MARKET HIGHLIGHT, APRIL 2005

PHOENIX: THE SUN ALSO RISES
Brad Goff, Jeff Harris and Steve McEndry

Growth and expansion are the buzz words in the Phoenix market as increasing job and population figures have the retail sector humming along and multifamily perking up.  The industrial sector is outpacing office, but both are correcting for an oversupply of product the past few years.

Multifamily

With low unemployment stemming from the 60,000 new jobs created in 2004, higher interest rates and a continued migration of people into Phoenix (140,000 last year), the multifamily market is experiencing a modest recovery. The greatest indicator of this recovery is the reduction in rental concessions, which is the most significant change in market trends to date. In the past 3 years, concessions have been the driving factor luring residents to move to other properties. Yet, with declining vacancies, owners and managers feel more confident about decreasing these concessions.

Currently, Phoenix’s multifamily vacancy is approximately 9 percent, marking a significant improvement compared to the past several quarters when vacancy rates were in the double digits. Asking rents have only increased $7 in the past 12 months, but rental rate gains should continue to follow an upward trend.

North Scottsdale remains the hottest submarket in Phoenix as several apartment properties have recently been converted to condos or acquired by condo converters. Price per unit in this submarket has increased to the $100,000 range, even for older apartment properties. This is caused by the housing gap between apartment dwellings and the average price of a single-family home in the area.

Development should increase in 2005, with 3,631 new apartments expected to be added to the Phoenix market. One of the hottest spots is the Southwest Valley, an area that remained relatively dormant during Phoenix’s rapid expansion during the past 10 years. The Southwest Valley has been the benefactor of recent growth with several master-planned communities and amenities driving a disproportionate amount of development to the area.

During fourth quarter 2004, 44 properties consisting of 100 units or more traded in Phoenix. The sales of these properties averaged $54,795 per unit and $72.39 per square foot, marking a significant decrease from third quarter 2004 when sales averaged more than $67,890 per unit and $77.51 per square foot. This decrease in price is largely due to the age of the properties sold in the fourth quarter, which had an average build date of 1985, compared to third quarter’s average build date of 1989.

Cap rates in Phoenix have compressed significantly. All Class A quality apartments are trading in the 5 percent cap rate range with the most desirable properties trading sub-5 percent. Class B quality properties are not trading much higher with 5 to 6 percent cap rates.

Overall, the multifamily investment market should remain strong. Currently there are many more buyers than there are desirable apartment properties. As the Phoenix apartment market continues to strengthen, the perception it is recovering will become even more solidified, causing more investors to flock towards this growing sector. 

— Brad Goff is a principal at Apartment Realty Advisors.

Retail

In 2004, the Phoenix metropolitan area continued its trend of extraordinary growth with all signs indicating a strong, if not stronger, 2005. The catalysts for this tremendous growth are the affordability of housing in comparison to other western cities, low interest rates, a rapidly expanding freeway system and, of course, great weather.

Last year, the Valley of the Sun posted a record number of new home permits, outpacing the previous record set in 2003 by 30.7 percent and positioning the Phoenix market just ahead of Atlanta, which had recently held the nation’s top spot for most new home permits issued annually. This tremendous growth spurt is projected to continue over the next 10 years with an average of more than 50,000 new home starts annually. It is also estimated that the population of the Phoenix market will double by 2030.

Maricopa County boasts three of the top five fastest growing cities in the nation from 2002 to 2004 (for cities exceeding 100,000 in population) and is the country’s third most populous county overall. Gilbert, the fastest growing city, increased its numbers by 23 percent, to a total of 135,000. Rounding out the top five fastest growing cities were North Las Vegas and Henderson in Nevada, followed by Chandler and Peoria, both in the greater Phoenix metro area. Phoenix passed Philadelphia in 2004  to become the fifth largest city and is currently the thirteenth largest metropolitan area in the U.S.

With numbers like these, retail tenants, investors and developers continue to have a bullish outlook when it comes to Arizona. This is supported by the staggering number of new commercial projects planned, under construction or recently completed. National tenants continue to expand into the market with drug stores, home improvement retailers and clothiers leading the way.

According to CB Richard Ellis’ fourth quarter 2004 MarketView Phoenix Retail report, the retail sector had a positive posting of numbers in 2004. The vacancy rate decreased for the sixth consecutive quarter to 6.05 percent. Net absorption for the year totaled 6.7 million square feet, passing the 5 million square feet mark for the first time since 2001, when the market absorbed 5.5 million square feet. At year’s end, there was 6.2 million square feet of new product under construction in the Valley.

Moving forward, vacancy in 2005 will be below 6 percent, and net absorption will exceed 5 million square feet in 2005 and 2006. New construction completions will surpass 6 million square feet, with anchor retail centers continuing to be the No. 1 choice for investors. Rental rates for shop space in newer shopping centers will remain stable between $22 and $28 per square foot.

