MARKET HIGHLIGHT, MARCH 2011

PHOENIX
Jerry McCormick, Brad Anderson, Mark Forrester and Jonathan Cowen

With all of its natural advantages plus its No. 2 ranking for those companies looking for a California alternative, is Phoenix set to rise again?

Industrial

With positive year-end net absorption, rising occupancies and flat average net asking rates last year, the metropolitan Phoenix industrial market could be the first valley sector to shake off the after-effects of the recession as it heads toward better times in 2011.

The market cruised into the new year with a 2010 year-end total of 4.45 million square feet of net absorption. Of the area’s 28 submarkets, the southwest valley submarket was almost single-handedly responsible for pushing the numbers into the black, pulling in more than 4 million of the overall 4.45 million total square feet in positive net absorption for the year. Compared to the office market, whose net absorption numbers ended the year just barely in the plus column, and the retail market, which continued to battle negative absorption, the industrial market’s performance was encouraging.

Several key factors sparked the increased activity. For one, Arizona’s growing solar energy industry is having a major impact on the market, thanks in part to the recruiting efforts of the Greater Phoenix Economic Council and state tax incentives that took effect on Jan. 1, 2010. Suntech Industries, Tower Automotive, Rioglass, Linamar, Power-One and Faist are just a few of the solar industry-related firms and supply-chain companies that announced plans to open manufacturing operations in the Sky Harbor Airport area and southwest Phoenix last year, taking down more than 1 million square feet of industrial space in the process.

Second, the southwest valley warehouse and distribution market received a big boost from users seeking to relocate a business from California or looking for a nearby home base outside the state from which to utilize port shipping. According to industry data, Arizona is the No. 2 choice in the nation behind Texas for companies seeking a California alternative.

Early indicators point to a year poised to build on the successes of 2010. The vacancy rate, which dropped to 14.7 percent from 16.3 percent in 2010, hopefully will continue its downward slide into 13 percent territory. The southwest Valley submarket will lead absorption once again, and new construction, while restrained, could return to the Valley of the Sun to answer growing user demand for large warehouse and distribution buildings.

— Jerry McCormick is a senior vice president at CB Richard Ellis in Phoenix.

Office

Positive net absorption, absent for the past 2 years, made a comeback in the metro Phoenix office market in late 2010, but continued to elude all but the top property classes and submarkets as a whole. Of the 25 submarkets in metropolitan Phoenix, roughly half lost more space than they gained last year, and in the fourth quarter, only Class A properties achieved positive net absorption.

Still, the overall market’s 233,670 square feet of net absorption and 5.9 million square feet of gross absorption at year-end signal that recovery is gaining a foothold. If nothing else, the unusually high gross absorption figures, coupled with nearly 1 million square feet of Class A space absorption, indicate tenants are taking advantage of sweet move-up deals and focusing on a fight to quality.

With its abundant supply of high-end office space, Scottsdale Airpark illustrates this tendency with 500,000 square feet of positive activity last year. The area tops the list of submarkets — including Chandler, Tempe and Downtown Phoenix — that did well. Meanwhile, the north Phoenix, north downtown, Camelback Corridor and 44th Street submarkets battled net losses.

While asking rents have only fallen by 15 percent from their 2007 highs, effective net deal-making is taking place 30 to 40 percent below this level, a trend that is expected to continue this year.

Deal-making will be front and center throughout 2011, in fact, as the valley chews through 19 million square feet of vacant multi-tenant office property, including 6 million square feet of Class A space. Current data pegs the vacancy rate at 26.2 percent as of the end of 2010, but some estimates place the effective use rate closer to 35 percent across the valley due to the amount of shadow space that exists.

With the high number of attractive options tempting tenants, flight to quality will endure, placing additional pressure on the owners of Class B and C properties. Landlords will continue to bolster occupancy with concessions that include excessive tenant improvements, flexible term options, abated parking charges, free rent and no expense stops.

