Increased Building, More New Offices, Higher Rents
Date: 12-24-2006
Newspaper: The Arizona Republic
Forecast for the valley's commercial properties is mixed but mostly sunny
Most people whose livelihoods depend on knowing such things, expect commercial real estate in the Valley to have a very merry 2007.
The consensus is that rents in all sectors will grow, vacancies will remain low -- even as many more buildings go up -- and institutional investors will continue pouring money into the area.
Phoenix isn't an afterthought anymore, they say. The Valley is expected to be the choice location for companies that traditionally have looked to Southern California, Dallas, Denver and Atlanta to set up warehouses and office support.
At least that's the sunny forecast.
But the road ahead may not end up looking so bright if interest rates climb too quickly or the national economy turns sour. So much of the area's growth has benefited from a strong national economy that has brought new companies and 94,500 jobs to Phoenix in the past year. That's more jobs created since October 2005 than in 46 states, according to the U.S. Department of Labor. Just Florida, Texas, California and Arizona generated more jobs, and Phoenix created 78 percent of Arizona's jobs.
Economists are forecasting that supply and demand for commercial real estate will be in balance into 2007, said Lee McPheters, director of the JPMorgan Chase Economic Outlook Center at Arizona State University.
The only hitch would be a hard landing for the economy that would slow job growth and the demand for commercial space.
But for now, economic signs are positive. "There's nothing right now putting the brakes on it," McPheters said.
So, the predictions are that commercial properties will become pricier to build and buy, rents will grow across the Valley and vacancies will stay historically low in 2007.
Industrial boom
A look at the Valley skyline betrays a boom driven by industrial building. About 9 million square feet of speculative industrial space, used for warehousing, distribution and manufacturing, is being built in the Valley and is expected to be available in the next 18 months.
"We're building on a feverish pace in the spec market," said James Wilson, senior director for Cushman & Wakefield of Arizona. Space that is much needed.
"Pressure for developers to get product in the marketplace is as high as I've ever seen it," Wilson said. "We've lost deals in the West because we haven't been able to show people space."
Overall vacancy rates, as of the third quarter, are between 5.6 percent and 6.7 percent, according to brokers. Those are considered low, as are leasing rates, which averaged 74 cents a square foot.
Cost constraints and business regulations have push some distribution companies that would typically set up or expand in California into more business-friendly Arizona.
Lead time for industrial building is now about 14 months. Costs are spiking as material and land prices continue to climb. Low interest rates still allow companies to reasonably finance deals.
And once the project is started, it isn't long before the space is spoken for.
Companies are choosing the Valley because it's a six-hour drive from the California ports, said Pat Feeney of CB Richard Ellis. And although housing prices have increased, they have yet to hit the levels in California.
Hot areas for industrial development include the southwest Valley, heading down Arizona 85 in Buckeye, and Pinal County, said Lane Neville of Land Advisors Organization, which provides land brokerage and site-selection services.
Interstate 8 will further fuel industrial growth in Casa Grande and Eloy. The ability to skirt Valley traffic via Arizona 85 to I-8 will make those outlying parcels much more attractive, Neville said. The rapid growth in housing in those areas also helps attract distribution companies and other industrial firms.
Industrial buildings also will cluster in Mesa, around Williams Gateway Airport, he said. The expanded Loop 202 is helping, even though it's not yet connected.
Finding office space
Office rents are rising, and vacancy rates are falling. That's a good thing for landlords, said Kevin Calihan, first vice president for CB Richard Ellis.
"I would say right now the market is very strong," Calihan said. "Our ability to create jobs is remarkable. And when you create jobs in the office world, they have to have a space to work."
Vacancy rates stood at 10.9 percent Valleywide at the end of the third quarter of 2006, according to CBRE. Anything lower than 10 percent is considered a constraint on the market, because prospective tenants may not be able to find the space they need. Rates higher than 20 percent are considered too open.
But Phoenix remains underdeveloped when it comes to housing office workers. And that could hurt the area's ability to attract companies that want to move in quickly.
Calihan points out that Phoenix has about 63 million square feet of office space, much less than Denver, Dallas and Atlanta.
Calihan said the Phoenix office market is in the midst of a building boom, with about 3.6 million square feet under construction. Of that new space, 15 percent is already leased.
Construction should continue to be strong in 2007, as developers can expect to quickly fill up space and ontinue to raise rents at the same time. But construction, from start to finish, is taking about two years, which also can turn off office prospects.
"They (companies) can't predict space two years from today," he said. "They want to say we'll open in six to 12 months."
Mixed retail prospects
Some say retail will remain a strong market because of the continued population and employment growth. Others say growth will be much slower.
"We don't see any drop-off in retail around employment hubs," said Spike Lawrence of Lawrence & Geyser, which develops retail centers around the Valley. His company is working on two mixed-use projects in Chandler and a redevelopment project in central Phoenix.
Michael Pollack, who also owns several East Valley retail centers, is not so bullish about the market.
"I'm preparing for what may be a little bit of a correction," Pollack said. He thinks rents have gotten a bit high, which may discourage further development.
Still, some big names have announced they are coming to the Valley. But the addition of high-end stores Bottega Veneta and Barneys New York at Scottsdale Fashion Square won't be a reality until 2008 and 2009, respectively.
"If there's a segment that filled their appetite over the last few years, it's retail," Neville said. Much of the land for commercial corners is acquired, and building on those sites could be years away as housing and office space catch up.
