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The metro Phoenix office market is finally starting to make a comeback. Metro Phoenix ranked third in the nation in terms of net absorption for the third quarter, posting a positive 1,008,933 square feet. Demand has been steadily increasing for the office sector, especially for buildings that can accommodate large corporate users.
Phoenix’s office market is still recovering from a large oversupply. The office vacancy rate more than doubled from the beginning of 2007 to the second quarter of 2011, increasing from 12.2 percent to 24.5 percent. Since then, a gradual increase in demand and a lack of new construction has brought the vacancy rate down to 21.2 percent. Right-sizing by office users through the consolidation of space, and by using more efficient floor plates, has slowed the overall decline in vacancy. To draw a parallel to the 2001 recession, demand for office space in Metro Phoenix was weak in the first three years of recovery, averaging 1.7 million square feet of annual net absorption. The office sector took off in 2005, 2006 and 2007, averaging 2.8 million square feet of annual net absorption.
Due to the recent increase in demand, build-to-suit and speculative construction announcements made the news in 2013. We expect more announcements in 2014. Companies like State Farm, General Motors and GoDaddy announced build-to-suit projects. This seems surprising at first glance because of the elevated 21.1 percent vacancy rate, but the majority of demand in today’s market is from large corporate tenants seeking efficient floor plates and a parking ratio of at least 5.0 per 1,000 building square feet. The majority of the vacant space lies within older buildings that are primarily set up for smaller tenants with below-average parking ratios, making some of this space functionally obsolete.
As of mid-November, Cassidy Turley was tracking 20 office users in Metro Phoenix that were looking for 100,000 square feet or more of contiguous space. During this time, there were 18 office properties that contained 100,000 square feet or more of contiguous vacant space that was immediately available for lease or sale. Only eight of these properties are considered high-quality options with competitive parking ratios and locations in desirable communities that are close to freeway transportation.
Office investment sales are expected to continue at a steady pace in 2014. Valuations for the strongest deals are approaching intrinsic value. Distressed properties have made up the majority of transactions in the past few years. Today’s sellers are more strategic, and distressed sales are declining.
Demand for metro Phoenix office space is soon expected to reach levels similar to 2005 through 2007 as a positive job forecast is expected through 2017. As demand increases and vacancy continues to decline, expect landlords to raise rates in the strongest locations and properties. As this occurs, some developers will begin speculative properties to meet tenant demand.
— Zach Aulick, director of research, Cassidy Turley