Phoenix, Arizona, USA cityscape in downtown at sunset.
The pandemic has disrupted what was a consistently positive performance in the Phoenix office market. Healthy employment growth and relatively limited new supply supported fundamentals over the past decade. But since the onset of the pandemic, leasing activity has slowed, sublease availabilities have climbed, and investment volume has tumbled. Admittedly, the degree to which the market will be affected, and the length remains unknown. The recovery will depend on how quickly people are vaccinated, when people will feel safe returning to the office, and how companies rethink their space needs.
LEASING
Before the virus outbreak, corporate expansions and relocations stimulated demand for Phoenix office space. Demand had outpaced new supply for nine consecutive years, and vacancies had compressed from the 2011 peak of more than 20%.
Last year, firms tried to give back unused space to reduce expenses as employees worked remotely. Available sublease space increased from 1.7 million SF in 19Q4 to about 4.1 million SF, and the level is expected to grow over the next several quarters. Leasing activity slowed substantially last March, but activity has started to pick up. Several notable deals have transpired over the past 12 months, and some of the largest announcements have been California-based firms entering the Phoenix market.
Net absorption will remain below the historical average over the next 12 months, according to the Base Case scenario. Vacancies will increase as new space delivers, with the rate expected to approach 14% by mid-2021.
RENT
Rents have held fairly steady in high-demand and well-located submarkets, like Tempe and Chandler, while other areas have recorded rent reductions. Stubbornly high vacancies in Downtown Phoenix and Midtown have translated into negative rent growth, far below the market average.
Despite 32 quarters of rent appreciation, Phoenix maintains its position as an affordable office market. The average office rent in Phoenix is roughly 30% less than the National Index, and the discount relative to West Coast markets is even greater. San Francisco’s average rent is about two and a half times that in Phoenix, and Los Angeles’ is about 50% higher. Phoenix’s relative affordability will continue to attract tenants looking to relocate or expand operations in the western part of the United States without paying sky-high rents in coastal markets.
CONSTRUCTION
About 2.2 million SF delivered last year. Some speculative buildings came online in Tempe, including The Watermark, IDEA, Rio2100, and 777 Novus. Developers also completed build-to-suits for American Express in North Phoenix and Harkins Theatres in Scottsdale. An additional 1.9 million SF is underway, and about half the space is available for lease. Construction is concentrated in Tempe and Scottsdale Airpark, high demand urban submarkets with a large and high-quality talent pool.
SALES
Phoenix has been a liquid office market benefiting from an expanding pool of buyers, though deal flow fell substantially since the onset of the pandemic. Last year, total deal volume was about half that of the previous year, even with an acceleration in investment activity in 20Q4. Well-priced assets had generally traded within six months, and buyer appetite had put upward pressure on pricing. Steady cash flows, higher yields, a moderation in new supply were attracting new buyers. Many investors who had previously written off Phoenix due to its boom and bust tendencies were taking a second look here since construction had slowed, and gradual leasing of shadow supply has helped compress vacancies below the market’s historical average.
The 113 office deals last quarter traded at an average price per SF of $282, which is above CoStar’s estimate of the average price across all assets in the market ($206/SF). The higher price reflects the quality of the basket of properties sold in 20Q4, which included a larger share of medical office properties than in previous quarters. Based on the property-level estimates, pricing in Phoenix increased 2.5% over the past year. Pricing has just recently approached the previous high. Most trades happened in the $160/SF-$240/SF price range over the past year, but a meaningful percentage of deals have traded above $320/SF.
ECONOMY
The competitive advantage and growth drivers that were stimulating growth in the Valley of the Sun may be stronger than ever. People living in dense and expensive cities have always looked to Phoenix for job opportunities and affordable living. But a rise in remote work will entice more people to move to Phoenix as an affordable option to California or East Coast markets. The market is better positioned than it was a decade ago. Population growth, a diversifying economy, relative affordability, and business-friendly regulation have strengthened the Phoenix value proposition. These characteristics are attracting more than 200 people to Phoenix each day.
Metro Phoenix is home to the largest public and private universities in the country: Arizona State University (ASU) and Grand Canyon University (GCU). ASU enrollment surpassed 127,000 students in fall 2020, spread across five campuses, and including online students.
Thanks to the extensive labor pool, businesses are selecting Phoenix to expand their operations. Some employers have announced expansions since the pandemic. Amazon opened 11 last-mile and fulfillment sites last year throughout the metro and leased a 95,000-SF office in Tempe, which will generate thousands of new jobs. Zoom, the California-based video conferencing company, revealed plans to open a Phoenix research and development center. TSMC made headlines for its commitment to bring more than 1,600 jobs to the state with a $12 billion semiconductor factory. Other companies that have added hundreds of new jobs over the past few years include Allstate, Deloitte, DoorDash, OpenDoor, Silicon Valley Bank, Choice Hotels, Mayo Clinic, Wells Fargo, Farmers Insurance, and USAA. Microsoft, Google, and Apple have also invested in data centers throughout the metro. While labor is the primary driver behind the market’s business attraction success, relative affordability helps tip the scale in favor of Phoenix when companies make their site selection decision.
The number of companies expanding to metro Phoenix is noteworthy, but the diversity of industries has helped sustain the region’s long-term stability. More than a decade ago, Phoenix was synonymous with cheap labor and land that attracted call centers and back-office operators. Moreover, the economy depended on industries associated with household growth—construction, lending, brokerage, tile and cabinet manufacturers, etc. Because of its past reliance on housing, Phoenix was among the hardest-hit markets during the Great Recession; the market lost more than 300,000 jobs, 25% of which were in the construction industry alone.
As the office market struggles to regain its strength, it is important to remember that there are many companies out there looking for space to grow and expand. If you’d like more information about the office market or any other commercial investment market, please do not hesitate to contact me.
Source: CoStar
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