MARKET HIGHLIGHT, MAY 2009

PHOENIX
Kevin Schuck, John Rehling, David Carder, Luke Walker, John Werstler and Tyler Anderson

Phoenix real estate players are rising to meet new economic realities. Despite the present challenges, plenty of opportunities still exist, whether it’s a tenant looking for favorable lease terms or well-capitalized investors searching for bargains.

Retail

Clouds may be gathering over Phoenix’s traditionally sunny retail market, but bright spots still exist, especially for well-capitalized investors looking for bargain buys.

The market wrapped up 2008 with a respectable 7.95 percent vacancy rate for all retail product, excluding regional malls. But the continued drag created by ongoing job losses, credit shortages, housing foreclosures and falling consumer confidence — not to mention the impact of major retailers shuttering multiple locations throughout the region — is expected to push vacancies this year into the double digits for the first time since 1993.

In addition to heading into 2009 with nearly 6.8 million square feet of big box space up for grabs — compared to 3.9 million square feet at year-end 2007 — roughly 2 million square feet of new space is presently under construction with another 3 to 4 million square feet moving from under construction to planned or delayed. With fewer anchors and shopkeepers in a position to take on new commitments, developers are attempting to combat future losses by downsizing their former appetite for super-sized projects.  Moving forward, look for smaller developments, both in size and scope, to replace the mammoth power centers of years past.

Meanwhile, market conditions continue to put downward pressure on both absorption and lease rates. At the end of 2008, gross activity totaled 8.7 million square feet, compared to 14.5 million square feet the year prior.

Tenants are seeking to draw landlords into a dance step akin to the leasing limbo, with tenants asking the question, “How low can you go?” While some landlords have responded to present conditions by preemptively lowering rents by 25 percent and holding steady, others are preferring to let the market dictate. Overall, rents for shop space are down by 20 to 25 percent, entering 2009 at an average of $19.68 per square foot.

Concessions, ranging from free rent to tenant improvement allowances, are dramatically increasing in the market and are expected to persist as landlords attempt to attract new tenants and retain the ones they already have.

On the investment front, the news is a mixed bag, depending on the presence of available capital. While credit remains tight, those with access to funds are finding it an opportune time to take advantage of significant bargains among single-property and portfolio bank notes, which investors are snapping up in some cases for cents on the dollar based on the integrity of the loan. Other investors sit patiently on the sidelines, waiting for the best opportunity to dive back in.

Not surprisingly, most new development is on hold until economic conditions improve. However, a handful of key already-in-progress projects are on track to come on line this year, including Glimcher Realty Trust’s Scottsdale Quarter, a $270 million mixed-use development that features a host of new-to-market retailers set among 400,000 square feet of shop space.

Looking to the future, developers, investors and tenants continue to keep an eye on the housing, credit and job markets, which experts say will experience little change heading into summer. 

— Kevin Schuck and John Rehling are retail market experts in the Phoenix office of CB Richard Ellis.

Office

During the past 10 years, Phoenix has led the country in terms of real job growth, adding more than 500,000 net new jobs. But with the loss of more than 27,000 jobs in 2008 and economists’ forecasts of nearly double that amount this year, the Valley of the Sun’s office market understandably is feeling the pinch.

Though metro Phoenix’s market fundamentals — business-friendly government policies, outstanding weather and low cost of living — remain strong, the area is suffering from the effect of oversupply and negative net absorption. Developers are responding by effectively halting all new speculative construction and many are downsizing staffs. Meanwhile, landlords, keenly aware of stiff competition from other building owners, are scrambling to secure early renewals from existing tenants or attract new tenants by shopping deeply discounted lease rates.

Savvy tenants will look at reducing occupancy costs by offering landlords a “blend-and-extend” proposal. Blend and extend simply means renewing the tenant’s lease by lowering the lease rate and/or reducing the premises’ square footage, while extending the existing lease term. Concessions, including free rent, larger commissions and moving allowances, are expected to remain until equilibrium returns.

