May 6, 2024

Q1 2024 Phoenix Industrial Market Report

A deluge of new development completions continues to drive Phoenix’s industrial vacancy rate higher, a condition that could persist into early 2025. The opening three months of the year marked the third consecutive quarter with 10+ million SF of net deliveries, bringing the total over the past 12 months to an unprecedented 39.7 million SF. For comparison, Phoenix averaged 8 million SF of annual net deliveries in the three years leading up to the onset of the pandemic.

The wave of construction overshadows a resilient demand picture. While demand has eased from the frenetic pace seen in 2021 and 2022, leasing volume is 20% above 2019 levels as occupiers related to logistics, construction, and manufacturing continue to expand. These factors, along with advanced manufacturing momentum, drove 12.0 million SF of net absorption over the past 12 months, the fourth most in the nation.

Increased competition from new supply is causing rent growth to decelerate. Average asking rents rose 9.6% over the past year, down from more than 16.0% in late 2022. Annual rent growth is forecast to slow to the lowest level in over a decade in the next 12 to 18 months as further supply additions normalize performance.

The 35.5 million million SF currently under construction, 60% of which is being built on spec, is expected to put further upward pressure on vacancies through early 2025. Looking beyond the near-term dislocation, the recent pullback in construction starts indicates that a reprieve of supply could be in store by late 2025 and 2026, setting Phoenix up for a return to tightening vacancies and an eventual re-acceleration in rent growth.

 

LEASING

The supply-driven spike in vacancy seen in the second half of 2023 has carried into 2024 as the Valley’s aggressive delivery schedule continues to overwhelm leasing activity. The industrial vacancy rate has climbed from a multi-decade low of 4.2% in early 2023 to 9.9% today, erasing the occupancy gains made during the pandemic era. Expectations are for further vacancy increases over the near term as the market grapples with a nation-leading construction pipeline and easing tenant demand.

Similar to the overall U.S., net absorption has been moderating from the breakneck pace seen during the post-pandemic demand boom. The Valley recorded 12.0 million SF of net absorption over the past 12 months, down from an average of about 24 million SF per year in 2021 and 2022. Even if demand figures were able to match those unprecedentedly strong levels, it wouldn’t be enough to absorb the 32.1 million SF scheduled for completion in 2024.

Indications from local market participants are that demand has thinned for the metro’s largest blocks of space, which is reflected in last year’s lease signings. In 2021 and 2022, Phoenix recorded 10 or more leases of over 500,000 SF each year, whereas in 2023, just four such signings occurred, and several newly built properties of that size remain available for lease. Vacant big box space is most likely to accumulate in West Valley sub-markets like Glendale and Goodyear, where large-scale speculative construction activity is most prevalent.

The area’s broad range of demand drivers provides a powerful long-term tailwind for the industrial sector. Not only has Phoenix established itself as a prominent link in national supply chains, but it also has tremendous momentum in terms of advanced manufacturing. TSMC and Intel are underway on several multi-billion dollar semiconductor plants, helping transform Phoenix into a nation-leading hub for chip-making. Estimates from government officials indicate that up to 45 other companies that supply or support these projects could relocate to the Valley as a result. For example, Amkor announced plans to build a $2 billion semiconductor packaging and testing facility in Peoria in November 2023. Additionally, several electric vehicle makers, battery producers, and solar firms have tapped Phoenix for expansion.

 

 

RENT

If occupiers sign on for larger blocks of space, they can generally achieve a discount on a per-SF basis. Big box space can fetch rents in the $8/SF to $11/SF range depending on location, building quality, lease term, and tenant credit. For example, ExxonMobil moved into a brand new 326,100-SF property in Buckeye in September 2023. The energy giant is paying $10.44/SF NNN for a five-year lease. Older vintage big box properties will generally lease for a dollar or so cheaper. In December, Tilson Technology Management signed a 103,900-SF lease to fully occupy a warehouse built in the 1970s paying $9/SF NNN in Chandler.

For smaller footprints, steady demand and a lack of construction have kept pricing power more firmly in the hands of landlords. According to one market participant, spaces smaller than 5,000 SF will usually include 4% annual increases instead of the standard 3%, and often only get one or two months of free rent at most.

