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Sluggish Demand for Office Space in Phoenix

Sluggish Demand for Office Space in Metro Phoenix Continues

The Phoenix office market continued to feel the effects of a sluggish and wavering economy, according to Cassidy Turley BRE Commercial’s 3Q 2010 office market trends report released today.

Economic indicators remain mixed causing uncertainty as to whether our economy is headed into a “double dip” recession or a period of slow growth. The best word to describe market conditions during the third quarter is flat. Net absorption was negative for the second time this year and the overall vacancy rate increased 30 basis points to finish at an all-time high of 27.9%.

Tempe/South Chandler and 44th Street Corridor posted the largest gains in net absorption; collectively they gained more than 257,590 SF in the third quarter. Downtown North and Airport Area were the two submarkets with the largest declines in occupancy; they collectively lost 221,927 SF during the third quarter. The majority of leasing activity has been in space that is an upgrade to the tenant’s prior location, otherwise known as “flight to quality.”

This has been a trend for several quarters, as nearly all positive absorption, both the quarter and year-to-date, have come from either Class A buildings or new construction. Class A average asking rates continue
to decline as landlords compete for tenants by offering heavy concessions and discounted rates. Class A rental rates dropped nearly 2 percent in the third quarter to finish at $25.07.

With the extreme over-supply of space, overall asking rental rates will continue to soften but at a slower pace and should reach bottom within the next 12 months. Office market leasing is likely to remain flat through 2010 and improve gradually into 2011 as businesses start to add jobs and tenants take advantage of reduced rates. Landlords that have weathered the recession, remained financially strong and adjusted to current market conditions should start to see some relief as tenant demand gradually improves.

With large blocks of premium office space available, lower rental rates, a high quality of life, affordable housing and great weather, Metro Phoenix is positioned to attract companies looking to relocate or add to their current operations. These factors should improve leasing and owner occupant demand bringing some relief to the office sector.

Vacancy Rising in Phoenix

Vacancy Rising In Phoenix Despite Construction Pullback

Though employment growth will stimulate an increase in retail sales in 2010, the job additions will not be sufficient to prevent the vacancy rate in Phoenix from rising for the fifth consecutive year, according to the latest Retail Research market update from Marcus & Millichap.

Unlike previous years when excessive construction drove vacancy increases, lagging demand has become the anchor on the market. The pace of store closures clearly has slowed, but too few retailers have emerged to open new locations in the vacant space that has amassed. With the vacancy rate nearing its highest level in 20 years, rents continue to fall as tenants exercise the upper hand in discussions with owners.

Rents have yet to settle at a new, lower market level and may not reach their low point until late next year. The upside of reduced rents, however, has been a sharp decline in construction, as many projects simply no longer pencil for developers. After deliveries averaged 5.5 million square feet of new space each year during the past decade, a fraction of that total will come online in 2010.

Although the slowdown in construction represents a positive trend in a market with frequent overbuilding spells, the lack of properties under construction will restrain sales of new single-tenant, net-leased assets. As in other markets around the country, single-tenant properties net-leased to top-rated corporate tenants generate intense bidding when listed. In fact, cap rates for nationally branded drugstores and fast-food properties have fallen about 50 basis points since early this year to around 7 percent, with ground leases commanding even lower first-year returns.

In the multi-tenant segment, buyers have intensified searches for suitable listings, but the ongoing reduction in rents continues to present challenges to arriving at valuations upon which owners and prospective buyers can agree. Current underwriting assumes additional increases in vacancy and further rent reductions, such that cap rates must vary from 10 percent to 11 percent to generate bids. Among specific properties, those with tenants that signed leases at the peak of the market
in 2006 and 2007 invariably face the prospect of re-leasing space at substantially lower rents when leases expire.

2010 Annual Retail Forecast

Employment: Government employment will decline over the second half due to the termination of census jobs and budget constraints at the state and local levels, while private
sector employers will hire conservatively. As a result, total employment will expand 0.8 percent in 2010, or by 13,700 jobs. Last year, 116,000 positions were cut.
Construction: Developers will complete 500,000 square feet of space this year, the lowest annual total in 30 years. In 2009, approximately 2.9 million square feet came online. Planned projects total 28 million square feet, although none has a scheduled start date.
Vacancy: The vacancy rate will increase 70 basis points this year to 12.6 percent, as store closures and a lack of new demand will result in negative net absorption of 721,000 square feet. Vacancy spiked 260 basis points last year and most recently surpassed 12 percent, a level last reached in 1991.
Rents: This year, asking rents will decrease 1.3 percent to $18.11 per square foot, following a 5.5 percent dip in 2009. Effective rents will slide 2.6 percent to $15.13 per square foot, compared with a 9.1 percent drop last year.