Well-capitalized opportunistic investors will continue to leave the sidelines to join the hunt for distressed assets for sale at steep discounts. Even so, investment sales activity overall will continue to be restricted by upside-down capital markets, potential credit risk among tenants, the ongoing buyer/seller pricing disconnect and the market’s attempt to establish a new baseline for cap rates on leased product.

Despite the slowdown, the valley remains a popular choice for companies, especially from California, looking to set up regional and national headquarters operations in a business-friendly environment. Active and expanding industries include energy, health care, education and technology.

— David Carder and Luke Walker, senior vice presidents, are office properties specialists in the Phoenix office of CB Richard Ellis.

Industrial

Without question, metropolitan Phoenix’s industrial market is experiencing the effects of a local and national economic slowdown. However, certain market segments and areas are performing better than others.

The Sky Harbor Airport submarket will continue to be the best performing market, with a vacancy rate of 8.2 percent, while the southwest Phoenix market will be the most challenging, with vacancy at 17 percent. Speculative developers will be out of the market for at least 3 years, and new construction activity will be based on build-to-suit projects.

As with the rest of the valley’s commercial real estate sectors, lack of absorption continues to be an issue for industrial landlords and developers. Last year, the market’s 265 million-square-foot base experienced a net absorption of approximately 650,000 square feet, marking the lowest rate in recent history. While 2008 drew to a close with little leasing or sales activity, the first part of 2009 shows an encouraging up-tick in interest. Business sectors that have shown recent activity include alternative energy-related companies, consumer-oriented food businesses and data centers.

Market conditions, not surprisingly, have put downward pressure on rental rates, which have slipped 10 to 30 percent from last summer depending on product type. In addition to rental rate reductions, landlords are also having to include free rent concessions in current deals.

The market’s performance in 2009 will be contingent upon how quickly the local and national economies stabilize and confidence returns to the market. If the economy stabilizes, look for a net absorption on par with 2008’s 650,000 square feet.  Meanwhile, trouble in the credit markets will continue to impact investors who, by and large, will be shopping for distressed properties. 

— John Werstler, a senior vice president, is an industrial properties specialist in the Phoenix office of CB Richard Ellis.

Multifamily

If there’s any good news to be had in today’s challenging economic climate, perhaps it’s that now is an opportune time to be an apartment investor in metropolitan Phoenix.

While the credit crunch has undeniably put a dent in sales activity — the difference between $52 million so far this year compared to $600 million for all of 2008 and $3.5 billion during 2007 — interest from well-capitalized private investors hunting for bargains among the rising selection of lender-owned properties for sale may provide a boost moving forward.

The number of distressed properties has crept into the double digits since early 2009. Offerings in good locations, where the pricing reflects the market correction, can easily garner 15 to 20 offers, on par with bidding activity occurring even during the best of economic times. Active investors are primarily individuals and private capital sources searching for positive leverage and high returns. Meanwhile, REITs and advisors looking to firm up balance sheets, developers needing to pay off maturing construction loans, and lenders hoping to unload distressed properties make up the bulk of sellers.

Another piece of good news: tighter lending requirements, coupled with a downturn in population and job growth, have effectively put the brakes on new development. The addition of just 6,000 to 6,500 new units in 2009 and less than 1,500 units in 2010 should aid a strong market recovery. Future development will be concentrated inside the Loop 101 and in infill locations close to employment centers and transportation corridors.

Overall, Phoenix’s 88 percent multifamily occupancy is down slightly from 90 percent in 2008. Concessions, averaging 1 to 2 months free rent, have pushed the effective economic rate closer to 80 percent.

In the near term, renters will enjoy lower rental rates, however concessions will disappear as the single-family market improves and employment growth returns. The significant slowdown in multifamily construction will ultimately result in a shortage of multifamily rentals. Sales will increase in the second half of 2009, as lenders dispose of assets and pricing adjusts to the current investor expectations.

— Tyler Anderson is a vice chairman and multifamily specialist in the Phoenix office of CB Richard Ellis.

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