Still, rental rates remain strong and occupancy is up. Space is about 95 percent occupied Valleywide, and CBRE's third quarter outlook has rents growing 5 to 15 percent.
But the story going forward, Neville said, is redevelopment projects.
Landlords are being inspired by the Biltmore Fashion Park renovation and redevelopment at 44th Street and Indian School Road, Neville said.
Large-scale projects are on the drawing board too. One with much anticipation surrounding it is Downtown's CityScape, a joint mixed-use project of RED Development, Barron Collier Co. and Cardon Development Group. The project combines urban living with shopping, office and entertainment, but the opening date is anticipated in spring 2009.
Apartments regain popularity
Few apartments were built in 2006, and relatively few will be built in 2007.
That's helping shape another strong year for apartment owners, said Jim Crews, director of Cushman & Wakefield's apartment brokerage service.
Vacancy rates on apartments dropped to 5 percent, from 8 percent, in the last year. Those vacancy rates are likely to stay at the 5 to 6 percent level.
About 5,000 units are expected to be built next year, mostly north of Phoenix, the southwest Valley and far east in Mesa, Gilbert and Queen Creek. That's less than 2 percent of the total available apartments in the Phoenix metro area, so rents aren't likely to stall.
The relative scarcity of new apartments led to the disappearance of such move-in incentives as free rent. Rents also were able to inch up 4 to 6 percent this year, the highest movement since 1994, Crews said. He anticipates rents could grow 8 percent in 2007.
Failed condo conversions may hurt some nearby apartment complexes by offering lower rents but won't hurt the overall market because last year's conversions took out less than 5 percent of the apartments.
Real estate watcher Jay Butler anticipates the return of some concessions because of those failed conversions. He's already noticed a few complexes posting free rent.
Butler, who heads the Arizona Real Estate Center at Arizona State University Polytechnic campus, said he expects rents to stay steady.
"They are not going to get the big rent increases," he said. "A lot raised rents (once the housing market stalled), and a lot are finding that they are having trouble keeping tenants."
As for the condo market, some owners are optimistic.
"My 2007 forecast is that as long as interest rates remain where they are, or continue to go down, the condo market will be healthy through 2007," said Stephan Heath, president of Phoenician Pines LLC. The company boasts selling more than 100 of its 240-unit condo conversion last year.
Investor outlook
Institutional investors have been snapping up commercial properties around the Valley in droves. Some big recent deals include two American Express buildings selling for $90.7 million to a Detroit-based pension fund, and the Corporate Center at Kierland two-story office building that sold for $32.17 million to two real estate investment companies.
That buying isn't necessarily expected to slow in 2007.
"Phoenix has become a better investment market (as the) typical investment markets have run out of space," said Butler. But that doesn't mean the money will flow freely.
"It's also a market with a lot of vacant land," he said. "Investors don't like to buy into a market where it (project) can be quickly duplicated."
Developer Pollack anticipates some potential investors will see the risks outweighing rewards. Building prices have skyrocketed, so squeezing out value is increasingly difficult.
"Just because you buy a piece of property that's 100 percent leased doesn't mean that's the right price for that property," he said. "There are many properties that have sold that have been overpriced in the last 2 1/2 years based on true underlying real estate."
Although he doesn't see a bust, Pollack thinks 2007 will be a year when more questions are raised about the investment value in Phoenix.
"I look at the real estate market like a car race. When the green flag is on, time will take care of mistakes. And we've seen that for many years now, since the mid-'90s. We're definitely not in the red. I'm not suggesting we shouldn't continue to build, but (it should be) responsibly. We are in the yellow."
Michael Pollack
President, Michael Pollack Real Estate Investments
"I would say right now the (office) market is very strong."
Kevin Calihan
First vice president at CB Richard Ellis
"Industrial has been a very strong category this year in the Phoenix metro area, and it's important for everyone to understand we include Pinal county now in the metro area."
Lane Neville
Designated broker, Land Advisors Organization
"Phoenix has created more jobs than every state (aside from Arizona) except the three big ones: Texas, Florida and California. We have a tremendous job machine, and they need office space, retail space, industrial space for storage."
Lee McPheters
Director, JPMorgan Chase Economic Outlook Center at Arizona State University
Office vacancy rates:
* 8.5 percent in north Valley/Paradise Valley to 20.8 percent in west Phoenix, according to CBRE. Average was 10.9 percent.
* 5.5 percent in downtown Phoenix to 32 percent in the West Valley, according to Cushman & Wakefield. Average was 12.8 percent.
Average asking leases:
* Class A space (excellent location and premier amenities): $26.67 a square foot for existing space and $28.68 for new construction.
* Class B space (good location and above-average amenities): $20.92 for existing space and $27.68 for new construction.
* Class C space (older office buildings): $15.94.
CBRE MarketView, Phoenix Office, Third Quarter 2006
Industrial vacancy rates:
Between 5 and 10 percent, depending on part of the Valley, according to CBRE. Marketwide average is 6.7 percent.
Rents/vacancies by industry:
High tech/flex: 8.7 percent vacancy; $1.08 per square foot.
Manufacturing: 3.4 percent vacancy; 57 cents per square foot.
Office service center: 5.7 percent vacancy; 94 cents per square foot
Warehouse/distribution: 5.6 percent vacancy; 56 cents per square foot
Cushman & Wakefield Phoenix Industrial Market Statistics, Third Quarter 2006.
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