Declining Vacancy Spurs New Spec Construction in Phoenix Office Market

Despite a slow start in the first quarter, conditions in the Greater Phoenix office market strengthened in the second quarter of 2017.  Net absorption remains positive, rents are rising and the vacancy rate is declining.  Strong market conditions have spurred speculative construction of new office projects.  Colliers International in Greater Phoenix released its mid-year office market report, which can be read in its entirety by clicking

Here.

 

Vacancy in Greater Phoenix at the mid-year point sat at 16.2 percent, 30 basis points lower than the end of March.  A slight rise during first quarter defied the city’s long-term trend of steady vacancy decline.

 

Net absorption totaled more than 725,000 square feet in second quarter, mirroring trends from previous quarters.  Chandler posted a leading portion of the absorption with approximately 320,000 square feet of net absorption that resulted from Wells Fargo and Orbital ATK leasing large spaces.

 

Rental rates are still increasing, but at a slower pace than in previous periods.  Average asking rates reached $24.07 per square foot per year, an increase of 4.1 percent from mid-year 2016.  Rents have increased an average of approximately four percent per year since 2013.  Class B property rental rates are growing at the fastest pace, increasing nearly five percent in the past year.  This is compared to Class A properties that have posted rental rate increases of only 2.4 percent during the past year.  South Scottsdale posted the strongest rental rate growth during second quarter, despite vacancy increases in the area.  Landlords in the area are commanding these rates because of the popularity of its amenity-rich environment.

 

Sales of office buildings in the second quarter slowed approximately 15 percent from first quarter.  Fewer properties have changed hands in the first six months of 2017 than in the same time frame last year.  Median prices rose to $137 per square foot and cap rates compressed slightly to the low seven-percent range.  While the average price per square foot has declined from last year, the market is seeing the sale of larger transaction sizes.

 

Strong market conditions have led to more speculative construction, but building activity is expected to slow in 2017 compared to 2016.  Deliveries in second quarter totaled only 315,000 square feet, compared to 1.2 million in first quarter.  Important to note is that deliveries in second quarter were 90 percent speculative, as opposed to build-to-suit.  Approximately 990,000 square feet of office space is currently under construction.  Several projects are slated to be started in Chandler and Tempe also has strong development activity.

 

The Greater Phoenix office market had a solid performance first half and the outlook remains optimistic for the remainder of 2017.  Employers are expected to continue adding jobs, which will fuel positive net absorption.  Colliers International predicts the vacancy rate will drop down to approximately 15.3 percent by year-end, boasting the lowest rate since 2008.  Landlords will continue efforts to raise rates.  Despite this bright picture, there are indicators to suggest that choppy conditions may be ahead for the office market.  Job growth is expected, but much of the anticipated expansion will be in non-office sectors like construction and hospitality.  Construction of office space will shift from predominantly build-to-suit towards speculative construction, potentially leading to a rise in vacancy.

 

The investment market should remain healthy during 2017, but the market will keep a keen eye on rising interest rates to impact sales.  Investor demand should remain strong for Greater Phoenix because of its solid market fundamentals.

 

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