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NAIOP Roundtable 2011 - AZRE Magazine September/October 2011

NAIOP Roundtable 2011

Q: What is the current state of our Metro Phoenix office market?

JD: The Metro Phoenix office market is slowly and gradually improving. With five or six consecutive quarters of positive absorption (although modest), we’ve definitely found a bottom and are slowly improving. The market activity is being dominated by larger/national tenant type deals.

National/multi-national companies today have capital and also realize that this is a very good time to lock down space before the market turns. What we really need to see is the return of the smaller/local office space users. These guys are still nervous and are more capital constrained.

Another dichotomy in today’s market is the true “A” buildings are doing relatively well, with lower classes of product really struggling. Tenants were absolutely frozen in ’08 and ’09. Today tenants are finally trading up, which to me, is a sign of a return to normal market conditions.

TH: As we all know, there has been a flight to quality in the local office market. Class “A” buildings are seeing the most activity now. There seems to be good gross activity. but net absorption is still negative for the year. Large spaces over 50,000 SF in Class “A” buildings are declining in availability, so market conditions may feel much tighter to a larger user than to our typical 5,000 SF to 10,000 SF tenant in the valley.

Vacancy seems to be flat or perhaps barely rising this year and is currently at approximately 27% metro wide. Average rents are down about 1%. Supply of new space is unchanged. Like all office markets, we really need employment growth to increase which will in turn reflect in more space being leased.

Q: What is the current state of our Metro Phoenix industrial market?

MH: The industrial market is experiencing positive net absorption. During the first six months, the market absorption exceeded 2010 levels at 3.2 MSF. Generally speaking, the activity continues to be from big corporations absorbing larger amounts of space. Our local economy continues to benefit as companies like Intel, First Solar and Amazon expand and create jobs. Assuming that our national economy growth rate is healthy with consumer spending rising; smaller to mid-size companies will take advantage of the available supply of high quality buildings at great pricing.

MC: We are seeing more activity across the board, which is a step in the right direction. One of the most positive indicators I’ve seen recently is net absorption in the smaller spaces. Positive net absorption for deals in the 5,000 SF to  20,000 SF range for Q1 and Q2 of 2011 was 661,345 SF, which puts 2011 on track to be the first year since 2007 that we’ve experienced positive net absorption in this size range. Considering there was negative net absorption of 1,228,699 SF in this size range in 2010 this is definitely encouraging.

Q: There has been a lot of recent coverage on the return of spec warehouse buildings in the Inland Empire, our neighbor to the west. How long do you think it will be before the Phoenix market sees its next spec building?

MH: Assuming existing market dynamics continue, by this time next year, southwest Phoenix will be home to a 500,000 SF to 1 MSF speculative distribution facility. This will be the result of a scarcity of supply and continued demand for this size of building.

JD: I predict that we’ll see at least one large spec warehouse on the southwest side before the end of this year and potentially a small handful of BTS transactions.

MC: With the most recent lease by Amazon of 1.2 MSF in southwest Phoenix there is only one warehouse building left there over 500,000 SF, and only a handful of spaces over 250,000 SF. One of the main reasons we have been able to get deals like Amazon in this market is because we had readily available buildings they could locate in.

A lot of these users don’t want to wait a year to 18 months for a building to be constructed, and considering the amount of interest that this market has been seeing as of late, I would bet there will be a speculative warehouse building coming out of the ground in southwest Phoenix sooner than many people think.

TH: My guess is that there will be a spec industrial building built in late 2012. A spec office building might be built in 2014.

Q: Are values in Metro Phoenix commercial real estate starting to move upward yet?

BM: By and large, the answer is not yet. While some large transactions in the office market (the University of Phoenix sale/lease back, the Arizona Center and Viad Tower deals) have pushed the averages higher, the truth is that prices for the meat of the market have yet to move higher. The median price for office deals closed in the first half of 2011 was $74 per SF, compared to $83 per SF in the first half of 2010.

Similar trends are being displayed in the industrial segment. In deals closed during the first half of 2011, the median price was approximately $50 per SF, down from roughly $60 per SF in the first half of 2010. The sales prices in the first half of last year were skewed somewhat higher by a number of owner/user sales. After accounting for these sales, prices for industrial buildings have been pretty flat.

Overall, commercial pricing is unlikely to move upward ahead of rent gains. With rents in industrial buildings likely to stabilize but not expected to push significantly higher, and with office rents expected to continue to creep lower for the next few quarters, I don’t anticipate any significant price appreciation in the near term. One “wild card” on price trends could come from investors who feel priced out of primary markets. Major markets, such as New York, Washington, D.C., and other top markets, have shown price appreciation as buyers compete for assets in these areas. With prices pushing higher in a few markets, we could see a move into the better properties in other markets.

JD: I believe values have certainly bottomed and for the highest quality product, have started to increase. Values for distressed real estate really are not increasing yet. A lot of foreclosures and distressed assets still have to work their way through the system before those values will start to come back.

KM: We are seeing some projects trade higher than a year ago, but we definitely have a long way to go. Underwriting has loosened up to a degree but is still very tough on office and retail.