Phoenix office fundamentals continue to trend in the right direction according to the 2018 CoStar report. Absorption has outpaced supply additions for eight consecutive years, and vacancies remain below the market’s historical average. Strong growth in office-using employment, bolstered by corporate expansions and relocations, has driven demand for office space, particularly at the top of the market.
State Farm –
Tempe Waterfront
The Valley of the Sun’s steady vacancy compression translated into some of the healthiest rent gains in the country in the past several years. Although rent growth has shown signs of deceleration in recent quarters, as it has in many major markets, Phoenix continues to outperform the national average.
Another factor contributing to the recent vacancy compression and robust rent growth has been a relative lack of new supply. Annual net deliveries have been well below historical averages this cycle as developers have taken a more cautious approach following the Great Recession, when vacancies spiked north of 20% due to supply-driven pressure at the bottom of the downturn.
Development activity has ramped up in select submarkets—particularly those in the East Valley region. Nearly 4 million SF of office space has delivered in Tempe since 2015, the most heavily built out submarket this cycle. Tempe and neighboring Chandler have received about 50% of all new supply in the past five years, and will continue to be the top Phoenix submarkets for deliveries in the near term.
Phoenix remains a liquid market for office investors with more than 10% of inventory trading in the past 12 months. Institutional investors have snapped up some of the higher profile office assets in the metro’s primary employment hubs.
Leasing
Robust growth in white-collar employment has fueled healthy demand for office space in Phoenix. Office-using job growth continues to outpace the national average as it has for the past five years, and nearly one-third of jobs in the metro are located in office buildings.
Corporate relocations and expansions drive the market. Many of these companies cite workforce availability and talent along with a low cost of doing business as driving forces behind their decision to locate operations in Phoenix. Several major financial services firms—State Farm, Freedom Financial, and Allstate Insurance—are in varying stages of completing large regional corporate expansions in the metro.
Phoenix has been among the top metros in the nation for tech job growth, and has also become a hotbed for financial employment. Both sectors are relying on each other more than ever before, as evidenced by the rise of online banking and budding financial technologies such as blockchain and cryptocurrency.
A host of homegrown and Silicon Valley-based tech startups are taking office space as their operations grow, including Phoenix-based Carvana, recently named one of the 40 fastest-growing companies in the nation by Inc. 5000. The online car retailer has moved into more than 175,000 SF of recently delivered space at Liberty Center at Rio Salado.
Rent
The Valley’s healthy state of fundamentals has translated into robust rent growth in the past several years. But like most of the U.S., Phoenix’s gains are decelerating from the highs of 2015–16, although they were still above the metro’s historical average and the national average heading in 19Q1. Rent growth at the top end of the market has been even more pronounced, with rents in 4 & 5 Star assets surging by more than 35% since 2013, significantly outpacing gains in 3 Star properties.
Despite the recent rent increases, Phoenix offers a sizable discount on office space on a national scale. The average office rent in Phoenix is roughly 30% less than the national index, and the discount relative to rates in nearby West Coast markets is even greater. San Francisco’s average rent is about two and a half times more than those in Phoenix and Los Angeles’ is about 50% higher.
The relative affordability of Phoenix could continue to attract tenants looking to set up or expand operations in the western part of the United States without paying sky-high rents in coastal markets. The wide gap between rents in Phoenix and those of other western markets suggests that rents in Phoenix may still have more runway, but a rise in speculative development could temper growth as tenants now have more options to choose from than at any other point in this cycle. However, the outlook for office-using employment growth in the Phoenix metro area remains strong and could potentially tighten the market further if supply is unable to keep pace with demand.
Construction
While net deliveries have consistently remained below their historical average, speculative construction is starting to ramp up in Phoenix—halfway through 19Q1, more than 65% of all space under construction was available for lease.
One of the more intriguing developments underway is the 4 Star, 228,000 SF Block 23 at CityScape in burgeoning Downtown Phoenix. In addition to office space, the mixed-use development will bring a 45,000 SF Fry’s Grocery and 300 apartment units. The project broke ground in 17Q4 and is slated to deliver in the summer of 2019. Ernst & Young LLP was the first tenant to lease space when it signed on for 20,000 SF in September 2018.
Sales
Strong growth in office-using employment has coincided with institutional players making big splashes in Phoenix. Major trades for some of the metro’s most-recognizable office buildings highlight the ongoing trend of strong demand for Class A space by both tenants and investors. The Valley continues to be a liquid office market as more than 8% of inventory has traded annually since 2014.
Last June, New York Life acquired the 302,209-SF 24th at Camelback, from Hines, for $100 million ($331/SF). The Camelback Corridor asset was reportedly more than 90% occupied at the time of sale with tenants including Cisco, Greenberg Traurig, AAA and Regus.
In one of the largest trades in recent years, billionaire Vincent Viola acquired the iconic Chase Tower in Downtown Phoenix for $107.5 million ($133.44/SF) in October. In addition to the 40-story, 724,000 SF building, the transaction also included a 1,900-space parking garage. Chase Tower was near full occupancy at the time of sale, but JPMorgan Chase is expected to vacate a considerable amount of space as part of an office consolidation.
Economy
The economy of Phoenix is predicated on population growth. Net migration is the driving force behind the population growing at more than twice the national average, one of the fastest rates in the country. More than two-thirds of 2017’s population growth was attributed to new residents from outside of the metro. Many people, and companies, decide to set roots in Phoenix for its low cost of living and doing business, housing affordability, and expanding economic opportunities.
An increasing number of companies are selecting Phoenix for corporate expansions and relocations, and financial firms are leading the way. Insurance giants State Farm and Farmers Insurance both recently moved into newly built regional campuses. State Farm’s 2.2 million SF regional headquarters in Tempe can accommodate up to 8,000 employees. Wealth-management firm Northern Trust chose the Discovery Business Campus in Tempe as the site for a major regional hub and is expected to generate up to 1,000 jobs in the area with an average annual salary of $82,000. In June 2018, New York-based financial consulting firm Deloitte inked a 102,000 SF lease for spec office space at Rivulon in Gilbert, a move that is estimated to create 2,500 jobs.
The uptick in interest in Phoenix is fueled by the metro’s business-friendly environment, growing talent pool, and advantageous geographical location. Arizona State University, the largest public university in the country by enrollment, has focused on producing graduates well equipped to fill the high-value-add jobs being created. The university topped U.S. News & World Report’s ranking of “Most Innovative Schools” in the U.S. for the third consecutive year in 2018, besting universities such as Stanford and MIT. Moreover, a relatively low cost of living and proximity to California make Phoenix particularly attractive to tech companies looking to offer their employees a high quality of life close to Silicon Valley. This combination makes Phoenix a strong candidate to continue attracting the high-value, upper echelon paying jobs the local economy needs to continue its diversification.
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