The office market is not ready to “give up” yet as we move forward through 2021. The pandemic may have taken a toll on the office environment, but it is proving strong as it pushes forward to say, “I’m coming out!”
The removal of COVID-19 restrictions on Arizona businesses and a rise in vaccinations have encouraged
employers to welcome employees back to the office, contributing to a perception the market is returning to normal. The feeling is welcome given that the pandemic disrupted Phoenix’s consistently positive performance.
Decision-makers have become more comfortable making long-term leasing decisions again, and quarterly
leasing volume returned to near pre-pandemic activity in 21Q2. Simultaneously, some tenants who found their remote workers performed well during the pandemic will stay fully remote or shift to a hybrid work schedule. These tenants are relinquishing unused office space, and as a result, sublease availabilities have surged to a record high. The concurrent rise in leasing activity and sublease availabilities indicates there is no one-size fits-all solution for businesses operating post-pandemic. There is still a great degree of uncertainty about the pandemic’s long-term effect on office space use.
Despite the lackluster performance over the past several quarters, developers are still betting on Phoenix. A few speculative office projects have broken ground since the onset of the pandemic. New supply is expected to outpace demand in the near term, putting further upward pressure on vacancies.
Leasing activity has picked up since falling to a low in 20Q2 and is approaching pre-pandemic levels. Tenants penned about 2.1 million SF in leases during 21Q2, which is up 65% from the same period last year. Carvana signed one of the largest leases during the quarter. The online car company committed to 52,000 SF at Rio West in Tempe. Some of the largest leases in recent quarters have come from California-based firms that set up operations in Tempe. Align Technology committed to 33,980 SF at the Watermark in Tempe in January. The location will serve as the San Jose-based company’s new global corporate headquarters when it occupies the space in 21Q2. Within the same building, Menlo Park-based Robinhood signed a 34,000-SF lease in January.
Following a long stretch of rent growth, rents edged down for a second consecutive quarter. Rents fell by
-0.7% year over year in 21Q2, which is still better than the national average of -1.5%.
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.
Marketwide, 2.0 million SF is under construction and about 66% of 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.
One of the most recent projects to break ground is Mortenson’s The Beam on Farmer in Tempe. Construction on the 184,000-SF speculative office building started in April after the project was delayed one year due to the pandemic. The developer believes the building’s healthy features, including an under-floor air distribution system and touchless features, will attract tenants. The building is slated to deliver in 22Q2.
Rising confidence in the market has contributed to an increase in Phoenix investment activity over the past several months. Transaction volume in the first half of 2021 was on pace with 2019’s activity.
Private and institutional investors have targeted single tenant properties net leased by strong credit tenants that offer stable cash flows and entail limited managerial oversight. In May, Phoenix-based Silver Creek Development purchased a newly completed 120,000-SF office building in Gilbert from the developer for $43 million. The single-tenant office building is fully leased to Northrop Grumman Space Systems under a 10-year triple net lease that began in November. The same buyer also purchased a single tenant building in Chandler for $34.2 million ($262/SF) at a 6.7% cap rate in June. The property was constructed in 2016 and was fully occupied by Zovio, a for-profit education services company.
SALES PAST 12 MONTHS
Numerous employers have announced expansions and relocations 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 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.
Phoenix recovered from the Great Recession about two years after the U.S. The companies that Phoenix is attracting have evolved. The market has emerged as a bustling technology and financial hub. This diversification of industry is what has helped Phoenix perform best among its peers.
Numerous reports have stated that the office market is beginning to take a turn for the better as employees return to their offices. I guess “You Can’t Hurry Love” or employees to their offices. 😊 Our hope is that this trend continues, and the office market begins to boom again. “Ain’t No Mountain High Enough”
If you have any questions about the office market or the current economy, please do not hesitate to contact us.
Your Team: Craig Trbovich & Niki Saunders