The Phoenix industrial market is approaching a period of transition as one of the most ambitious construction pipelines in the country begins to deliver in the coming year. A record 55.3 million SF of industrial space is currently underway, about 75% of which is being built without a tenant in place. So far, strong leasing demand across a variety of industries has absorbed the bulk of supply additions, keeping vacancies modestly above the all-time low. Moving forward, however, vacancy rates are expected to rise in 2023 as the substantial development activity outstrips new demand.
Although investors remain attracted to Phoenix’s long-term value proposition, higher interest rates and economic uncertainty have begun to weigh on sales volume. One local industrial broker described market conditions as “opaque” and that a lack of consensus on the future path of interest rate policy has widened the expectations gap between buyers and sellers, leaving the current transaction climate stalled.
However, the Fed has kept wrestling with inflation and increased rates for the tenth time in a row last week. The 0.25 percentage point escalation may be the final increase for now as the economy shows signs of finally being pinned by the Fed.
LEASING
The Phoenix industrial market started the year off strong, as leasing activity caused the metro-wide vacancy rate to compress from 4.9% at the end of 2022 to 4.4% in 23Q1. That figure leaves the market at one of the tightest levels seen in several decades, sustaining healthy property performance. The historically low vacancy rate will be tested in the coming year as one of the largest construction pipelines in the country begins to deliver. CoStar’s current baseline forecast, which includes a moderate recession in the second half of 2023, indicates new deliveries will moderately outpace space demand, causing vacancies to drift upward. This will bring Phoenix back into alignment with where it was entering the pandemic as the market enters a period of normalization.
The area’s broad range of demand drivers provides a powerful long-term tailwind for the industrial market. Not only has Phoenix established itself as a prominent link in national supply chains, but it also has tremendous momentum in terms of manufacturing. These industries were key factors underpinning the record 25.3 million SF of net industrial space that was absorbed over the past 12 months.
RENT
In the past, tight vacancies coupled with the delivery of new high-end products caused industrial rents to surge 14.6% in the past 12 months, one of the strongest rates of growth in the nation. Moving forward, however, there are several indications that rent growth has peaked as the market enters a period of normalization. Base effects are beginning to play a role as year-over-year comparisons to 2022’s elevated level can make annual rent growth figures appear softer. Additionally, the metro wide vacancy rate is poised to drift upward in the next few quarters as substantial new supply outpaces leasing activity.
Moving forward, the pace of rent growth is expected to downshift to a trajectory more in line with the recent historic average, according to the Base Case scenario. The wave of speculative deliveries in Phoenix may limit landlords’ leverage to raise rents in some areas of the Southwest Valley in the near term.
CONSTRUCTION
Phoenix industrial developers are projected to add the newest supply the market has seen in decades, with 37.0 million SF set for completion in 2023. The Valley’s rapidly growing consumer base, along with its critical role in national supply chains, has prompted a surge in construction activity for large, modern industrial parks that support users’ distribution efforts. Additionally, the high-quality labor force and business-friendly regulatory climate have made the area a top choice for advanced assembly. Several major manufacturing facilities are underway, including TSMC’s massive semiconductor campus in Deer Valley. Moving into 2024-25, the pipeline is expected to thin as new construction starts to begin to ease amid higher interest rates and more stringent lending standards for new development financing.
The surge in development activity is being met by record space demand, keeping market conditions in relative balance. In 23Q1, builders completed 4.5 million SF at the same time over 6 million SF was absorbed, causing vacancy to compress to start the year. The sizable volume of construction scheduled for the rest of 2023, much of which is being built without a tenant in place, is anticipated to moderately outstrip demand, normalizing property fundamentals.
SALES
Sales activity is easing from the record levels seen in 2021 and the first half of 2022. In the opening three months of the year, about $533 million worth of industrial assets traded hands in Phoenix, the softest first quarter result since 2019. Elevated interest rates and tighter lending standards are undoubtedly having an impact as market participants work through a period of price discovery. The lack of consensus on the economic outlook and future path of monetary policy is leading to a pricing expectations gap between buyers and sellers, stalling transaction flow.
A pick-up in investment sales could materialize if interest rates begin to stabilize and clarity returns to the market. Overall, investors remain attracted to Phoenix’s value proposition, sustaining healthy buyer demand. Double-digit rent growth, an expanding population, and tailwinds related to supply chains and advanced manufacturing support the area’s long-term outlook.
ECONOMY
The competitive advantage and growth drivers that have historically stimulated growth in the Valley of the Sun remain strong. 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 residents in California or East Coast markets to relocate. Population growth, a diversifying economy, relative affordability, and business friendly regulation have strengthened the Phoenix value proposition. These characteristics attracted an average of 175 people to the Phoenix metro each day in 2022 and made Maricopa County the fastest-growing county in the country.
An influx of residents and the market’s large educational institutions and colleges are significant contributors to the local talent pool. Metro Phoenix is home to the country’s largest public and private universities: Arizona State University (ASU) and Grand Canyon University (GCU). ASU enrollment surpassed 140,000 students in fall 2022, spread across five campuses and including online students. ASU’s primary location in Tempe is the largest, with more than 57,000 students on campus. Beyond producing new graduates, the universities collaborate with local employers on research and classroom curricula.
The first quarter closed with a strong industrial market but with the rise in interest rates, we can’t be sure it will remain that way throughout the remainder of the year. Arizona has remained one of the fastest growing states in the nation and that may hold us strong as we move forward. If you have any questions regarding the economy or commercial real estate, please do not hesitate to contact us.
Team Trbo
Source: CoStar