The mid-year forecasts from Hank Amos and his team at Tucson Realty & Trust are out. Uncertainty over the future of Davis Monthan and job creation in Southern Arizona were repeated themes affecting Tucson Commercial Real Estate across all segments of the market going into the second half of 2014.
INVESTMENT OVERVIEW
Terry Lavery, CCIM, CPM, GRI, Investment Specialist at TRT, delivered the Investment Overview and had this to say,“The Tucson Real Estate Investment market is in a quandary. Huge out-of-state investors have purchased over $100 MILLION DOLLARS of Tucson’s finest retail properties so far this year as these investors are looking across the country for premium properties to invest in. Our Central Business District is continuing its six year renaissance with a potential new convention center hotel and further downtown development. Oro Valley is exploding along Oracle Road with new development all the way to the Dove Mountain Resort. Marana has two discount malls competing for space along a recently improved I-10. National private REITs have raised over $19.6 billion dollars for more purchases nationwide. The stock market is trading near 2007 highs. Wall Street has great merger and acquisition activity. Life seems so much better than our recent five years.”
“As to local business velocity, we are not at 2005 levels for residential or commercial in Tucson. Compared to other markets of similar size to Tucson, we have one-third the economic purchasing power as compared to our city’s piers. When we compare office and industrial markets, we in Tucson follow distribution centers (New York, Chicago, Inland Empire, and Dallas) and primary markets (Houston, Phoenix, Denver and Atlanta). For those fore mentioned cities, they have functional governments that create a growth opportunity, in which Tucson receives a trickle-down effect. Arizona state income tax on corporations does not help major employment relocations and the ACA has little money to give. Buyers and investors seek stable and improving markets to invest. We have many choices of old mom and pop buildings which are not institutional grade quality and lack the 40-foot clear heights demanded by, say a logistic company. We have to build-to-suit to entice new business to Tucson with current demanded properties….not Tucson’s currently available old, functional obsolete buildings with low rent projections and high property taxes. Tucson CAP rates are currently between 4 percent and 12 percent based on location, size, quality, income, and property type. The best investments currently are mostly multi-family under 50 units. Premium properties, such as El Con, are selling at a premium.”
“However, it is difficult to get excited to invest in Office, Industrial, or Land given Tucson’s current economic condition and lack of business vitality or velocity. Apartments (greater than 100 units) are not that attractive given the low cap rates and the threat of Davis Monthan closing. This real danger is casting a dark shadow over all investment classes,” Lavery concluded.
TUCSON OFFICE MARKET OVERVIEW
Tari Auletta, CCIM, Office and Medical Properties Specialist at TRT, had this to say, “The Office Market vacancy rate was 18 percent at the start of the year and here we are six months later and the vacancy rate is still 18 percent, just as Tucson Realty & Trust Co. predicted,” at the start of the year.
“We are not seeing new office users moving into the Tucson market and many office users are actually reducing the size of their space. Tenants continue to shop for better deals in the market, only to use them as negotiating terms against their current landlord when their lease renews. Any movement at all is really from existing tenants in the marketplace.”
“The sole bright spot has been office medical activity. While the office market remains soft with little activity taking place, medical continues to shine.
- Doctors breaking away from the current practice where they work and starting their own practice.
- Office buildings converted into medical.
- Urgent Care & Surgery Centers continue to pop-up all over town. Former bank branch buildings, video stores and convenience markets have been converted into Urgent Care Centers in many locations.
- Leasing space in Shopping Centers for more foot traffic and an abundance of parking.
The Current Tucson Office Market:
Rents being offered in some buildings are at the same rates we saw in the 80’s. The lack of activity has forced landlords to reduce rates as an incentive to attract potential new tenants to their buildings or to simply keep their existing tenants.
Class “A” building rents $18.50 - $20.50
Class “B” building rents $16.50 - $19.00
Class “C” building rents $12.00 – $15.00
“Remember, these are only quoted rates and landlords have learned that if they get one chance with a strong tenant considering their space, they need to make the deal because they don’t know how long it will be before another tenant comes along,” concluded Auletta.
