In 2019, a commercial office building could be purchased in Metro Phoenix for $160 per square foot. Two years later that same product is fetching $310 per square foot.
The story line in 2021 – lack of inventory and pent-up demand.
Signs point to the fact that Metro Phoenix is in a full-blown sellers’ commercial market with demand for building ownership the highest it’s ever been, according to Andrea Davis, CCIM, Owner/Designated Broker at Andrea Davis CRE. Sales are tracking alongside residential records, she adds.
“Based on the influx of daily calls and offers on listed properties,” Davis says, “there could be as many as 10 qualified buyers for one building. This is the opposite of historical markets.”
Only one to two percent of the market is comprised of commercial buildings that work for small businesses to own. The bulk of the market is multi-tenant lease buildings primarily owned by large landlords such as REITS and pension funds, she says.
Of that one to two percent of for sale inventory, a majority is office condos rather than fee-simple buildings. Currently, owner/user buildings under construction are build-to-suit only. In addition, there are no spec owner/user projects underway for 2021 or 2022, Davis adds.
This phenomenon is happening across the Valley. Davis has identified several factors to explain the anomaly and the signs of a sellers’ commercial market.
Business owners want, need to control their rental destiny
More and more, tenants are getting tired of landlords’ lack of empathy and their demands, Davis says, when it comes to the renewal of the lease. The landlords want more money but don’t offer up incentives. It’s a dated process, Davis says. Incentives include free rent, some new paint and carpeting to freshen up the space.
With more investment being purchased by outside investors, tenants can’t anticipate what a renewal will resemble. California landlords are harsh compared to Arizona landlords. Repeatedly, Davis says she hears tenants complain that their landlord wants to increase their rent 20 percent or more and offer nothing in return.
“If landlords aren’t being reasonable, the tenant is saying they don’t want to keep putting money in their (landlord) pockets,” Davis explains. “Owning allows tenants to control their destiny.”
Businesses are expanding – or shrinking
A business person knows that by owning a building, they can increase their retirement plan. That’s why it’s prudent for a business owner to buy his or her own building, Davis says.
“Once they establish the footprint that fits their business, they go out and buy it (a building),” Davis says. “They have to be sure they don’t outgrow it or strike out because it’s too big.”
“With the market experiencing historically low interest rates,” she says, “the cost of money is favorable to buyers.”
Businesses are migrating to Arizona
Davis says she this as a trend for the next few years as companies are leaving other states for “business-friendly” Arizona. This is attracting small businesses from around the country that have greater restrictions on doing, well, business. They are being taxed “through the roof.”
“Restaurant concept companies, warehouses, business logistics companies,” Davis points out. “Dental labs, medical. Those are the prime businesses wanting to move to Arizona. They conduct actual business. They need a physical location.”
The business turnover cycle is changing
Younger businesses want to stay competitive for another 5 to 10 years, Davis explains.
“In a business cycle that has stabilized its growth, purchasing a building puts the company in the driver’ seat when managing rental rates,” she says. “If they can keep their rental rate at say, $5,000 per month as opposed to annual escalations of $5,600, $6,000 and more, instead of paying additional rent they can hire another employee or put the money towards marketing.”
Going back to 2000, office condos came on the market in the Valley, Davis recalls, translating to millions of square feet. In the late 1990s, business owners that bought typically after 20 years, were looking at retirement. It should have opened up lots of inventory. But due to economic changes, many of those businesses need to stay open 5 to 10 years longer, she says. Thus, no turnover of product.
There is minimal product on the market
Most of the prime land for office condos was purchased in the early 2000s. Now there is very little available. Land prices and construction costs have both gone up exponentially, Davis says. At this point, it is cost prohibitive to build office condos. The sale of office condos is driven by location, she says.
“If you came to me as a business owner and and wanted to purchase a building, I would suggest a second-generation option,” Davis explains. “It is cheaper to buy and remodel than buy the land, build the shell and build out the interior. That difference is about $75 – $100 per square foot on average.”
There is also the wait time. A new business can go in and remodel an existing building and be up and running in four to six months. If a business has to build, Davis says, it is looking at 18 months before it can open its doors.
“When some of these local retail centers go dark or up for sale, they may be good properties to repurpose for office condos with a creative developer,” Davis says. “They already have the right zoning. It’s that natural timeline where stuff becomes obsolete.”
No construction of smaller buildings in the pipeline
Again, it’s all about cost per square foot. The smaller the building the higher the price to build it. That’s why developers are building bigger, Davis says. They can spread out the cost of the construction and development. A 50,000 square foot office condo project needs a minimum of 3 to 4 acres to work.
“Not having reasonably priced land in strong locations is what saved our office market from being overbuilt. That is a blessing and a curse for office product. Now, they can’t build it fast enough for those who want it,” Davis says.
While it’s too soon to determine the long-term effects of these changes, one thing is for sure – “commercial real estate in Arizona is thriving with no sign of slowing down,” Davis predicts.