Despite posting some of the strongest rent growth figures in the nation, Phoenix industrial properties remain affordable compared to many other markets, helping attract users looking to build out their distribution networks in the Southwest. Rents average $13.60/SF, which is in line with the national average and well below levels seen in most California markets

 

 

CONSTRUCTION

The Phoenix industrial market is facing one of the most aggressive construction pipelines in the nation. Developers delivered a record 23 million SF in the final two quarters of 2023, on pace with the completion total from 2017 to 2019.

The wave of supply is expected to continue over the near term with 35.5 million SF currently underway, the most of any U.S. market. That amount represents 7.7% of existing inventory, more than triple the 2.1% share for the national level. With two-thirds of development occurring without a tenant in place, the delivery of speculative buildings is expected to put further upward pressure on vacancy in the coming quarters.

The West Valley has been the primary target of new construction as developers look to capitalize on the area’s emerging role in domestic supply chains. More than half of the construction pipeline is in the Glendale, Goodyear, and Surprise sub-markets. The modernization of the Loop 303 freeway and easy access to Southern California ports of entry prompted a surge in construction for large, modern industrial parks. Four 1+ million SF properties are un-leased and underway here, including a 1.2 million SF building at Prologis 303 Business Park, which is scheduled for delivery this spring.

 

 

SALES

While sales volume is downshifting from the unprecedentedly strong pace seen in 2021 and 2022, the Phoenix industrial sector maintained its momentum better than the other main property types last year. About $2.4 billion worth of industrial assets traded hands over the past 12 months, representing a 45% decline from 2022. When compared to the pre-COVID five-year average, however, sales volume is up about 30%. The retail, multifamily, and office sectors, meanwhile, saw investment volume decline 17%, 35%, and 56%, respectively.

As borrowing costs have increased, however, properties with a more predictable income stream and limited ability to create value have become less desirable. Investor demand is now strongest for value-add deals, particularly those with in-place leases that are more than 20% below market.

Moving forward, transaction activity could begin to re-accelerate this year. Upcoming loan maturities, including over $1.7 billion in CMBS through 2025, could prompt owners to bring assets to market and harvest gains. Decelerating rent growth, however, serves as a downside risk. Explosive NOI growth was the primary driver keeping Phoenix industrial more insulated from the broader slowdown. If buyers meaningfully lower near-term rent growth projections, it could make it difficult to pencil deals, re-opening the expectations gap.

 

 

ECONOMY

Phoenix remains one of the nation’s better-performing markets for employment growth, adding 55,300 jobs in the trailing 12-month period through February 2024. The labor market now has 218,500 more jobs than before the pandemic, the third-largest gain in the nation. The local economy was highly resilient during the pandemic, thanks to a diversified employment base across a broad range of industries. Metro Phoenix lost about a quarter of a million positions in March and April 2020, but by July 2021, Phoenix fully regained those losses, nearly a full year ahead of the U.S. This marks a stark contrast to its protracted recovery from the global financial crisis when Phoenix didn’t recoup its job losses until well after the broader nation did.

Businesses select Phoenix to expand because of the extensive labor pool and favorable regulatory treatment. Numerous employers have announced expansions and relocation’s since the pandemic. Taiwan Semiconductor Manufacturing Company (TSMC) is tripling down on its commitment to Arizona. The chip-maker announced it will now build a third fab at its North Phoenix semiconductor plant, increasing its investment to $65 billion. Preliminary estimates from city economic development officials indicate the investment by TSMC could bring up to 45 additional businesses to the Valley that support and supply the plant. Additionally, Intel is underway on a $20 billion expansion at its Chandler campus, where the semiconductor giant is building two new fabs alongside its four existing ones. Microsoft, Google, and Apple have invested in data centers throughout the metro.

 

 

 

Team Trbo,

Craig Trbovich

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Source: CoStar

In the News, Phoenix Commercial Real Estate News, Uncategorized
About Craig
Craig Trbovich is a commercial real estate broker with Commercial Properties, Inc. in Scottsdale, Arizona, specializing commercial sales and landlord representation in the Phoenix Metro Area. He applies 35 years of experience as a CPA and an investor to help other owners and investors maximize their returns, bringing a strong financial and tax perspective to all aspects of commercial real estate ownership. His strengths include sales and leasing, as well as an in-depth knowledge of the development community and the local market.