As 2010 ended, Arizona’s commercial real estate industry gained some much-needed momentum entering the new year, thanks to a slew of new construction projects just completed or scheduled for completion in 2011.
The much-anticipated opening of CityScape signaled a resurgence for Downtown Phoenix, and as the year ended, it boasted a 90% occupancy rate. Rising in the shadow of CityScape is the new Maricopa County Superior Court Tower, scheduled to open later this year.
Elsewhere, Fountainhead Office Plaza in Tempe (439,070 SF); Banner MD Anderson Cancer Center in Gilbert (130,000 SF); and the new FBI building in Phoenix (210,000 SF) are scheduled for completion this year. The new spring training facility in Scottsdale for the Arizona Diamondbacks and Colorado Rockies opened in February.
Although a few new high-rise offices buildings, a hospital and a federal building won’t cure the industry’s ills, still, there is optimism in 2011 that the markets will pick up. The keys, according to experts are business attraction, quality jobs and the loosening of capital.
“I’m really bullish on this year that equity is coming back,” says Barry Broome, president and CEO of the Greater Phoenix Economic Council. “If Arizona shows growth in the third and fourth quarters, it could be a great year for jobs. Once capital frees up, we can start going somewhere.”
Adds Barry Albrecht, CEO of the Central Arizona Regional Economic Development Foundation: “Once the lending marketplace returns to funding 75% projects, we will see new construction respond. When state leadership designs a meaningful and competitive tax base, existing Arizona companies will expand and occupy available properties.
Additionally, once the Arizona Commerce Authority develops incentive programs that compete with other states’ programs, we will see business attraction. When we, as a state, create a competitive operating environment for industry to prosper, we will see a commercial real estate recovery.”
Here’s the outlook for 2011 from industry experts:
“By far the biggest influence on current conditions is the status of the national economy. The Arizona economy will improve as the U.S. economy improves and as people continue to get their financial houses in order. Even without action, Arizona will again lead the nation in growth before mid-decade. However, we want to create more than lower value added jobs in retail and real estate. We want to expand our deteriorated economic base with higher value added jobs and industries. Arizona no longer makes anything of higher value. This is critical to not only grow, but to grow well. While conditions will continue to improve in commercial real estate, Arizona is still two to three years away from normal vacancy rates. The good news though, things are not getting any worse and expect improvement in 2011 and 2012.
“Employment will drive the business expansion needed to create material positive absorption in the office markets and reduce existing supply (vacancy) and eventually have upward pressure on rents (both critical elements to increasing asset values). These newly created jobs will add disposable income to the local economy and will drive sales activity in both residential housing and disposable products. The retail industry will get the much needed boost in increased spending via this new addition to disposable income, which will in turn drive demand for retail space, reduce existing supply and increase rents and eventually asset values.”
“2010 was our year for healing. 2011 will be our transition year. We’re moving in to full recovery mode. Our development cycle officially ended in 2010, which means that the landscape of our commercial market and inventory will, by-and-large, remain static the next two, three, even four years.”
“What’s not being talked about nationally is that Phoenix is a preferred strategic location for value-add industrial employers. Last year, the Phoenix industrial market topped 4 MSF of absorption. That puts us in at least the top five — and possibly higher — of all U.S. markets. We may even have a shortage of larger space beginning as early as the end of this year. Mid-size clients typically have two or three dozen options to choose from at very soft pricing, but larger clients are having a harder time. In December, for example, we had an industrial client looking for 500,000 to 630,000 SF and only had three possible local solutions. In the same time period, we had a client looking for 250,000 SF of industrial space and had nine solutions Valleywide.”
OFFICE & RETAIL
“There still exists an over-supply of space in office and retail. The existing inventories will take several years to absorb prior to any major new development taking place. During any down real estate cycle, tenants take advantage of the ability to move up in class. We have seen that happen locally, which has had some effect on the Class A product. As things begin to gain momentum, we will experience a shortage of Class A product in core areas, which then leads to rental growth and eventually allows new development to once again be warranted. Multi-family is still a strong sector due to the economic downturn forcing many home owners out of their homes and into the rental market.”
“The industry will begin to see a slow but steady climb out of the recession. Most of us have been bouncing along the bottom with good and not-so-good months. The thaw has begun for owners with capital and they are ready to enter the market cautiously. Deals on real estate are prevalent and owners are beginning to take advantage, which is great for architects.
“Lending will continue to be difficult, therefore cash is critical to any new project. Architects should be cautious and assess the level of risk when a project is dependent on bank financing.
“Medical facilities are still being developed due to aging baby boomers in tandem with technological advances. Physical facilities will either require renovations to accommodate the new technology or additions to accommodate the older population.
“Retail will be the last market to recover and will see a very slow start. There will be a balancing act between keeping rent rates low for recovering tenants and keeping retail centers attractive to tenants and visitors alike.”
“2011 is shaping up to be another year of great challenge to the commercial real estate industry. A sampling of BOMA Greater Phoenix property managers gave similar results to 2010. Some of their concerns:
“Vacancy rates are high, and competition for available tenants is serious. Deals are all over the map, and it is essential to make a building stand out in the market in order to be able to justify a lease at or above break-even. Keeping a building in Class A condition with the budget constraints from owners and lenders is extremely difficult. Negotiating with current vendors to lower contract costs and rebidding when contracts come up is absolutely essential.
“Banks are not working with owner on market rate and/or tenant improvement allowances as they have historically. Tenants’ businesses are vulnerable to market swings. Many tenants are asking for rent relief or not paying as they should, as well as just defaulting. This is another challenge that owners and managers need to work together to meet.
“Smart, energetic management is always important, but under current conditions is critical. A manager will need all of the tools available, and the knowledge to use them well, to successfully meet the new year.
There is also some momentum in the Tucson market entering 2011 as construction projects include the UniSource Energy Corporate Headquarters (200,000 SF) and a new FBI building (84,353 SF).
In the office market, Tucson experienced a slight, but noticeable, uptick in lease activity at year-end, largely attributed to a more pro-business sentiment and the extension of tax cuts, according to PICOR Commercial Real Estate Services. Following a 25% to 40% drop in rents since the market peak, landlords have been more creative in length of lease and structure of concessions. Renewal activity has, accordingly, been very high.
Office building sales activity remained low by historic standards, as 75% of 2010 sales were to users. The overall volume for 2010 totaled just 628,000 SF. The outlook for 2011 appears to mirror 2010. Expect similar activity and slightly negative absorption.
The Tucson industrial market showed a slow recovery, with positive absorption advancing at a very slow pace. Companies that delayed expansions and relocations during the past two years are now moving forward, however, this activity is limited. Rents are continuing to decline, according to PICOR, although many property owners are reluctant to recognize this and are losing deals as a result.
Land sales were at a standstill in 2010, with no demand for new construction. Lender requirements and restrictions stifled the sale of leased investments as well, and few owners wanted to sell into the current environment. It is likely to be an uneventful year in 2011, with the local economy limping along toward recovery.