As jobs return to Arizona, industry experts predict a brighter future for the industrial and office markets

After 4 to 5 years of being bludgeoned, the Metro Phoenix industrial and office markets appear to be on the mend.

“It has been our belief that in order for the industrial and office segments to return to health, the Metro Phoenix housing market would first need to be firmly entrenched in recovery — and it is,” says Chris Toci, executive director, Cushman & Wakefield of Arizona.

As one of the four states hammered during the subprime housing fiasco, Arizona — specifically the Valley — received more than its share of negative press during the Great Recession. Arizona’s fall from grace was hard as the state witnessed a peak-to-trough decline in the median single-family home price of about 55%.

According to the Arizona Regional Multiple Listing Service (ARMLS), median home prices in Phoenix peaked in June 2006 near $265,000 and hit bottom near $120,000 first in March/April 2009 and then again in late 2010 after the $8,000 new home price stimulus was withdrawn. Th rough 2Q 2012, the median home price is $147,960, 24.9% higher from the lowest point in 2Q 2011.

“The key metrics to indicate a bottoming real estate cycle are one, trend reversal on price, and two, an increased velocity of sale transactions,” Toci says.

With the median home price 25% higher than 2Q 2011 and with annual sales of single family residences approaching, and in some instances exceeding, peak levels in 2005, there are indications to suggest that Arizona has bottomed in the housing market. Continued reduction in housing supply — combined with elevated demand from new home buyers and investors purchasing at deep discounts — have led to new affordability levels which have had the impact of attracting major employers to the Valley, namely American President Lines (APL),, eBay/PayPal, Safelite Auto Glass, Transperfect and Power One.

Both the Metro Phoenix industrial and offi ce markets are the beneficiaries of this employment growth. In 2005, Phoenix was No. 1 in the nation in terms of job growth with 103,800 new jobs added. Three years later, in 2008 and 2009, Phoenix lost nearly 230,000 jobs.

During that time, the industrial market, with a current base inventory of 263 MSF, suffered negative absorption of 2.3 MSF and 2.8 MSF, respectively. Similarly, the office market, with a current base inventory of 78 MSF, suffered negative absorption of 1.1 MSF each year in 2008 and 2009. With 2010 being a transition year, 2011 witnessed 6.1 MSF and 1.1 MSF of positive industrial and office absorption, respectively. 1Q 2012 trends are continuing with nearly 600,000 SF of industrial and 210,000 SF of office absorption, respectively.

“Phoenix is leading the national recovery in housing and commercial development,” says Kurt Rosene, senior vice president for The Alter Group. “The current activity from potential corporate relocations looking at Arizona are at an all-time high. Phoenix is on every site selection list, based upon affordable housing, strong educated employment base, the availability of zoned land, a relatively easy development process and a proactive state government that keeps signing additional economic incentives into law.

“We believe that all of these factors will combine to cause positive job growth in Arizona, maintaining the recovery that has already taken place in the industrial distribution sector,” Rosene adds.

According to Toci, rental rates for the industrial sector are beginning to firm with strong rental increases projected within the next 12 months across many of the submarkets. Office rents in certain submarkets are beginning to firm and will continue to do so in those submarkets with rapidly declining vacancy rates. More peripheral office submarkets will take more time to chew through excess supply levels generated in the last development cycle.

“After nearly five years of ‘chill’ in Phoenix, institutional investors are beginning to lift their restrictions for acquisitions,” Toci says. “As trite as it sounds, blue sky and sunshine will once again prevail and will continue to attract residents from the frozen tundra of the Rust Belt.

“The systemic challenges related to California’s deep budget deficit will serve as a catalyst for future growth in Phoenix and we will once again demonstrate that the Valley of the Sun’s resilience should never be taken lightly.”

Industrial outlook

“Net absorption of industrial space slowed in the first quarter following a 2-year run where tenants moved into a net of more than 12 MSF. The easing pace of absorption was not a function of a retreating demand, however, but rather a function of a lack of available product, particularly among large users.

“Tenant demand for large blocks of space has been driving the local industrial market, and will fuel future development. After peaking at approximately 20% in early 2010, vacancy in industrial buildings 250,000 SF and greater fell below 7% in the first quarter, well below the rate for all industrial properties in the market and nearly identical to levels achieved from 2002-2006.”

— Bob Mulhern, managing director, Colliers International

“The Metro Phoenix industrial market has seen 2+ years of growth as demand among users continues, resulting in declines in vacancy and positive absorption. Large users, 250,000 SF and greater, continue to be active and have fueled the growth in the Southwest Valley. With only three or four viable options in this size range, Phoenix will see both spec and build-to-suit development projects break ground this year. In 2012, and specifically during the second quarter, there has also been renewed interest from mid-size users looking for 100,000 to 200,000 SF of industrial space. Growth among the mid-size user, continued interest from large users, and developers willing to pull the trigger on new development are strong indicators that the Phoenix will continue its positive trend as one of the country’s leading industrial markets.”

— Brad Ahrens, vice president, Cassidy Turley BRE Commercial

“With the banks beginning to loan to owner-occupied small business industrial sites, I predict that smaller industrial spaces will become scarce and the average price will begin to rise. A small business person can now purchase a building with an equal to or lower mortgage payment than lease payment and only put down 10% for an SBA loan.

“This re-entering of the banks into industrial building loans should start to slowly drive up prices.”

— Rex Griswold, VP sales & leasing, Commercial Properties Inc.

