Virgin Industrial Park.
Phoenix industrial rents increase 31% in 12 months
Greater Phoenix is in hot demand by industrial tenants, which has resulted in record low vacancy levels, rising rates in rents and a flurry of new construction. According to the first quarter 2023 report released by Colliers in Arizona, rental rates have increased 31.4 percent in the past 12 months. Construction activity has increased 37.8 percent year-over-year to a new high of 46.8 million square feet currently underway.
The Greater Phoenix industrial sector is leading the commercial real estate market in all categories from leasing to rental rate growth, as well as compressed vacancy and historic levels of construction. The area’s industrial market does not seem to be feeling the impact of rising interest rates, except in the investment sales sector.
Industrial rental rates increased 5.5 percnt quarter-over-quarter, ending first quarter at an average of $0.99 per square foot (NNN). Since 2019, rental rates have increased an annual average of 11.9 percent. Rates have risen rapidly in the past two years, increasing more than 52.7 percent compared to first quarter 2021. All five submarkets experienced rate increases, both year-over-year and quarter-over-quarter. The largest increase year-over-year was found in the Southwest submarket, rising 47.3 percent in 12 months to end at $0.82 per square foot.
Strong tenant demand is pressuring these rents. The first three months of 2023 marked the 12th consecutive quarter of net absorption surpassing the one million square feet mark. First quarter ended with 4.8 million square feet of net absorption, slightly lower than the previous quarter and three million square feet lower year-over-year. Despite the decrease, the market is on course for the three-year average of 4.2 milion square feet. Demand is extremely positive and many leases have not yet been executed. The largest lease of the quarter involved CubeWorks, a flexible co-working company, taking 915,160 square feet at Cotton 303. The second largest lease was signed by Sysco, the food distribution company, taking 353,662 square feet on Scannell Properties’ new project.
Vacancy remained level during first quarter at 3.0 percent, which is a decrease of 100 basis points year-over-year. The Southwest submarket ended first quarter with the lowest level of direct vacancy at 1.8 percent. This is a 330 basis point decrease year-over-year. The Northwest submarket delivered the most new inventory during first quarter, 2.9 million square feet. Despite the sizable increase in inventory, the submarket’s vacancy decreased 20 basis points quarter-over -quarter to settle at 4.9 percent.
Greater Phoenix Economic Council reports 47 prospective tenants in the market looking for space in excess of 200,000 square feet. This is an increase of 46 percent compared to the previous quarter. Currently only 12 existing buildings can accommodate a 200,000-square-foot tenant and only one option is available for a user of 500,000 square feet. This level of demand is creating strong pre-leasing activity.
The amount of new product being started is outpacing the square footage being completed, causing the total amount of under construction to rise. There are currently 46.8 million square feet underway throughout the market, an increase of 7.0 percent from 4th quarter 2022 and a 37.8 percent jump year-over-year. This marks a new record for amount of square footage under construction. More than 18 percent of the space under construction is pre-leased. During first quarter, 4.5 milion square feet of space were completed, 60 percent of which was located in the Northwest submarket. Total inventory has risen 15 percent in the Northwest area during the past year. The 4.5 million square feet of new deliveries was 71 percent leased upon completion. The West Valley dominates the construction market with more than 68 percent of the construction taking place in the Northwest and Southwest clusters. The Southeast valley is quickly transforming and has nearly doubled its construction activity in the past 12 months.
Investment sales remains the only area of the industrial market to be struggling. Following a slow down in investment sales at the end of 2022, first quarter 2023 postd a second consecutive decrase in sales volume, totaling $477 million. This marks a 15.3 percent decrease quarter-over-quarter and a 44.7 percent decrease year-over-year. While sales volume is down, increased rental rates at properties has translated into increased values. The median price per square foot rose 15.3 percent year-over-year. The Southeast valley led the market in total sales volume during first quarter, nearly reaching $200 million. The largest sale of the quarter was the two-building Warner Commerce Center in South Tempe. The 197,000-square-foot project delivered this quarter 100 percent vacant and sold for $42 million, $215 per square foot.
Increased interest rates and the resulting drastic decline in lending will continue to impact the Phoenix industrial market. The market will be driven by leasing moving forward. While Colliers anticipates another decline in investment sales during second quarter, the firm predicts an uptick in the second half of 2023. Arizona continues to be a focal point for national and international investments. The state ranked first in the nation for international investments in 2022, which helps fuel the rapid growth of the Phoenix market.