WESTERN SNAPSHOT, NOVEMBER 2006

Tucson, Arizona, Retail Market

The Tucson economy continues to add jobs primarily from smaller employers, while its retail investment sales market continues to show persistence despite a flattening national economy. Although many perceive Tucson as a small-sized city, there are approximately 925,000 people residing in the metro area. A majority of the new development is occurring north of the city toward Phoenix, particularly in the submarkets of Oro Valley and Marana. Simultaneously, new development is sprouting up south of Phoenix. According to one Phoenix-based economist, 30 years from now, the two metro areas will eventually connect, thus becoming one sprawling metropolis.

New construction in Tucson has been matched with solid job growth, particularly in the healthcare and education sectors. Consequently, retail vacancy remained flat during the first half of the year but has started to tighten. Rents will start to rise, and concessions will begin to burn off as effective rents climb at a faster rate than asking rents. Retail construction has continued to increase in the past few years. However, construction is likely to level off due to the stagnant national economy. Most of the retail development to come will be part of mixed-use properties consisting of multifamily and office components.

As construction in the Tucson metro area begins to slow, vacancy will drop and asking rents will rise as retailers compete for limited space. By year’s end, Tucson’s retail vacancy rate is expected to drop 50 basis points to 8.6 percent, with the northeast submarket boasting the lowest vacancy rate (4.9 percent) in the metro area. Asking rents are forecast to increase 3.6 percent to $17.08 per square foot.

All types of property investors, not just retail ones, are attracted to Tucson because the metro area offers opportunities for better returns than most other western markets. However, the city is still close enough to Phoenix to provide some investors with a sense of stability. In addition, cap rates, currently hovering in the 7-percent range, remain reasonable compared to those of other western cities.

Both retail transaction velocity and total dollar volume continue to rise. Growth in the next 12 months is expected to outpace the preceding 12-month period. In 2005, there were 81 retail property transactions priced at $500,000 or more for a total of $145 million in volume, and there were 30 single-tenant property sales totaling $117 million in volume. This year, there has been a shift among investors toward multi-tenant properties. It won’t be a surprise for area brokerage firms to close slightly more multi-tenant transactions than single-tenant sales.

A growing number of retail investors in the Tucson marketplace hail from California, although local players still dominate. Breaking it down by property type, 58 percent of the multi-tenant property buyers are in state, while 29 percent of the buyers are from California. As for the single-tenant market, 59 percent are in-state buyers, while 25 percent come from California.

Is Tucson a Mini Phoenix?

Separated by only 90 miles, it’s not surprising that Tucson and Phoenix have a number of similarities, although Phoenix has a larger population and job base. Phoenix and Tucson stand out from other western markets because they boast the most affordable single-family housing markets in the West. Compared to other cities in the West with a metro area population of close to 1 million, Tucson tops the list in terms of housing affordability. Not only are their economic growth and development patterns similar, but Tucson also mirrors Phoenix in terms of investment sales trends. Much like its neighbor to the north, a healthy amount of out-of-state capital is attracted to Tucson commercial real estate.

Strengthening in 2007

The Tucson retail investment market will continue to improve in 2007. Expect healthy rental-rate increases and improving vacancy in the short term. Strong retail demand and moderate new construction will keep market fundamentals in balance. In fact, early estimates suggest that vacancy could retreat to the low 7-percent range by year-end 2007. Investor interest for retail properties in the metro area will remain strong due to Tucson’s relative affordability compared to other western cities.

David Wetta is the senior vice president and regional manager of Marcus & Millichap’s Tucson office.

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