Office outlook

“During the first quarter of 2012, the Greater Phoenix office market failed to gain any notable momentum and similar performance is forecast for the remainder of this year. Vacancy ended the quarter at 22.1%, marking the 12th consecutive quarter where the rate was above 20%. While the local economy is showing signs of life, more sustained expansion will be needed to ultimately prompt developers to move new projects into the pipeline. The good news for the office market is the accelerating pace of employment growth in Metro Phoenix. The addition of more than 23,000 workers in the first three months of 2012 was the strongest quarterly growth in six years and forecasts for future expansion were recently revised higher.”

— Bob Mulhern, managing director, Colliers International

“All of the leading indicators — vacancy, rental rates and net absorption — were flat at the end of the first quarter. However, everyone agrees that we are seeing much more tenant activity in the market whether its calls, tours or proposals. Based on this increased first- and second-quarter demand, I believe we will look back at year-end and see significant leasing activity in the third and fourth quarters. Our sense is that the indicators will move from flat to positive as vacancy declines, net absorption increases and rental rates start to improve in the metro Phoenix office market.”

— Tyler Wilson, vice president, Cassidy Turley BRE Commercial

“The office market remains mired at 27% vacancy. After a reasonable 2011, net absorption reverted to negative in 1Q 2012. We continue to be bullish. Long term, however, we need job creation from basic industries to spur expansion and a lowering of the vacancy rates. As long as vacancy stays at this level, there will be downward pressure on rents. We are still surprised at some of the low terms we have been able to negotiate for tenants we represent. “One bright spot is Class A properties. They are leasing up (at the expense of Class B properties) and have been able to tighten their leasing criteria in select areas.

— Craig Coppola, principal, Lee & Associates

“To date, 2012 is showing a lot of positive signs. Tenants are certainly active relative to that of 2010 and 2011. Businesses seem to be gaining confi dence in the market as well as in their own industries and in turn are looking to relocate and expand. Distressed properties are being traded and struggling owners are being replaced with stable, healthy owners that are in a much better position to raise funds for capital and tenant improvements and to sign leases at rates in line with this environment.”

— Justin Horwitz, senior advisor, Sperry Van Ness

“Per square foot sale prices will increase throughout 2012, especially for assets in good locations with 80% occupancy or higher. We will experience cap rate compression due to a scarcity of good assets on the market and the influx of institutional investors that have been priced out of larger/coastal markets.

“Rental rates will remain relatively fl at through 2012 and incentives (free rent, higher fees, etc.) will likely remain unchanged. We should experience rental increases in 2013, as the vacancy for Class A and B spaces begins to fall, and incentives will begin to decrease.

“Over the next 12 months, we will see a handful of build-to-suits and pre-leasing of certain planned developments (in core markets), with limited speculative development taking place.”

— David Carder, senior vice president, CBRE

“The office market is still scraping along the bottom and will remain there until more jobs are created. Companies are taking advantage of this huge buying opportunity to own their space and reduce and control their occupancy costs.”

— Craig R. Trbovich, commercial real estate advisor, CPI

Today’s market

  • We are still experiencing a high number of well known companies searching for large, big box, distribution space in the West Valley. The amount of spaces more than 300,000 SF has severely decreased over the past 2 years leaving the user who is looking with a minimal amount of spaces to choose from. There are currently only 2 options left fora tenant that needs 300,000 SF or more.
  • There are 5-6 well known developers who are in various stages of design for speculative distribution style buildings ranging from 400,000 SF up to 1 MSF. All of these facilities are located in the West Valley.
  • Rental rates remain low in the West Valley but most anticipate a rise in the rates due to the increased volume of activity and the decreased number of functional spaces.
  • There are two build-to-suits underway in the West Valley, Dick’s Sporting Goods for 600,000 SF and TJ Maxx for 1 MSF. There are also a few on hold, a large boot company and a door company.
  • In the East Valley, the sales market remains strong for the owner/user type facilities with 11 buildings being sold of more than 40,000 SF in 2011 and a number of buildings in escrow of the same size range now.
  • Smaller facilities from 5,000 SF to 20,000 SF for sale are difficult to find. The sales prices have dropped but the inventory is also low.
  • The leasing activity in the East Valley is slow for the local and regional companies ranging in size from 5,000 SF to 25,000 SF. Most of these small companies have made it through the economic downturn and are now trying to recover. A large majority of them still rely on the “home-building” industry and as that market slowly returns so will their confidence.
  • Companies in the East Valley that are buying and leasing are in industries including aerospace, nutrition, technology and of course all of the contract work with Intel and its massive construction project in Chandler.
  • Overall, the sales activity for small buildings is up and trending that way. The product is hard to find for those buyers but most buildings that are for sale today have good activity.
  • Overall, the leasing activity for small space remains slow and the large distribution spaces remain robust.

Future market

  • Expect more build-to-suits by local and national contractors. While the market has a number of vacant buildings, the number of quality buildings available for sale is very low.
  • Expect 2-3 developers to break ground on speculative distribution facilities within the next year in the West Valley.
  • Expect to see a slight increase in rental rates in all sectors of the market, distribution, flex and multi-tenant.
  • The sales prices on buildings will increase faster than lease rates and outpace the leasing market.
  • Lenders will remain strict in underwriting, however, the SBA program will stay in place and allow the smaller buyers the ability to buy real estate.
  • Expect institutional investors to pay a premium for institutional grade product, as they are flush with cash and need to place it. Nationally, Phoenix is showing a turnaround and those who did not get in during the last cycle find themselves trying to get in on this cycle at a lower basis.
  • Source: Chris McClurg, principal, Lee & Associates

AZRE Magazine July/August 2012