There was a lot of bad news to go around in 2020, as many businesses in Arizona were affected by the COVID-19 pandemic. As our attention turns to what lies ahead in 2021, it’s still not quite clear how much damage the pandemic had on the various commercial real estate sectors.
In the Greater Phoenix multifamily, industrial and land markets, that damage was minimal, as those sectors enter 2021 with strong momentum that looks like it will carry well into next year. The office and retail markets, however, weren’t so lucky. How people work and buy goods during a pandemic continue to evolve, and both sectors head into 2021 with a lot of questions about how much space will companies use in the future, and will people return to the store after spending a better part of a year doing their shopping online.
AZRE Magazine talked to experts on the various commercial real estate sectors to get their insight on what we can expect in 2021.
Commercial real estate in 2021 – multifamily
The Greater Phoenix multifamily market appears to be very healthy heading into 2021, despite a 2020 that caused many players in the market to pause as they gauged the effects of the pandemic restrictions.
“We started the year with a hot first quarter. When COVID-19 hit in Q2, Phoenix multifamily activity came to a screeching halt,” according to Alon Shnitzer, senior managing partner at ABI Multifamily. “Everyone wanted to wait and assess the market to see how things were going to pan out. When it became clear Phoenix was a hot destination, and rent payments were holding steady, activity began to pick up in the third quarter. As for the fourth quarter, it’s been a blistering hot market. ABI Multifamily currently has 40 properties in escrow.”
One negative factor caused by the pandemic appears to be new product in the pipeline, as new construction is well off of the 2019 pace that saw more than 6,000 new units delivered. That slightly slower delivery pace will have an effect on rental rates, as well as unit sales prices. According to the Kidder Mathews Q3 2020 Multifamily Market Trends Report, average asking rents in the market have gone up 3.65 percent to $1,122.
“Apartment sales in Phoenix dropped to about half of their normal levels in Q2 as shutdowns and uncertainty created a challenging market,” said Steve Gebing, partner at Institutional Property Advisors, a subsidiary of Marcus & Millichap. “Deal activity has already started to recover, a trend that will be supported going into 2021 with positive demographic and economic drivers, along with historically low interest rates spurring investment sales.”
Gebing points out that the state is seeing its population boom continue, and it may be accelerating due to the pandemic driving many people out of high-density coastal cities. Gebing feels that the demand for lower living costs will support demand for rentals in the West Valley and for Class C product more broadly across the metro.
“Workforce housing, which is already in short supply, will see greater demand due to economic uncertainty,” Gebing states. “These trends have and will continue to push occupancies and rents higher on Class B and C apartments across the Valley.”
With the majority of factors working to increase demand for multifamily products, it appears poised to perform at record high levels in 2021.
“Based on what we’re seeing, multifamily is expected to remain the top product type of choice for investors, with increasing momentum going into 2021,” adds Shnitzer.
Commercial real estate in 2021 – industrial
The industrial market in Greater Phoenix has turned into the Belle of the ball in the commercial real estate world.
Despite the pandemic, industrial activity was unprecedented, with just under 10 million square feet of product delivered through Q3 and another 9.3 million under construction.
“Industrial should remain the “Belle of the Ball” in Greater Phoenix through at least 2022,” said Jim Wilson, executive managing director for Cushman & Wakefield. “Because the market didn’t enter 2020 with an excess of available industrial space, new development won’t result in an overbuilt market.”
That assessment played out during 2020, according to Rusty Kennedy, senior Vice President at CBRE.
“Quarter one was one of the most, if not the most active we have ever seen for positive net absorption with just under 4 million square feet,” Kennedy said. “As we headed into quarter two, we saw a ‘tapping on the brakes’ early, but then activity picked up again in mid-April. Subsequently, absorption in the third quarter was well balanced and getting back on track to a record pace. I expect 2020 to likely end up at over 11 million square feet of positive net absorption and possibly pushing higher.”
The bulk of the industrial development in 2020 occurred in the Southwest Phoenix submarket, according to the Arizona Industrial Research & Forecast Report for Q3 2020 by Colliers International in Arizona. There was 4.7 million square feet of industrial product delivered in Southwest Phoenix through Q3, with another 3 million SF under construction. This growth was sparked by the opening of the Loop 303. The other hot submarket was the Northwest (Deer Valley), with 2.5 million SF delivered in 2020 and another 5 million SF under construction.
“I believe 2021 will have more momentum than any year in our market’s history. We feel it is almost a perfect storm,” said CBRE senior vice president Pat Feeney, who teams up with Kennedy on many transactions. “California is making it increasingly more difficult and expensive to do business there, and companies in cities and states that are fiscally upside down are moving to the sunbelt, and Phoenix is inching higher up on the list of affordable and “business friendly” alternatives. Hence, I envision 2021 to likely be a banner year for the region.”
One untapped area that Wilson feels could have vast potential is the land along the South Mountain Loop 202 freeway, including hundreds of acres of Gila River Indian Community land.
“If developers can successfully navigate the process of building on leased land and working with Tribal Projects Development and landowners, that area provides major opportunities,” Wilson said. “It offers the same desirable attributes as the West and far East Valley, large blocks of available land, access to freeways and close proximity to growing populations for staffing.”
Commercial real estate in 2021 – office
The COVID-19 pandemic fundamentally changed the office environment (at least temporarily) and the numbers reflect that change.
