Several large office tenant move-outs during first quarter fueled the Phoenix office market to post negative net absorption reaching -572,754 square feet, according to a report released by Colliers. Despite total vacancy rising to 19.9 percent, the city’s landlords have been able to maintain healthy rental rates.
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As office space utilization continues to evolve with hybrid work schedules, the Phoenix office market is experiencing a trend of tenants releasing their large amounts of space in exchange for smaller footprints. This resulted in the average new direct lease signed during first quarter dropping 23 percent year-over-year to 4,048 square feet. Leasing activity remains active, but the ratio of tenants expanding compared to those shrinking is very lopsided. Five companies that downsized or terminated operations in Greater Phoenix during first quarter accounted for 491,623 square feet of new vacant space. Those five move-outs more than counter-balanced the new direct leasing activity for first quarter, which totaled 438,250 square feet. The largest new direct lease signed during first quarter was Pulte Homes’ relocation from Terra Verde to Axis Raintree. The homebuilder will minimally downsize by 7,000 square feet and has signed a lease for 49,875 square feet at the Scottsdale Airpark building.
Direct vacancy rose for the fourth consecutive quarter to 15.1 percent, which is a 20 basis point rise quarter-over-quarter. Total available space rose to 19.9 percent. The past three quarters had demonstrated a slowing of sublease space hitting the market, but first quarter 2024 ticked up with 461,109 square feet of sublease space being added. That new sublease availability includes two spaces over 100,000 square feet, the largest of which being Freeport McMoran’s 246,490 square feet in Downtown. Currently, there are four submarkets with more than 750,000 square feet of sublease space, including Tempe, Chandler, Airport Area and Deer Valley. Vacancy rates have decreased in Downtown North, Scottsdale South and Scottsdale Airpark. The largest year-over-year increases in vacancy were posted in Tempe, South Tempe/Ahwatukee and Chandler.
Rental rates continue moving in a positive direction, increasing by 0.7 percent quarter-over-quarter and 2.6 percent year-over-year ending first quarter at $29.87 per square foot. Class A assets posted the largest rate increase year-over-year, rising 2.9 percent and ending at $33.10 per square foot. These increases are driven by the intense expansion of building amenities in high-end properties, primarily focused in Scottsdale submarkets, Camelback Corridor, Tempe and Chandler. The highest rental rates for the third consecutive quarter were obtained in Class A assets in the Camelback Corridor where rates ended the quarter at $41.10 per square foot.
The first quarter posted the second lowest amount of construction going back to 2014, ending the quarter at 711,673 square feet. The only building to break ground during first quarter was the third office building at The Grove project in the Camelback Corridor. The 40,000-square-foot facility is being developed by 3Edgewood, an investment real estate company being funded by Robert Sarver. During 2022 Viasat announced plans to expand its footprint in Tempe at ASU Research Park and in 2023 construction broke ground on a 135,000-square foot building. Viasat will not take possession of the building, making the space available for sublease when it is completed in third quarter of this year. This marks the second company to abandon its commitment to new office construction during the past 12 months. Carvana will not be occupying its committed 243,301 square feet in Tempe. These two projects comprise nearly 40 percent of the total construction underway in the market.
Investment sales volume in the office market during first quarter totaled $189 million, which was the second lowest quarter in the past two years. This marks a 15.4 percent decrease year-over-year and 29.6 percent decrease quarter-over-quarter. Average price per square foot last quarter was $181.78, which represents a 26.3 percent decrease year-over-year. The top sale of the first quarter was a four-building complex in Deer Valley known as The Corridors. The 100 percent leased, 164,235-square-foot complex was purchased by The Voit Company for $32.9 million. The highest price paid per square foot during the quarter was $506.30 for a 30,417-square-foot medical office building in Mesa. A few notable Class A assets are expected to be sold this year, including The Beam on Farmer in Tempe and the 24th and Camelback building in the Camelback Corridor.
Colliers anticipates current trends to continue in the Greater Phoenix office market as the spread of office space volume leased is pressured by space being handed back to the market. The results of hybrid work are adding stress to assets not just in office space, but also for the retail and service tenants of those projects that rely on occupancy to create business. The biggest question in the market is when the downward pressure on sale prices and high vacancy rates will create a decrease of rental rates. Many assets being sold require high capital investment to make them competitive. A business rationale for Infusing these assets with capital improvements will require rates to hold or increase to create acceptable yields.
