MARKET HIGHLIGHT, NOVEMBER 2009

PHOENIX
Michael Romney, Tom Semancik, Bobby Bull, Jack Hannum and Eric Jones

Phoenix tenants with staying power are enjoying their options in the current market while developers and investors continue to look for positive signs.

Office

Both large and small companies are taking advantage of current market conditions by blending and extending their leases or upgrading locations by way of the aggressive rates currently being offered.

Size really doesn’t matter when it comes to renewing and renegotiating. All tenants have been hunkering down in their current space by renegotiating reduced rates without incurring relocation costs, especially if their current location suits their needs for the next 2 to 5 years. Despite some positive economic news, absorption has been negative for 4 straight quarters, a total of 3.2 million square feet vacated. Leasing activity has slowed to approximately 1.7 million square feet per quarter this past year compared to 2.5 million square feet per quarter the previous 4 years.

Developers have delayed some projects and completely shelved others. Deliveries averaged 1.8 million square feet per quarter the past 4 years, whereas year-to-date 2009 only 1.8 million square feet have been constructed. There are currently no construction starts in Phoenix.

Vacancy rates continue to climb, as they have since fourth quarter 2006 (98 percent jump), and rental rates continue to contract since their peak in second quarter 2008 (9.2 percent drop). Fringe markets will not see demand increase as businesses move closer to freeways, airports and amenities at cheaper rates than were offered in the past.

Scottsdale, Camelback Corridor and Phoenix’s central business district will remain the hot submarkets. The southeast valley’s 202 San Tan corridor began with significant growth in the last 2 years, but that growth was stymied when the market crashed and it will be slow to recover.

All investors have had to adjust their expectations and pro-formas to account for longer holding periods, due to increased leasing periods — currently 290 days is the average lease-up time — and depressed rental rates.

Investment sales total $140 million year to date in 2009 compared to $1 billion in 2008 and $43 billion in 2007. Cap rates during those same periods were 8.66 percent, 6.1 percent and 6.3 percent, respectively. The biggest deals in 2009 have been purchased by out-of-state investors from California, Colorado and New York.

2009 will continue to be a tough market for all parties. Landlords will continue to decrease rental rates to attract tenants, and tenants will be hesitant to move knowing they can aggressively renegotiate terms at their current location. Development will pick up again once absorption returns to positive levels and new tenants reappear in the market.

— Michael Romney is a sales & leasing agent in Commercial Properties, Inc./CORFAC International’s Office Group in Tempe, Arizona.

Retail

The one word that describes the metropolitan Phoenix retail market at the start of fourth quarter 2009 is challenging. Drastically reduced retail spending has significantly battered retailers both large and small. Vacancy is still climbing but at a decreasing rate, with valley-wide third quarter retail vacancy likely to top out at 11.3 percent compared to 11.1 percent during second quarter 2009 and 10.3 percent during first quarter 2009. More importantly, large percentages of remaining tenants are asking for rent relief as they struggle to survive. In turn, the reduced cash flow from retail properties has challenged owners with significant debt, especially from loans that were put in place at the end of the boom from 2004 to 2006.

The big box sector has been hit unusually hard as vacancy has increased. The most notable increase to vacancy was posted by the local grocer Bashas’ Supermarkets, which filed for bankruptcy last quarter. At the time of filing, Bashas’ said it would close 10 stores as well as cancel several leases with the majority of the Food City, Bashas’ and AJ’s Fine Foods stores in Maricopa County. According to CoStar.com, the average Bashas’ store is 43,500 square feet. The abundance of vacant second- and third-generation big box space should be a drag on the retail market sector for a long time.

Another segment that has been hard hit is restaurant businesses. With incomes dwindling, restaurants, especially the sit-down variety, have been closing at a significantly accelerated rate, further depressing rents and investment sales.

However, not everything is gloomy. Speculative building has largely stopped. With construction activity down, construction costs are estimated to be reduced by 20 to 25 percent from 2006 levels. Select projects that have been in the works for some time are moving forward with anchor tenants in place. Owners are accepting the new reality and moderating their rental demands so that tenants can survive in the current environment.

