 Redwood and 1519 Helm, are also in the pipeline.

Net absorption, which turned positive during the third quarter, has gone back to its old

tricks, releasing approximately 377,000 square feet back onto the market in the fourth

quarter of 2010. In general, net absorption is showing some improvement over time, with

2008 averaging 56,841 square feet of negative net absorption per quarter (bolstered by

strong performance in the first quarter of that year), 2009 averaging 726,055 square

feet negative net absorption per quarter and 2010 averaging 294,267 square feet

negative net absorption per quarter. For 2010, only the Henderson submarket posted

positive net absorption of 49,953 square feet for the entire year. Among product types,

Light Industrial space had 83,680 square feet of positive net absorption for the year.

Gross absorption, which had rebounded in the third quarter of 2010, declined slightly

in the fourth quarter to 2,238,342 square feet. Gross absorption for the year was

10,711,473 square feet, an increase of almost 2 million square feet over 2009.

Industrial vacancy was 15.8 percent in the fourth quarter of 2010, up 0.3 points from

last quarter and 1.3 points from one year ago. The Northwest submarket continued to

have the Valley’s highest vacancy rate at 31.8 percent, a 10.7 point increase from last

quarter caused mostly by the release of 25,000 square feet at the former Westwood

Studios building. Southern Nevada’s lowest industrial vacancy rate was in the West

Central submarket, at 11.1 percent. Vacancy decreased in the Airport submarket, and

increased in all other submarkets. The largest increase was in the Northwest submarket.

All product types other than Light Distribution and Light Industrial experienced an

increase in vacancy this quarter and all product types have a higher vacancy rate now

than they did one year ago.

The most active businesses taking industrial space in 2010 were involved in manufacturing, the wholesale trade, transportation, exhibition services (i.e. conventions) and construction. Companies headquartered outside of Nevada took 65 percent of the all the square feet leased or sold during 2010. This trend of national companies dominating leasing activity should continue into 2011. 33 percent of all leases signed in 2010 were signed by companies headquartered in Nevada, while only 10 percent were with California-based companies. 67 percent of leases signed so far in 2010 were with regional or national companies (i.e. companies operating in multiple states and/or internationally).

The weighted average asking lease rate for industrial space decreased this quarter to $0.53 psf NNN from last quarter’s $0.54. If adjusted for inflation , the weighted average asking lease rate decreased this quarter by $0.01 to $0.44 psf. Adjusted for inflation, the weighted average asking lease rate for industrial product has dropped by $0.27 from its peak of $0.71 psf the first quarter of 2007. Current asking rental rates are the lowest they have been since the third quarter of 2004. Inflation-adjusted rates are as low as they have been since the fourth quarter of 1999.

The gap between achieved and asking rates averaged $0.11 in 2009 and $0.14 in 2010. The largest gap was in Incubator projects ($0.26), while the smallest was in Light Distribution projects ($0.04). The smallest gap between achieved and asking rents was in North Las Vegas, which had achieved rents $0.04 lower than the average asking rent. The remaining submarkets had a rent gap ranging between $0.07 and $0.14, with the largest gap in the West Central submarket.

Adjustments in asking rents from quarter to quarter continued to lean towards rent reductions. In the

fourth quarter of 2010, 14 percent of existing availabilities had a reduction in asking rent, with an average reduction of $0.12. Only 3 percent of existing availabilities increased their asking rent, by an average of $0.16. The 419 availabilities that entered the market in the fourth quarter had an average asking rent of $0.53 psf, a value equal to Southern Nevada’s overall average asking rent for industrial product. All submarkets this quarter except East Las Vegas and Northwest experienced a decrease in asking rent this quarter. The largest rent decrease was $0.02 in the Airport, Henderson and Southwest submarkets. The inventory of industrial properties available for owner/user sale decreased at the end of 2010 to 3,339,000 square feet from 4,044,000 square feet at the end of 2009. The average asking price for owner/user industrial sales decreased to $110 psf, well below the average asking price of $152 psf recorded two years ago. More than 60 percent of the available owner/user sale square footage in Southern Nevada was in the North Las Vegas and Southwest submarkets, with average asking prices of $90 and $135 respectively. Prominent owner/user sale availabilities include the Traverse Point Distribution Building in the Henderson submarket (154,000 square feet), the Berlin Industries Building in the Northwest submarket (146,000 square feet) and 1550 Helm Dr in the Southwest submarket (91,000 square feet).