Despite the high vacancy rate, the Valley of the Sun’s supply of large blocks of space likely will be diminished by year’s end, leading to the return of build-to-suits and possibly even speculative construction.

— Brad Anderson is executive vice president at CB Richard Ellis in Phoenix. 

Multifamily

The Phoenix apartment market is recovering, although the pace of recovery reflects a tale of two cities: Class A assets are seeing occupancy improvement, while troubled/REO assets are exhibiting considerable stress.

Overall, vacancy for the metro area is around 10 percent, but certain areas are well below this mark, and other sectors are in the high teens or exceeding 20 percent. Concessions are prominent, but better locations are seeing modest increases in effective rents. Chandler, Tempe/Scottsdale, newer infill areas and assets near the city’s new transportation systems are improving the most.

Little new construction is anticipated for the near term — perhaps 1,000 units in 2011 — an important ingredient for a recovery. Developers are sparse with one exception: Alliance Residential, which in a joint venture with AEW Capital Management LP, is about to break ground on a 270-unit infill project near the Arizona Biltmore/Biltmore Fashion Park.

Job growth is re-emerging, though at a modest pace as 33,000 jobs were added during the past year. This trend, together with continued population growth, should help Phoenix recover. Buyers and investors are quite optimistic. Investment sales picked up in 2010 — metro Phoenix saw 77 sales in the 100+ units range, compared with 33 in 2009 and 18 in 2008. Many buyers are looking here — predominantly private capital, except for institutional interest for high-quality infill projects. Cap rates should hold in the 5 percent range for Class A assets and 6.5 to 7 percent for Class B, assuming that no big spike in interest rates appears. Lower quality assets with high vacancy and little if any NOI are selling in the $20,000s per unit (or less if a master-metered community and/or in poor physical condition) on a price-per-pound basis.

Phoenix still has single-family issues, but the key in the long run will be the rebound in job growth. Single-family permits in 2010 registered 7,500, down from annual totals averaging 30,000 to 60,000 units from 2004 to 2007.

In short, Phoenix is on the radar screen for many owners and developers. The rental market is poised for a recovery. Smart investors will “set the table” with investments as attractive opportunities now arise, but will also need to prepare for a choppy recovery. Five to 7 years from now, the market should be strong, but the rebound could be uneven.

— Mark Forrester is a senior partner in Hendricks & Partners’ Phoenix office.

Retail

Everyone involved in Phoenix’s retail real estate market is finally feeling cautious optimism as 2011 gets a full head of steam. The mood among everyone, from brokers to owners to tenants, is one of “maybe there is a light at the end of the tunnel,” instead of the gloom and doom experienced the past 2 to 3 years. Perhaps the best sign is the positive absorption, albeit small, seen in the 4th quarter 2010. Rental rates across the Valley of the Sun seem to have bottomed out and stabilized. Deals that are being done are still tenant-driven as this is still one of the strongest tenant markets Phoenix has seen in 20 years.

Investors are still looking at mostly price-per-square-foot deals, with only the highest quality real estate actually being traded on a cap-rate basis. The trend among investors and developers is to find quality infill projects for value-add or potentially redevelopment purposes. The challenge most have is the amount of capital looking for deals and the lack of supply currently in the market.

Tenants are finally starting to look at the Phoenix market as a potential expansion market. Winco Foods is expanding their 95,000-square-foot grocery operation w/ three to five initial stores with more to come in future years. Jimmy John’s, SmashBurger, Café Rio and Café Zupas, to name a few, are also are expanding into the market.

As it relates to new retail development, there won’t be any unless it’s specifically for a tenant and user-driven. Phoenix’s market needs to see job growth, decline in vacancy rates and a rise in rental rates before any significant new development will happen.

But the good news now seems to be the optimism that everything will improve in 2011 and in the years to follow. Time will only tell but it seems that the worst is behind us.

— Jonathan Cowen is senior director, Retail Advisory Group, for Cushman & Wakefield of Arizona in Phoenix.

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