As more and more people begin to work in hybrid mode; part time in office and part time from home, office spaces are starting to come alive again. The need for greater space between coworkers has given way to some companies wanting larger environments, giving the market a well needed boost of activity. While it hasn’t returned to its full potential, the office market is holding strong and should be pushing forward through the coming months ahead, and that would be great.
The increase in available space has created favorable conditions for tenants. Rents have contracted for two consecutive quarters, and current conditions will limit the ability of landlords to increase rents in the near term. Discounted rents and higher vacancies have created opportunities for tenants who couldn’t find space or were previously priced out of highly desirable submarkets like Tempe and Scottsdale. Several California-based companies have penned new leases since the pandemic, including Robinhood, Align Technology, and PennyMac.
The Phoenix office market has recorded its weakest performance in the first three quarters of 2021 since the Great Recession; however, a few indicators are boosting optimism. Leasing activity has picked up in recent months, but that has occurred alongside a rise in sublease availabilities. The difference in operation strategies among office occupiers, post-pandemic has contributed to mixed demand.
Available sublease space increased from 1.7 million SF IN 19Q4 to 4.9 million SF. One of the largest sublet space availabilities, USAA’s Norterra building (149,210 SF) in North Phoenix, has been available since 20Q2. Meanwhile, International Cruise & Excursions 150,000 SF sublease didn’t sit vacant for long. JFQ, a Scottsdale based mortgage lender, subleased 125,000-SF in the building in 21Q1. Other large sublease availabilities include First Solar’s Tempe HQ (80,000 SF), Synchrony Financial’s office in the Airport Area (68,000 SF), and Voya Financial (50,000 SF), and Paypal (47,200 SF) in Chandler. The rise in sublease space has created favorable conditions for tenants who were previously priced out of high-demand submarkets since the space is offered at a discount. Much of this space will likely weigh on the market in the near-term.
Unfavorable rent pressures will persist over the next several quarters, according to CoStar’s Base Case scenario, due to a rise in direct availabilities and sublease space. Sublease spaces are offered at a 10%- 30% discount to direct space throughout the market. The discount varies by star rating, location, and lessor motivation. Downtown Phoenix offers some of the highest discounts due to its more than 20% availability rate. At One North Central, sublet space was discounted from $34/SF to $24/SF. In Scottsdale and Tempe, sublease space is generally between a 10% and 20% markdown. MUFG Union Bank listed 42,000 SF for sublease in Tempe for $24/SF, compared to a direct lease at $32.50/SF. Endurance International Group listed 139,000 SF for sublease at Papago Buttes Corporate Plaza in Tempe for $27/SF while direct leases in the building are listed at $30/SF.
Despite a steady stream of new office deliveries since 2015, the pace of completions has moderated from the building boom in the early 2000s. From 2000–08, the market’s stock grew by an average of 6.2 million SF each year, but the annual level has slowed to 2.0 million SF over the past five years.
In Goodyear, Globe Corporation started construction on Goodyear City Hall and a 100,000-SF speculative office project in 21Q2. Class A Spec office development is limited in the West Valley, and the space will provide tenants with new options in the region.
DPC Development is nearing completion on the Scottsdale Entrada in South Scottsdale. The spec development is located at a vacant lot in an Opportunity Zone and will include 245,000 SF of office, apartments, and retail space. The project is expected to deliver in 22Q1 and was fully available for lease in August. Rents are marketed at $38/SF FSG.
Phoenix has garnered increased attention from national investors, though the buyer profile is relatively unchanged; private and some institutional interests drive the majority of the transaction activity. Foreign investment, particularly from Canada and Asia, has picked up in recent years but still represents a small slice of the market. In August, Australian financial services firm Macquarie Asset Management acquired the CASA office building in Phoenix from the developer, George Oliver, for $56.5 million ($312/SF). The building was constructed in 1990 and was renovated in 2019. At the time of sale, CASA was fully leased.
The 285 office deals last quarter traded at an average price per SF of $197, which is below CoStar’s estimate of the average price across all assets in the market ($209/SF). The lower sales price may reflect some type of pandemic-related discount; there was a -5% difference in the sales versus the asking price during the quarter. Pricing has just recently approached the previous high. Most trades happened in the $160/SF-$240/SF price range over the past 12 months, but a meaningful percentage of deals have traded above $280/SF.
According to The Milken Institute, Phoenix is now a Tier I city. Milken considers 401 metropolitan statistical areas (MSAs) across the US when ranking city performance and computing the index.
Phoenix has maintained its place among the best-performing markets for job growth. The local economy has been one of the most resilient around the country during the pandemic and has added jobs at a much faster clip than many markets of its size. The market lost about 243,000 jobs in March and April of last year. By June 2021, the market recovered about 78% of those job losses. Phoenix is still on the road to recovery, and the baseline forecast anticipates that employment will return to pre-pandemic levels by the end of 2021.
The competitive advantage and growth drivers that have historically stimulated growth in the Valley of the Sun may be stronger than ever. Affordability and job prospects are attracting people living in dense and expensive cities to Phoenix. The adoption of remote work has given more people mobility and has enticed more people in California or East Coast markets to move to Phoenix. Population growth, a diversifying economy, relative affordability, and business-friendly regulation have strengthened the Phoenix value proposition. These characteristics are attracting more than 220 people to Phoenix each day.
Although the office market has greatly suffered through the pandemic changes, it appears that with the population growth and people returning to their offices, the market is coming back as we move ahead, AND THAT WOULD BE GREAT! If you have any questions about the office market or any other commercial real estate inquiries, please do not hesitate to contact us.
Thank you from Team Trbo!