The inventory of industrial buildings for sale as investments increased from 1,185,000 square feet in

2009 to 1,519,000 square feet in 2010. The average asking price has decreased to $100 psf from $149 psf in 2008. Cap rates have recovered since hitting a low of 7.3 percent in 2008, averaging 8.4 percent in 2010. Prominent investment sale availabilities include Las Vegas Airport Business Center in the Airport submarket (142,000 square feet), Hughes Airport Center Bldg 14 in the Airport submarket (133,000 square feet) and the Graphicsland Building in the Southwest submarket (86,000 square feet). By the end of 2010, 475,000 square feet of industrial properties sold as investments at an average price of $92 psf and at an average cap rate of 8.9 percent. This represented a decline from the volume of investment sales in 2009 and 2008. Owner/user sales, on the other hand, have recovered since hitting a low in 2009. Owner/user sales totaled 721,000 square feet in 2010, compared to 582,000 square feet in 2009. The average sales price of owner/user industrial

was $118 psf, a decline from last year’s $135 psf and 2008’s $149 psf. This drop in price per square foot is attributable not only to issues of over-supply, but also the difficulty in securing loans necessitating cash purchases. Net absorption in Warehouse/Distribution product has been uneven in 2010, positive in the first and third quarters, negative in the second and fourth quarters. Overall, warehouse/distribution product returned 652,514 square feet to the market in 2010, about half as much as was returned in 2009, so a definite though negligible improvement. Gross absorption for warehouse/distribution space reached 3.4 million square feet, more than a million square feet more than in 2009, another sign that demand for large warehouse spaces is increasing in Southern Nevada. Several large, national tenants took warehouse/distribution space in Southern Nevada

in 2010, including Czarnowski Display Services of Chicago IL, and Global Equipment Co of Bedford GA. The Veteran’s Administration and Fellowes Inc signed large leases for warehouse/distribution space in 2010, but will not occupy that space until 2011. The asking rent of Warehouse/Distribution space in Southern Nevada was higher than in California’s Inland Empire and Reno in the third quarter of 2010, but lower than in Phoenix.

Demand for Light Distribution space has been relatively strong in 2010, with 124,539 square feet of positive  absorption in the fourth quarter, but still losing 234,000 square feet of occupancy for the year. Light Distribution product is still mostly drawing local tenants, primarily in the transportation, automotive, wholesale and construction industries. Light Distribution vacancy was 21.9 percent this quarter, well above the overall industrial vacancy of 15.9 percent and 2 points higher than in 2009. Gross absorption of Light Distribution space stood at 2,593,622 square feet in 2010, a 600,000 square foot improvement over 2009.

Light Industrial space, possibly the poster child for overdevelopment in Southern Nevada, has seen some real improvement in 2010. Light Industrial vacancy is only 2 points higher now than it was at the end of 2009, and it is the only industrial product type to post positive net absorption for the

year. Light Industrial space has seen a significant increase in owner/user and investment sales and has one of the lowest gaps between achieved rental rates and asking rental rates. Gross absorption for Light Industrial space was 2,630,485 square feet at year’s end. Incubator space, which relies heavily on small, often start-up business tenants, has had a dire 2010. In the fourth quarter alone, net absorption was negative 161,107 square feet representing more than half the negative net absorption the incubator market experienced in 2010. Gross absorption of incubator space was roughly equal to what it was in 2009, at approximately 1,000,000 square feet. R&D/Flex space ended 2010 with the highest vacancy rate (27.3 percent) of all industrial product types. At year’s end, net absorption was only negative 44,535 square feet, and most of that cropping up in the fourth quarter of the year. Like incubator space, gross absorption was about what it was last year, approximately 1,000,000 square feet.

On the whole, Southern Nevada’s industrial market appears to be heading for stability. Job losses are declining, but we’re not yet seeing job gains. Asking lease rates are beginning to stabilize though continued negative absorption in the first half of 2011 (and possibly beyond) will keep asking rates from improving. Now that the deterioration of the market is slowing down, our chief problem is one of adjusting perception to the “new normal”. As mentioned earlier in the report, Southern Nevada has an industrial inventory designed for 80,000 more industrial workers than we presently have, or can reasonably expect to have in the near future. This gives us a long-term situation of vacancy rates many points higher than the market enjoyed during the early part of this decade. To put it another way, 10 percent vacancy may be the new 5 percent vacancy. The way out, of course, is increased employment or decreased inventory. While it is likely that, over the next decade, some industrial product – poorly located, poorly designed and constructed despite a lack of demand – could be rehabilitated into office or retail space, or demolished, it is unlikely that such redevelopments will remove a substantial portion of our vacant inventory from the market.

In essence, there is not much more demand for office or retail space, and undeveloped land is no longer scarce.

What Southern Nevada needs are jobs, and herein lies the problem. Of the 80,000 industrial jobs that

were lost since the peak, approximately 60,000 of them were construction jobs – workers engaged in

building the excess capacity we currently enjoy in commercial and residential real estate, and jobs that cannot return until that excess capacity has been filled. In other words, we need workers to fill empty space, but the existence of that empty space precludes us from hiring new workers. A tricky prospect indeed! We think that gross absorption will generally continue its upward trend in 2011 as the national and regional economies slowly recover. Net absorption will likely bounce between positive and negative in 2011. Vacancy rates will probably end 2011 close to where they ended 2010 – perhaps a bit higher, hopefully a bit lower. On balance, 2011 will probably shape up to be slightly better than 2010, barring any tax increases or major international disruptions in trade.