For retail property owners and their tenants the theme for the rest of 2009 and 2010 will be “back to basics.”

— Tom Semancik is a senior vice president, sales & leasing, in the Tempe office of Commercial Properties Inc./CORFAC International.

Multifamily

The Phoenix metropolitan apartment market is reeling from the double blows of widespread unemployment — still climbing toward the 10 percent mark — and declining single-family home prices. The result has been a drastic weakening of apartment market fundamentals: rental rates have declined 2.7 percent from $802 per month in fourth quarter 2007 to $780 in second quarter 2009. Concurrently, the overall vacancy rate has increased from 8.64 to 13 percent during the same period.

With eager-to-deal landlords now offering concessions of 1 to 3 months as compared to 2 weeks in 2007, net rental incomes have declined 10 to 25 percent since that time. Not surprisingly, new multifamily development will be at a relative stand-still for the next 3 years, as the global economy plods toward recovery and the employment rate in Phoenix begins to move upward, probably around 2011. Currently there are 3,057 units under construction — a 1.3 percent increase to the current inventory — with one third being developed in Tempe near Arizona State University.

However, investment capital is highly interested in the Phoenix market, which is still considered a high-growth metro area. Savvy investors remain confident that it is an excellent place to own multifamily assets for a 5- to 10-year hold. The majority of apartment investors now snapping up available properties are private capital ownerships such as HSL Properties; Nevins, Adams, Lewbel & Schell; ConAm; Sherman Residential; Orion Residential; Stonecraft Homes; Mid-America Apartments and MC Companies. Although sales volumes for the 12-month period ending in January 2009 were off by more than 80 percent from the same period ending in 2008, there has been a spate of encouraging acquisition activity this year. Significant transactions in 2009 include the 592-unit Wachovia portfolio, featuring Desert Mirage, Springs at Alta Mesa and Montana, for $40.5 million or $68,412 per unit; the 316-unit San Tropez for $29 million or $91,772 per unit; the 308-unit Sage Stone at Arrowhead for $23.2 million or $75,325 per unit; the 472-unit Villagio for $20.25 million or $42,903 per unit; and the 240-unit San Montego for $20 million or $83,333 per unit.

Like the mythical bird for which the city is named, Phoenix’s apartment market is sure to rise, stronger than ever.

— Bobby Bull and Jack Hannum are vice presidents in Transwestern’s Phoenix office.

Industrial

The Phoenix metropolitan industrial market, like others, has been impacted by the global recession and the turmoil in the credit markets. There are positive trends however. Preliminary reports show a potential bottoming of the market; it appears that the third quarter will have ended with a vacancy rate of 16.1 percent, leveling the upward trend of the previous 3 quarters — 14.1 percent in fourth quarter 2008 to 16.1 percent at mid-year 2009. Lower rental rates are helping companies adjust to challenging market conditions. Rental rates in general have attuned to market conditions, in some cases as much as a 30 percent decrease. Some landlords have lowered rates to the extent that they eliminate or substantially minimize other concessions.

Generally, tenants have opted for shorter-term leases to give themselves flexibility. However, tenants with a longer-term perspective are taking advantage of favorable lease rates for bigger savings. Free rent and moving allowances have become common in the market. These incentives enable tenants to offset the cost of moving.

Building sales have slowed dramatically, lowering asking prices, providing value opportunities for those with the adequate resources and a need to expand. In many cases companies are opting to lease rather than purchase in an effort to conserve cash as credit has become difficult to obtain. There is an ample supply of improved industrial land, creating opportunities for build-to-suits and those companies looking to the future.

Active investors are opportunistic and are scouring the market for distressed properties, although at present there are few sales as those properties haven’t yet come on the market.

— Eric Jones is a senior vice president, sales & leasing, in the Tempe office of Commercial Properties Inc./CORFAC International.

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