Seventh straight year of declining vacancy
Phoenix, January 18, 2018 – The Greater Phoenix office market experienced an uptick in the fourth quarter of 2017 to finish the year. The city experienced its seventh consecutive year of declining office vacancy.
The city’s office market posted a slowdown in third quarter, but net absorption gained momentum and vacancy fell by 20 basis points during the fourth quarter to 16.1 percent. This marks a 10-basis-point decline from year-end 2016. Vacancy rates remain elevated in select submarkets, but the overall trend is positive. Vacancy is anticipated to drop by 50 basis points during 2018, falling to 15.6 percent in the next 12 months.
Net absorption totaled 1.7 million square feet in 2017, which is well below the three-million square feet average experienced annually from 2014-2016. Absorption totals lagged, but nonetheless produced enough tenant activity to drive vacancy lower for the year. The decline in net absorption can be attributed to a slowdown in build-to-suit deliveries and a few prominent tenants moving out of large spaces. Net absorption is expected to gain momentum during 2018 and produce a total of approximately 2.5 million square feet this year.
The average asking rental rate for office space rose 3.3 percent in 2017, closing out the year at $24.40 per square foot. Rental rate growth has decelerated, following the 2015 and 2016 increases of more than 5 percent per year. Rents have increased across all classes in the market with the largest spike in Class C product. Rental rates have increased in each of the last five years and are anticipated to continue that trend in 2018.
Construction of new office space rose slightly during fourth quarter. During the second half of 2017, less than 360,000 square feet of new office space was delivered. This was the lowest six-month delivery total since late-2013/early-2014. During 2017 approximately 2.1 million square feet were added to the inventory, down from more than 2.3 million square feet in 2016. Construction levels have risen and projects totaling nearly 1.7 million square feet were underway at year-end. This marks an increase of approximately 5 percent from a year ago.
Sales transactions in the office sector ticked up during fourth quarter, rising by more than 10 percent from the previous three-month period. Dollar volume surged during the final months of the year, fueled by the sale/leaseback of the Marina Heights project in Tempe. The median price for properties that sold in 2017 was $138 per square foot, a 6 percent increase from the median price in 2016. Cap rates dipped below 7 percent during fourth quarter and the average for all of 2017 was 7.5 percent. Cap rates for 2017 were approximately 30 basis points below the 2016 level.
Improvement is the word for the Greater Phoenix office market in 2018. Tenant demand will likely remain strong as businesses expand. Consumer confidence is elevated and corporate tax rates have been cut, which should support a robust business climate in the year ahead. The office market is shifting significantly from build-to-suit construction to spec development. Approximately 70 percent of the square footage currently underway is spec development. Investor confidence in the Phoenix market remains strong and the market is forecast to see larger projects selling for higher prices.
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