MARKET HIGHLIGHT, OCTOBER 2005

PURE GROWTH, NO TRICKS IN PHOENIX
Laura Becker, Skip Corley, Jeff Alba and Neil Sherman

Growth is the buzzword in metropolitan Phoenix as real estate players expand right along with the population and job numbers. Like an Arizona summer, hot opportunities have come from the resulting real estate demand that spans most area submarkets and property types.

Office

A hearty combination of new construction activity and a strong leasing market has paved the way for long-term growth in the Phoenix office market. Phoenix, which ranked second in the nation for job growth at the end of 2004, boasts one of the strongest local economies in the country. As a result, the demand for both for-sale and for-lease office product is continuing to grow.

As rental rates move upward and vacancy rates remain at a 3-year low of 16.7 percent, landlords will be offering fewer concessions to lure in new tenants. Businesses seeking leased office space will soon be hard pressed to find concessions such as free rent, free covered parking and unamortized tenant improvements.

Many businesses are now deciding to purchase newly constructed office buildings and/or recently converted office condominiums. Throughout the region, this increase in acquisition activity has affected overall net absorption, which remains strong at 2.4 million square feet of occupied space.

The diminishing availability of developable land for office properties has caused demand to spread to suburban markets, such as West Phoenix and North Scottsdale. West Phoenix's sparse competition and close proximity to less expensive housing make it a desirable submarket for new office development and enable business owners and employees who live in the West Valley to bypass the increasing levels of traffic congestion on Phoenix's freeways.

North Scottsdale is fast becoming the area of choice for Class A office product. The submarket currently boasts the highest level of construction activity, with newly constructed Class A product posting the lowest vacancy rate and experiencing the highest level of pre-leasing activity in the valley.

Leasing activity is also expected to increase in suburban submarkets, buoyed by a newly established biotechnology sector, an efficient light-rail system and the expansion of the Phoenix Civic Plaza.

The Phoenix office market is also setting new standards for sales transactions. The Esplanade I and Esplanade II towers, located in the Phoenix's sought-after Camelback Corridor, sold in May for $162.5 million, setting a new price-per-square-foot record at $310. Another significant transaction was the sale of One Renaissance Square in Downtown Phoenix, which sold for the second time since March 2005, for $128 million.

As a multitude of new construction projects break ground throughout the region and vacancy rates continue their downward descent, the Phoenix office market appears poised to build on its momentum and continue its growth and expansion in the months and years ahead.

— Laura Becker is a senior associate for GVA DAUM in Phoenix.

Industrial

The Phoenix industrial market is in the midst of an unprecedented period of growth and expansion, with values currently at all-time highs and vacancy rates sitting at 3-year lows. While these record-setting figures may suggest that the market is approaching its pinnacle, a prevailing scarcity of available product has the market positioned for an extended period of high property values and positive growth.

The past 8 months of 2005 have witnessed a windfall in industrial properties. Buildings that sold for $55 per square foot in February are now re-selling with only minor modifications for as much as $90 per square foot. Despite this sharp increase in pricing, there remain approximately three buyers for every lessee.

Cap rates in the Phoenix industrial market remain low and are expected to stay in the 7-to-8-percent range, with signature tenant deals possibly dipping under the 7 percent mark. This continued stability is largely due to the high demand for investment property and limited availability of product.

With vacancy rates reaching a 3-year low of 10.1 percent, the response has been to feverishly build new industrial product. The 3.5 million square feet of new construction currently underway in the market suggests that developers are confident about the continued demand for new product.            

Many major developers, including SunState Builders, EJM Development and First Industrial are buying bulk land on which to build new industrial parks. Among the properties currently under development, a majority of the activity appears to be in the construction of small-to-medium sized buildings.

A large portion of the new industrial construction activity has been occurring in the Southwest Valley, which continues to entice developers with its convenient location 15 miles from downtown Phoenix and abundance of available land. This fast-growing submarket is home to a broad variety of industries, ranging from light manufacturing, assembly and warehouse distribution, and is well positioned to be the leading submarket for new industrial development.

With 65 percent of all industrial properties owner-occupied and a slew of new buyers flooding the market, statistics certainly suggest a strong trend toward buying versus leasing. However, lease rates continue to move higher, increasing 7.5 percent year over year to 53 cents per square foot NNN. While the market continues to be dominated by new construction and property sales, these strong lease rates remain a key variable in its overall strength.

Even with this remarkable period of growth and expansion, the remainder of 2005 through to 2006 should yield more of the same. While fears regarding interest rate increases abound, the impact will be only marginal if they continue the current trend of minor increases.

With a multiplicity of new construction efforts either planned or underway and an overwhelming scarcity of available product stoking demand, the Phoenix industrial market appears poised for continued growth and expansion, buoyed by high properties values, well into the future.

— Skip Corley is executive vice president for GVA DAUM in Phoenix.

Retail

As the residential housing market continues its strong growth throughout metropolitan Phoenix in 2005, the consistent population momentum continues to fuel demand for new retail development projects. These new projects include more power centers along the major freeway corridors, new lifestyle centers in regional core areas, grocery-anchored neighborhood centers surrounded by new housing and new strip retail. With all of this activity, Phoenix's retail market is as strong as it's ever been.