According to Don Morrow, senior Vice President, investment sales for NAI Horizon, through Dec. 1 of 2020, there has been 617,000 square feet of negative net absorption in the Greater Phoenix market, most of which has been a result of the sublease market. This negative net absorption caused the overall office vacancy rate to go from 11.4 percent at the beginning of 2020 to 12.8 percent.
“Larger tenants have seemed to be more impacted and many have placed any moving plans on hold,” Morrow said. “Smaller tenants are slowly resuming their real estate activity with leasing of these smaller spaces becoming more active.”
So, what does 2021 look like for the office market?
“We believe we will continue to see slower activity in the leasing market for the early part of 2021, with many companies having found efficiencies in their employees working remotely,” said Tyson Breinholt, partner and associate broker for Commercial Properties Inc. “I expect some spaces will be coming back on the market, and predict an increase in the amount of sublease space as companies shift to take advantage of smaller footprints with some teams effectively working from home.”
“I think that companies are learning to navigate some of the initial challenges that they faced and are focused on putting together business plans that successfully blend a hybrid work model for their employees that includes a combination of working in the office, working from home (WFH) and possibly a third off-site remote or satellite location,” said Larry Downey, vice chairman/tenant advisory services for Cushman & Wakefield. “Companies will continue to focus on evaluating their real estate options during the early part of 2021.”
The biggest question mark heading into 2021 is how companies implement work from home (WFH) strategies. The general feeling is that people will want to return to the office, but also have the flexibility of WFH. Just how that will affect leasing demands, remains to be seen and may take a couple years to fully play out.
“We’ve seen and heard from employees, C-Suite executives and corporate commercial real estate occupiers over the past nine plus months that most of their workforce want to return to the office for at least a good percentage of their work schedule,” said Downey. “As they
work through the new work schedules, companies will evaluate their
current and future real estate requirements and whether that includes up-sizing to allow for increased space for distancing or reducing their square footage for a smaller numbers of workers.”
Commercial real estate in 2021 – retail
According to Darren Pitts, executive Vice President at Velocity Retail Group, many brick-and-mortar retailers were struggling prior to the COVID-19 pandemic, so the impact of that were too much to overcome, with many businesses forced to close in 2020, creating vacancies that would not have been there in a normal year.
“The Phoenix market will have negative absorption for the first time since the Great Recession with nearly 500,000 square feet of negative net absorption in 2020,” reported Pitts. “This has been reflected in the current market statistics which show a vacancy rate of 7.7 percent, which is up from 7.3 percent at year-end 2019.”
Heading into 2021, Pitts expects retail users to be more “refined and disciplined.”
“We believe the retail market should become stronger and more efficient than it has been in the last decade. Brick and mortar isn’t going anywhere,” according to Pitts. “We expect retailers to be healthier and have better technology, logistics and delivery platforms.”
Despite a less-than-stellar 2020 and a pandemic that keeps dragging on, it’s not all gloom-and-doom heading into 2021. The Newmark team of Steve Julius, Jesse Goldsmith and Chase Dorsett see much to be bullish about, with continued population and job growth in the market, which will support retail development, especially in high-growth areas like the East Valley and Southwest Valley.
“Phoenix’s strong job market, favorable climate and affordability has long made it a top living destination for people all over the country,” Julius, Goldsmith and Dorsett said in a joint response. “From 2010 to 2019, Phoenix Metro added over 750,000 new residents (US Census), making it the third fastest growing metro area in the entire country. In addition, in 2019 Phoenix metro posted wage growth of 3.84 percent, ranking second among metros for highest wage growth. These factors make Phoenix a top market for new retailers and existing retailers expanding.”
The Newmark team did note, however, that one potential factor that could work against retail expansion is the expected increase in capital gains taxes for high earners, and the possibility of eliminating the 1031 exchange for investors with incomes over $400,000.
“We estimate that 40 to 50 percent of multi-tenant retail transactions involve a 1031 exchange so eliminating this would have an immense impact on the industry,” Juluis, Goldsmith and Dorsett added.
Commercial real estate in 2021 – land
It’s not quite the great Oklahoma Land Rush of 1893, but the current status of land sales and transactions in the Greater Phoenix area is nearing “boom” levels.
“For the first time in several years the land market in 2020 gained intense momentum,” said Nate Nathan, founder at Nathan & Associates. “The fact that all the finished lots, both in Maricopa and Pinal county, were acquired by mid 2019, builders had no other option other than to turn their attention towards land in the growth corridors.”
Nathan said that the growth patterns are becoming clear as we head into 2021, with areas west of the White Tanks, Grand Ave., Southeast Buckeye, City of Maricopa, San Tan Valley, and Pinal County all becoming very important for home builders to find new inventory.
One growth corridor that saw tremendous activity is the Loop 303 corridor in the West Valley. There have been major industrial developments along the Loop 303, which have created job centers for the growing population out in that area.
“Starting approximately four years ago the 303 corridor created approximately 5,000 jobs, this is changing the land market dramatically,” said Ryan Duncan, broker at Nathan & Associates. “There are thousands more jobs predicted over the next few years in and around this corridor. For the first time, the West Valley is going to thrive due to this employment corridor. The same phenomenon holds true for the 202 corridor and more specifically land in Laveen. Those changes to the employment map will also impact housing from the standpoint of reasonable commute times in support of growth. Look to see sub-markets that had been previously non-viable to suddenly come alive.”
Nathan said that he has seen the lot prices increase by 30 percent in 2020, driven by high demand and low supply, as well as increasing costs of infrastructure.
As more than 100,000 new residents arrive in Arizona each year, it will be a few years before the land market slows down.