INDUSTRIAL OVERVIEW
Chuck Blacher, Industrial Specialist at TRT, reported on the state of Tucson’s Industrial real estate. “Tucson’s industrial market is greatly influenced by the residential homebuilding market. Thus, warehouses and contractor yards normally occupied by the building trades will struggle to find tenants until home building locally improves – a challenge, to say the least,” Blacher reported.
“Manufacturing jobs have been outsourced to Asia and wherever labor rates are lowest. Trade jobs such as roofers, electricians and framers, used in home building are the middle-class jobs we need, but until the housing market improves, job growth will be limited. The national yearly middle-class salary range is $32,000. Tucson is approximately $27,500, below the national averages of $30,000 to $50,000.”
“Net absorption for the total Tucson Industrial Market was a negative 45,000 square feet compared to positive absorption of 201,751 square feet in the fourth quarter of 2013. Strictly warehouse space fared a little better with positive absorption of 25,921 square feet compared to positive absorption of 160,841 square feet in the fourth quarter of 2013.”
“The industrial vacancy rate in Tucson is approximately 11.3 percent, up from 11.1 percent at the beginning of the year. Currently, there are 85 industrial zoned buildings for sale 5,000 square feet or larger. The largest at 300,000 square feet is the Lisa Frank building in the airport area.”
“The largest lease signings year-to-date were: 1) 52,346 square feet signed by Farnswork Wholesale at 6701 S. Midvale Park Road in the south market; 2) 27,919 square feet signed by Pacific Insulation at 3759 E. 43rd Street in the central market; and 3) 26,501 square feet signed by B/E Aerospace at 1671 S. Research Loop. The average rental rates available for industrial space are $6.28 per square foot. Warehouse rental rates are up slightly to $5.77 per square foot from $5.74 at the end of 2013. During the first half of this year, only one building was completed in the Tucson market area totaling 14,214 square feet.”
“No buildings were completed in the fourth quarter of 2013. Currently there are no buildings under construction,” Blacher reported.
RETAIL MARKET OVERVIEW
Pat Darcy, TRT Retail Division Head, said that as we reach the midyear point in 2014, “The Tucson Retail Market is steadily improving, similar in its performance to last year…two steps forward and one step back, a familiar phrase when describing Tucson’s Retail market.”
“The current retail vacancy rate is approximately 7.8 percent. Quoted retail lease asking rates are averaging $15.60 per square foot NNN. According to the Pima County Real Estate Research Council, there was approximately 240,000 square feet of positive net absorption for the first quarter. This includes the 99,000 square-foot Wal-Mart at Houghton Center, the 40,000 square foot Conn’s and the 20,000 square-foot Guitar Center at Marana Marketplace.”
“In my opinion, there are four reasons for the increased absorption of retail shop space: (1) the small amount of new retail construction the past few years; (2) the redevelopment of central area properties by retailers such as Wal-Mart Neighborhood Markets, Walgreens, CVS, Quick Trip and Circle K; (3) the leasing of most of our vacant big boxes to tenants such as Stein Mart, Hobby Lobby, Chuze Fitness, Floor & Décor at Broadway & Kolb, and Conn’s Home Plus; and (4) the emergence of Urgent Care facilities and dental chains entering the marketplace.” said Darcy.
“The redevelopment taking place in central Tucson has been a good thing. There is too much outdated retail space in Tucson’s central core and assemblages have taken many of these older, smaller retail spaces off the market and replaced them with newer product and stronger retail tenants.”
“After the recession, anchor tenants are still very cautious before moving forward on sites in the outlying areas of Tucson. Before the recession, in order to get the best corners in suburban growth areas, supermarket developers would agree to deals by looking at home builders’ new home projections. When the homebuilding suddenly stopped, they were stuck. Now anchor tenants want to see actual rooftops before making a decision.”