— Jeff Harris is a retail specialist for Retail Brokers Inc. in Phoenix.

Office

The Phoenix office market continues to experience an over-supply of available space, with vacancy hovering around 19 percent in 2004. The over-abundance of space has not come as a result of less demand, but rather the torrid pace of new development during the past 5 years. Since 1999, the market has delivered approximately 20 million square feet of new office space to its base inventory, which represents nearly a 30 percent increase in the total market size. This high volume of new development has pushed vacancy levels from 10 to 19 percent during this period, despite 6 consecutive years of positive net absorption gains, totaling nearly 10 million square feet since 1999. During 2004, the market posted strong growth levels, gaining 1.6 million square feet of occupied space, but new construction totaled 2.5 million square feet.

Average rents in the market remained relatively unchanged for the year, after seeing modest declines in both 2002 and 2003. The leasing market has begun to see increased activity levels in recent months, including The Capital Group Companies signing a 7-year, 110,000-square-foot lease in Scottsdale, valued at approximately $17 million. The sales market has remained very strong for both users and investors alike, as the total dollar volume sold last year reached its highest level in more than a decade. Median sales prices rose 10.7 percent during 2004, its largest increase since 1999 when median prices jumped 15 percent.

Noteworthy sales include Younan Properties expanding its Phoenix office portfolio to more than 800,000 square feet with the acquisition of 444 N. 44th Street in early January. The Class A office building totals 137,844 square feet and was purchased for approximately $20.5 million or just shy of $149 per square foot. In a multi-state acquisition, Inland Western Retail Real Estate Trust acquired a six-property, sale-leaseback portfolio from American Express for $390 million in December 2004. Two of the six properties, consisting of approximately 455,000 square feet, were located in the Phoenix market and were valued at approximately $68 million.

Construction activity will remain upbeat in 2005, as 58 buildings totaling more than 1.5 million square feet of new space were under construction at the end of 2004. The bulk of the new development has been located within the Scottsdale and East Valley submarkets, although all eight submarkets within the Phoenix office sector witnessed at least one new project during 2004. Based on projected job growth for 2005 in the office sector, net absorption should slightly outpace the expected new development in 2005, pushing vacancy levels lower by year’s end. However, the market will still need a few strong years of growth and a reduction in new construction activity to move vacancy levels back towards the low teens.

— Steve McEndry is executive vice president and principal at GVA DAUM in Phoenix.

Industrial

During 2004, the Phoenix industrial market witnessed its overall vacancy decline for the first time since 1999, moving to 11.2 percent at year’s end. New construction activity has been on a strong pace for more than 6 years, adding nearly 32 million square feet of new industrial space. This high volume of new development has kept vacancy levels in the 8 to 12 percent range during this period, despite strong net absorption gains of nearly 20 million square feet since 1999. During 2004, the market posted very strong growth levels, gaining 5.7 million square feet of occupied space, while adding 3.9 million square feet of newly delivered space.

The Phoenix-Mesa metro area is expected to see overall employment increase by 3 percent in 2005, after growing 2.7 percent during 2004. Manufacturing is expected to grow 0.9 percent after seeing declines of 5.9 percent in 2003 and 2.7 percent during 2004. Trade, transportation and utilities are expected to grow 2.4 percent in 2005. The forecasted employment growth for the market should translate into continued industrial gains in occupied space as the overall economy continues to strengthen in 2005.

Average rents in the market rose 4.2 percent for the year, after seeing modest declines in 2003 and minimal growth since 2000. The leasing market has begun to see more activity in recent months, including Le Natures Inc. signing a 500,000-square-foot lease for a new production facility, to be completed by July. The sales market has remained very strong for both users and investors alike, as the total dollar volume sold during 2004 reached its highest level in more than a decade. Median sales prices rose 12.6 percent during 2004, its largest increase since 1999, when median prices jumped 15.2 percent.

A couple of noteworthy examples include Pepsi Co. purchasing an adjacent 147,751-square-foot expansion facility from Sea Ray Boats. On the investment side, supply remains very low, and institutional investors continue to seek buying opportunities. Crown West Realty made one of 2004’s largest acquisitions, purchasing an 11-building portfolio in the Arizona Business Park for a reported $48 million. Expect price growth to soften some this year if long-term interest rates begin to rise.

Industrial development will remain active in 2005, as nearly 2.5 million square feet of new space was under construction at the end of 2004. The market should be able to outpace the expected new deliveries in 2005, which should push vacancy levels back near 10 percent by year’s end. The outlook for the Phoenix industrial market remains very positive, as market fundamentals all point towards increased growth and expansion in 2005.

— Steve McEndry is executive vice president and principal at GVA DAUM in Phoenix.

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