Phoenix Office Market Remains Healthy During Pandemic

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Sublease Availability Increased 32 Percent in Third Quarter as Tenants Re-evaluate Future

Phoenix, Arizona –  Sublease availability has become a noteworthy element of the office market, increasing approximately 133 percent year-over-year since last September.  As a result, Colliers has adjusted its research tracking policies.  Sublease space is now listed in availability but will not be factored into direct vacancy or net absorption figures.  As long as the original tenants are adhering to lease obligations and paying rent on space, their vacating of square footage will not impact absorption or market vacancy in Colliers reports.  However, if a tenant defaults on a lease and the space is handed back to the landlord, the square footage will then be counted as negative net absorption and an influence on vacancy.

The Greater Phoenix office market remained relatively healthy during third quarter, despite impact of the COVID-19 pandemic.  As companies are evaluating the return of employees to the workplace, Phoenix continues attracting companies looking to expand or relocate.  They are choosing Greater Phoenix because of its low cost of living business-friendly culture and a growing, talented workforce.  While the city experienced a significant uptick in sublease availability, landlord-controlled space posted 109,718 square feet of positive net absorption during the past three months.  Class A Sublease space now comprises approximately 1.12 percent of the total office inventory.

The past three months marked the 34th consecutive quarter of positive net absorption in the Greater Phoenix office market.  For the second consecutive quarter, Tempe and Chandler earned the highest levels of net absorption.  The 777 Tower at Novus in Tempe was completed this past quarter and delivered with just 17 percent vacancy due to its large tenants Arizona State University and Infosys.  Brokers pushed through the quarter with in-person tours, which helped increase leasing activity by 47 percent compared to second quarter.  We still have a decrease in lease activity of 53 percent year-over-year. Net absorption will fall behind the average 3.3 million square feet the city has averaged during the past five years.  But 2021 is expected to bring a resurgence of absorption activity.

Direct vacancy of landlord-controlled space settled at 12.7 percent at the end of September, which is a 20-basis-point increase over the third quarter.  This marks a 10-basis-point decline year-over-year. Office vacancy has been trending below 15 percent since mid-2017, which is a big improvement over a decade ago when vacancy was approximately 20 percent.  Southwest Phoenix has the lowest vacancy rate in the metro area at just 5.2 percent.  This is attributed to the area’s abundance of government occupied and owned properties.  Chandler posted the biggest decrease in vacancy year-over-year, declining 6.1 percent to just 11.3 percent vacancy at the end of September.  Large tenants such as Voya Financial, Toyota and Aetna have leased spaces in new buildings that were completed in 2019 and 2020.

Tempe has delivered the largest amount of new space in 2020 with 870,333 square feet completed.  However, when focusing on Class A buildings built before 2020 in Tempe, direct vacancy in these buildings is at 2.8 percent compared to current Class A direct vacancy at 5.8 percent. This indicates that new construction is still in the lease-up phase and relatively quick occupancy is expected.

Sublease space increased significantly within Class A buildings, rising 41 percent over the quarter and 150 percent over-the-year.  Approximately 1.12 percent of the entire office market inventory is now available for sublease.  Fortunately, much of this space is high-end, well-built space in newer buildings that offers very appealing options to tenants needing immediate move-in.

Deliveries of new projects during third quarter increased inventory by 448,785 square feet. Thus far, 1,859,700 new square feet have been added to the market during 2020.  The pipeline remains strong with more than 3.3 million square feet of office space under construction, 44 percent of which is pre-leased. During third quarter ground was broken on two spec buildings along the Price Road Corridor in Chandler.  The Scottsdale Airpark submarket leads construction in the valley with 785,000 square feet underway, 77 percent of which is leased by Nationwide Insurance and Choice Hotels. A pause is expected in future construction of speculative projects as developers wait out the pandemic to diminish potential risk of investment.

Rental rates held at competitive levels during third quarter. Asking rents in Class A building increased 0.50 percent over-the-quarter and 5.1 percent year-over-year to $32.25 per square foot. Greater Phoenix has not experienced the discounting that has occurred in other markets around the country.  Companies in Phoenix did not jump to terminate leases at the first sign of distress and this city is viewed as a Top Five market for net migration from California.  As a result, our office market and its rental rates have been buoyed by momentum.  Rental rates are expected to remain fairly competitive, but until economic stability is reached, sublease space will be offered at a discount compared to market rents.

Investment sales increased by 24 percent during third quarter in terms of transaction number, but sales volume decreased by 40 percent.  This was the lowest quarter of sales volume in the past five years with just $155,153,536 in sales posted.  Only one building larger than 100,000 square feet was sold during third quarter, which brought the average building size sold down to 29,081 square feet.  Investment sales were evenly scattered across the entire metro area during third quarter.

The forecast for the Greater Phoenix office market is very optimistic.  Healthy pre-leasing of new construction and stable rental rates are good indicators in this difficult time.  Businesses continue to relocate to Phoenix and existing tenants are bullish on this market.  Evaluation of new office options will surely change as a result of the pandemic.  New health certifications will be a key part of analysis, including touchless technology in high traffic office complexes.

See full report here: Arizona Office Report 3Q 2020

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