“In the past five years, over 160 businesses have opened (or plan to open) in the downtown area. They include over 60 restaurants, 53 retail stores, 2 markets and 18 nightclub destinations, with almost all of them locally or statewide owned. The two markets, Johnny Gibson’s Downtown Market and Proper Meatery will be interesting to follow. Hi-Fi Kitchen & Cocktails has already made a huge impact to the area attracting hundreds Thursday through Sunday. An 8-story hotel called AC by Marriott with 147 rooms with first-floor retail and a parking structure is expected to break ground in January and open in the Spring of 2016.”
In January, Darcy had predicted the sale of the El Con Center. It sold in May for $81.7 million dollars. “It was a good deal for both sides. El Con is way over parked so I look for some type of mixed-use development to be built on the north side of the property,” Darcy added.
“Mid-year predictions from Darcy include: “More nontraditional shopping center tenants such as health clubs, charter schools, pawn shops, thrift stores, churches and medical & dental care facilities to lease space in retail centers. High-visibility retail pads and end-cap shop space will command retail rates in the $30.00 per square-foot range in and near high profile shopping centers.”
“The Retail market in Tucson is slowly improving and large and medium retail spaces are becoming fewer and fewer. The Retail market has started toturn and good things will be in store in 2015,” Darcy concluded.
LAND OVERVIEW
Bob Solfisburg, TRT Land Specialist reported, “Local homebuilders remain cautious starting the second half of 2014. Single-family permits are lower than forecast and tighter credit remains problematic. The Dodd-Frank Act represents the most stringent underwriting laws in decades. Combine tighter credit with an increase in median home values, higher lending rates from year ago, very slow job growth and a housing recovery becomes flat. There are provisions of Dodd-Frank under fire, especially the mandatory 20 percent equity down payment.”
“The Northwest submarkets, including Marana and Oro Valley, continue to represent nearly two thirds of all single-family permit and sales activity. However, median home prices jumped over 20 percent in the central and northwest areas of the city limits. Expect housing permits within the city to rise in the second half as impact fees are temporarily waived until the start of 2015. The median sales price of new construction has moved higher at $254,000 with a strong showing in the retirement market. This past year, Del Webb and Toll brothers opened in Dove Mountain and gained traction as newcomers.”
“The key word in single-family housing is MOBILITY. This best describes homeowners successfully selling their primary home to purchase another…typically, families seeking larger space or baby boomers downsizing as empty nesters. MOBILITY has recently improved over the past year as California/Midwest economies improve, but the second home/retirement market has been the most consistent performer in our housing recovery.”
“A strong housing market is fueled by job growth and lending. Clearly, job growth is the driver. Mobility begins to improve outside the retirement market when new jobs are created and local payrolls are higher. Tucson job growth has been operating below the state and national average reporting under 2.2 percent growth. In addition, manufacturing and construction jobs have not returned to post recession levels. Population and job growth has been realized, but primarily in the service sector areas. If this trend continues, Tucson single-family permits will remain in the 1,600 to 2,000 range per year.”
“In Tucson, single-family inventories under $300,000 are reported near 4-1/2 month supply. It is reasonable to assume that a local job boom would likely push home prices higher given tight inventories plus low rates. In Phoenix, this is exactly what happened as home prices stabilized much quicker as institutional and private investors purchased distressed residential properties which helped stabilize the overall market. Once stability is attained, increase in home prices becomes a direct result of job growth and higher payrolls.”
“Over the previous 2013/2014 period, the apartment rental market has been quite active, opening over 740 new units in the Oro Valley submarket. In addition, Miramonte Homes and Aerie Development are opening single-family rental developments anticipating sales conversion. Rental rates for new construction need to be greater than $1.00 per square foot with a target absorption rate at 15 units/month. Tucson has an aging apartment base so in most cases newer construction offers better design and amenities. HSL has been the most active player and recently purchased 12 acres located along I-10 in Continental Ranch at $2.75 per square foot, or approximately $12,000/unit. Competition for tenants is forecast to increase over next 6 months so a stress test remains forthcoming,” Solfisburg concluded.