Phoenix’s Office Market Remains Questionable
By Laurel Lewis, Senior Vice President, NAI Horizon
The office market is in uncharted territory, like going “Down the Great Unknown.” When John Wesley Powell navigated through the Grand Canyon, he did not know what lay ahead. Perhaps if he did, he might have chosen to leave it uncharted. Yet here we are in the midst of the proverbial river, wondering what lies ahead.
The advent of a pandemic is changing minds about how and where we work. The work-from-home model may have started a decade ago, but the pandemic and new technology have exacerbated the trend. How will this affect the office market and, more specifically, the office market in Phoenix? The long-term effects remain to be seen, but we know Phoenix continues to attract new residents and new businesses. The Central Business District, for instance, is experiencing renewed interest. This is enhanced by the City of Phoenix’s efforts to offer a pedestrian-friendly environment, more entertainment and access to the light rail.
The investment is paying off. Companies in bioscience, education, technology and financial services are taking an interest in the area’s vibrancy. To top it off, the second quarter came to a close with the Phoenix Suns making it to the NBA finals, bringing national attention to the corridor.
While current trends point to a positive outcome, unknowns remain. How will new variants affect the demand for space, and how many employees will be required (or opt) to work from home? Second-quarter numbers show vacancies have risen due to sublease space. However, we can argue much of that sublease space resulted from mergers, acquisitions or companies already downsizing. It is important to note sublease space is not always in competition with direct space due to challenges with subleasing.
Surprisingly, speculation of where the office market is heading has not affected overall rental rates in Phoenix. According to CoStar, the average full-service gross rate is up 21 cents from the previous quarter, coming in at $27.48. This is compared to the $26.92 rate seen at the pandemic’s start. Newly constructed Class A space is attracting companies focused on quality, amenities, location and walkability. Office rental rates support this development — with an all-time-high asking rate of more than $50 per square foot.
When it comes to negotiating leases, larger tenants are in the driver’s seat. Although rates are steady, tenants can expect a close-to-turnkey buildout, in addition to free rent. Landlords are benefiting from longer lease terms, unlike at the start of the pandemic, when tenants were hesitant to sign long-term renewals and chose to wait and see. Optimism in the market is returning, and the trend is increasing lease terms from a five-year average to seven years, sometimes more.
In addition to built square footage, land is becoming more valuable. Hopeful developers are buying land and getting entitlements, preparing for tenant demand and timely delivery. Phoenix is hot, and Phoenix will rise.