May 7, 2024

Q1 2024 Phoenix Office Market Report

 

The total amount of net space absorbed since the onset of COVID has now reached over negative 4 million SF, surpassing the total occupancy loss seen during the worst of the Great Recession. Nearly half of the space givebacks occurred in the past 12 months as tepid tenant demand persists even four years after the pandemic’s start. Empty space is accumulating more quickly in larger suites and single-tenant buildings than in smaller ones.

Market participants indicate that spaces under 5,000 SF in quality buildings are still in demand and typically get more competitive as suite size shrinks. The diverging performance across building sizes reinforces this trend. The average vacancy among properties smaller than 50,000 SF has compressed 100 basis points since the onset of the pandemic, while buildings larger than 50,000 SF have seen a 910-basis-point increase. Another pocket of strength can be found in the medical office sector, which also has a lower vacancy than it did in 4Q19.

The lack of meaningful construction activity has helped avoid a more severe imbalance between supply and demand. Builders completed just 270,000 SF of net new office space over the past 12 months, the lowest four-quarter total in nearly a decade. Additionally, just 1.0 million SF is underway, representing a third of what Phoenix saw on average between 2017 and 2019. Persistent uncertainty is expected in the Phoenix office market over the midterm as higher vacancy, softer rents, and elevated sublease availability weigh on market conditions.

 

 

LEASING

Although net absorption remains starkly negative due to continued move-outs and surging vacant sublease space, actual leasing volume is far from historical figures. In the 12-month period ending in 1Q24, about 9.6 million SF was leased, lagging the average from 2015 to 2019 of 10.9 million SF per year. The most significant occupancy of 2023 was Onsemi’s 170,200-SF takeover at the former McKesson office in Central Scottsdale. The semiconductor supplier company is relocating its corporate headquarters from a pre-1960s-vintage research and design campus near McDowell Road and 52nd Street to the Scottsdale office that was built in 2018. A representative of Onsemi cited the desire for a more modern, environmentally friendly facility and better location as the reasons for the move, highlighting the preference among many office tenants for higher-quality space.

Moving forward, the leasing environment will likely remain challenging over the near term. As leases for tenants who choose not to renew come due in the next 12 to 24 months, property owners will likely be met by a less accommodating climate. The modest construction pipeline will help avoid a worsening of current fundamentals, but higher vacancy is nevertheless expected in 2024.

 

 

RENT

Smaller footprint spaces are in relatively strong demand and won’t receive the same level of discounting as large ones. For leases less than 5,000 SF, a tenant may get one to two months of free rent on a three-year term and between two and three months free for a five-year lease. For example, Creative Networks signed a five-year lease for just under 1,000 SF in October at a 2 Star office in North Phoenix. The tenant received two months of free rent at the start of the term and is paying $25/SF full service. In addition to building location and quality, tenant credit plays an important role in determining the level of discounts.

Geographically, suburban areas on the periphery of the metro have held up better than denser areas. Annual rent growth in the suburbs ended 24Q1 above 2.7%, compared to about 1.2% in the CBD. Suburban sub-markets like Arrowhead and Northwest Phoenix are among the leaders in Phoenix rent growth. The Scottsdale Airpark has also seen steady rent gains. Meanwhile, higher-density areas closer to the core, like Downtown, Midtown, the Camelback Corridor, and the 44th Street Corridor, have been lagging.

 

 

CONSTRUCTION

Construction starts have slowed considerably as developers take a more cautious approach. New groundbreakings are down 60% over the past 12 months compared to the pre-pandemic five-year average. The bulk of the current pipeline comprises smaller properties and medical office space, two market segments that have shown more resiliency. About 1.0 million SF is currently underway, representing just 0.5% of total inventory.

In the Camelback Corridor, perhaps the Valley’s most in-demand office node, renovations have become the center of construction activity. The area has an older inventory and limited land for new ground-up construction, leading many owners to upgrade existing assets. Several major office parks have been renovated over the past five years, including Camelback Center, Camelback Lakes, 24th at Camelback, Link, and Elevate 24. Renovations in the works include a $45 million investment to upgrade the Esplanade and George Oliver Companies’ $52 million renovation of Bond (formerly Biltmore Commerce Center).

The delivery schedule is expected to remain minimal, helping avoid a further imbalance between supply and demand. Standalone speculative office development is expected to remain rare. Most of the proposed projects in the pipeline are either for purpose-built offices, medical space, or mixed-use developments that feature an office component, like South Pier at Tempe Town Lake.

 

 

 

SALES

Negative NOI growth coupled with a lending climate that has become more expensive, restrictive, and cautious have created a challenging investment landscape for many office investors. As a result, sales activity is now dominated by deals at the sub-$5 million price point, often selling to private investors and owner/users, which tend to be less sensitive to higher borrowing costs. The share of total sales volume for transactions less than $5 million has climbed from about 25% in 2022 to over 40% since 2023.

The medical office sector stands out as a bright spot in the tattered office sector, with its comparatively sturdy operations. While many buyers of traditional office properties are bargain hunters, medical office investors are more likely to purchase assets based on in-place income and steady NOI growth rather than value-add opportunities.

 

 

ECONOMY

Phoenix remains one of the nation’s best-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 relocations since the pandemic. Taiwan Semiconductor Manufacturing Company (TSMC) is tripling down on its commitment to Arizona. The chipmaker announced it will build a third fabrication facility 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. For example, Amkor announced plans to build a $2 billion advanced semiconductor packaging and testing facility near TSMC, bringing roughly 2,000 jobs to the Valley. 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

View the Full Report Here

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.