Many office tenants have become more comfortable locking in long-term leases in the past year, and
quarterly leasing volume returned to pre-pandemic levels. Simultaneously, some tenants who found their remote workers performed well during the pandemic will continue to allow various forms of home-based work. 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 and the headwind effect to follow.
Development has slowed in the past 18 months, partly due to the uncertainty of office demand moving forward. The amount of office space under construction is at its lowest level since 2017, reducing supply-side risk in the near term.
The Phoenix office market fundamentals are facing headwinds not last seen since the Great Recession.
Vacancies rose by more than 100 basis points during the year, driven by an additional 1.7 million SF of sublet availabilities coming on market. However, several indicators give reason for optimism. After five consecutive quarters of negative absorption, Phoenix rebounded with nearly 1 million SF of positive absorption in 21Q4. Leasing activity has also picked up in recent months and mirrors pre-pandemic levels.
Over the past year, several of the largest occupiers in the market have rightsized or shifted to new buildings, leaving behind vacant space. In 21Q1, Nationwide vacated 250,000 SF across two offices in Central Scottsdale and occupied 282,500 SF at a newly completed office in North Scottsdale. Initially, Nationwide planned to take the entirety of the 460,000-SF building, but its plans changed due to the pandemic. In 21Q2, Cognizant vacated 140,000 SF at Canyon Corporate Plaza in Northwest Phoenix. Earlier in the year, the health care services IT provider moved into 87,000 SF at a newly delivered building in North Phoenix.
Despite the ongoing slow recovery in Phoenix’s office market, rents have rebounded stronger than many major metros. Annual rent growth currently registers at 3.4%, compared to the national average of 0.8%.
Despite 32 quarters of rent gains, 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 likely continue to attract tenants looking to relocate or expand operations in the western part of the United States without paying exorbitant rents in coastal markets.
Market-wide, 1.8 million SF is under construction and about half of the space is available for lease. Construction is concentrated in Tempe and the West Valley.
Construction is progressing on 100 Mill Avenue, a 5 Star office tower located in the heart of Downtown Tempe. Hines is the developer behind the 287,000-SF high-rise that is scheduled for completion in mid-2022. The office is 60% leased to multiple tenants, including Amazon and Deloitte, and has the highest asking rents in the market at $50/SF.
In early 2021, RED Development started construction on two speculative office buildings at The Grove, a mixed- use office project at 44th Street and Camelback Road. Sendoso committed to 60,000 SF and Banner Health signed for 70,000 SF. In addition to the 263,770 SF of office space, the project includes the new Phoenix Suns training facility. Future phases will include retail space and a hotel.
Lastly, Douglas Allred recently finished construction on two spec office buildings at Allred Park Place Central in Chandler. The two buildings total 300,000 SF and were fully available for lease in December with rents listed at $27/SF NNN. The developer has successfully lured prominent tenants to its other offices within Allred Park Place since it planted its stake in 2008.
Office investment in the Phoenix market has generally been in line with recent trends. Approximately $3.4 billion in office assets have traded here in the past 12 months, compared to the five-year annual average of $2.8 billion. At $230 per SF, pricing remains well below the national average of $300 per SF. Despite the rise in vacancies and sublet space, cap rates have remained relatively stable at 7.2%.
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. Silver Creek Development has been active in the market, targeting single-tenant buildings. Last May, the buyer purchased a newly completed 120,000-SF office building in Gilbert, which is occupied by Northrup Grumman from the developer for $43 million. Silver Creek 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 fully occupied by Zovio, a for-profit education services company.
Like many Tier II markets, Phoenix has garnered increased attention from national investors, though the buyer profile is relatively unchanged; private and some institutional interests drive the majority of transaction activity.
The number of companies moving to metro Phoenix is noteworthy, but the diversity of industries has helped sustain the region’s long-term stability. Phoenix was synonymous with cheap labor and land that attracted call centers and back-office operators more than a decade ago. 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. Phoenix recovered from the Great Recession about two years after the U.S. The companies that Phoenix is attracting have evolved, and the market has emerged as a bustling technology and financial hub. This diversification of industry has helped Phoenix perform best among its peers.
As the office market bounces around through the turbulent economy, companies continue to push forward with many pursuing newly built office space. We would love to help you with your investment portfolio along with any other commercial real estate needs. 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!