For retail development, look no further than the three main submarkets. The southeast submarket has more than 2.5 million square feet under construction, followed by the southwest and northwest submarkets, each with almost 1 million square feet under development. The new projects in the southeast valley are being delivered by companies   like Vestar Development (Crossroads Towne Center and Gilbert Gateway Town Center), Diversified Partners (SanTan Gateway), RED Development (Fulton Ranch Towne Center) and Westcor (SanTan Village). In the southwest valley, in towns like Laveen, Avondale, Goodyear and Buckeye, a strong mix of power and neighborhood centers continues to serve the rapid population and housing growth. In the northwest valley, the main focus is on continued development in Peoria, Surprise and along Lake Pleasant Parkway, which includes new projects planned by Fronterra Development, The Pederson Group, Barclay Group, Kornwasser Development and Vestar.

As for leasing, the total absorption year-to-date has surpassed the 2.5 million-square-foot mark, leaving vacancy hovering around 10.3 percent. Grocery-anchored inline space is going for $26 to $28 per square foot while inline shop space at power centers have asking rates of $28 to $32 per square foot. Mall lease rates range from $45 to $90 per square foot NNN. The vacancy rate and the new construction, which is growing Phoenix's total retail inventory to more than 105 million square feet, add to the continued interest of in- and out-of-state investors, developers and tenants.

Wal-Mart Supercenters are anchoring more of the power centers along the freeways mentioned above, and the Wal-Mart neighborhood centers are starting to enter the market. Other box tenants like Target, Kohl's, Lowes Home Improvement Warehouse, The Home Depot, The Sports Authority, LA Fitness, and PetsMart continue to aggressively pursue additional sites throughout the Valley. Other large box tenants like Cabela's and Bass Pro Shops Outdoor World have identified sites and will be opening stores in 2006. In the grocery segment, there continues be a strong push by natural and gourmet grocers to expand, while other retailers like Safeway, Fry's and Bashas' Supermarkets are being very cautious and selective about their location choices. The market for bank pad users has become very competitive among tenants like Compass Bank, M&I Bank, Bank of America, Wells Fargo and Washington Mutual.

Another retail trend is the revitalization of the downtown urban core areas. Cities like Phoenix, Scottsdale and Tempe are going vertical with condominium towers that will demand more retail services. Scottsdale has the Waterfront project under construction along with some redevelopment along the south canal bank. Tempe has a new retail and condominium tower project to be developed at Centerpoint on Mill Avenue. Plans are also under way for the new ASU downtown campus in Phoenix, which will spur more retail services. Downtown Chandler has a large mixed-use project planned for the very near future that will include a street-front urban retail component called San Marcos Square.    

With the continued progress of the freeway system and strong population growth in the various submarkets, the future for new development, leasing and sales on existing retail product in metropolitan Phoenix will remain strong for the rest of the year and well into 2006.  

— Jeff Alba is a senior associate of retail services at Trammell Crow Company in Phoenix.

Multifamily

Two major forces are driving development in Phoenix's multifamily market: condominium conversions and new luxury condominium construction. While converters have been dominating the multifamily scene for approximately 2 years, new construction has been trickling into the market fairly recently. Already, these ground-up luxury condos can be found everywhere from the Central Corridor and downtown Phoenix to the Camelback Corridor, North Scottsdale and the Waterfront area of downtown Scottsdale.

Since late 2003, approximately 2,500 condominium units have either already been constructed or are in the planning stages, and that number could double by the end of 2006. These mostly luxury units target affluent buyers and young professionals who can afford to live just about anywhere but prefer the lavish amenities of condo living over the hassles of maintaining a single-family home. Such condos offer resort-like services and may sell for upwards of $3 million per unit.

One of the most high-profile developments currently underway is the Scottsdale Waterfront Residences. Developers Opus West Corp. and Geoffrey H. Edmunds & Associates Inc. are investing an estimated $200 million in this luxury urban high-rise project. The completed project will consist of 198 luxury condos in two 13-story buildings. It is located within the Scottsdale Waterfront, a highly visible mixed-use development just north of downtown Scottsdale. In northeast Phoenix, The Weitz Co. has just broken ground on Phase II of The Landmark, a six-story mid-rise condominium complex. It will total 101 units upon completion, with prices starting at $300,000. Larger units, with scenic views of the Kierland Golf Course, will sell for as much as $2 million.

Condo converters are also targeting the high-end consumer, though most of these projects are not as extravagant as new luxury condominium developments. During the next 12 months between 6,000 and 8,000 apartment units are expected to be converted into condos, about double the number converted from 2002 until now. The 348-unit San Mateo Apartments, located in the Kierland area of North Scottsdale, were recently acquired by Sedona Commercial Corp. for $175,000 per unit. The buyer plans to upgrade this 1994 community and re-sell the units for $225,000 to $400,000 each.

Although condo converters are sweeping up apartments across Phoenix and nearly 3,500 new apartment units are expected to be brought on line this year, Phoenix is still a long way from being considered a fully recovered multifamily market. It struggles with double-digit economic vacancy rates and minimal rent growth. Physical vacancies average 7 to 10 percent, while economic vacancies can add an additional 5 to 8 percent or more per year. Rental rates across the Valley average $825 to $1,000 per month for Class A properties, while Class B and C buildings range from $500 to $750 per month.

Still, apartments are the hottest investment product on the market with record-setting sales prices. Already this year, sales of 50-plus unit multifamily properties in the Phoenix market have topped $1.6 billion, as compared to roughly $917 million for the same period last year.

While there seems to be no end in sight for condo conversions and new ground-up condo developments, the onslaught of luxury condos has created a significant need for affordable housing in the Phoenix area. A shift from luxury to affordable condo projects targeting the middle market will soon emerge to meet this demand. For now, however, condo converters are showing no signs of slowing down and the remainder of 2005 should continue to bring record setting prices for apartment sales.

— Neil Sherman is a senior vice president at Sperry Van Ness in Phoenix.

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